Liquidation

Liquidations are a key part of leveraged trading. When you open a leveraged position, you are using collateral to borrow money from the protocol to purchase an asset.

For example, if you open a 5x leveraged position using 100 USDC, your notional is worth 500 USDC and 400 USDC of that position's value is borrowed.

If the value of your position falls, your losses begin to approach the value of your margin (i.e. your initial collateral). This puts the protocol at risk — a sudden price movement could make your position worth less than your collateral. Traders and liquidity providers may get liquidated if an account's margin requirements fall below the minimum requirements enforced by the protocol, this requirement is also called the maintenance margin. If the value of your position is dangerously close to the value of your collateral, the protocol will allow others to liquidate your position in order to secure against losses. Positions are automatically closed by liquidators, while receiving a percentage fee of the notional value of the liquidated position.

Look at the example in margin to see how the free collateral is used to determine the margin requirements.

Collateral seizing

As a general principle, Increment accounts profits and losses in UA. In the context of liquidation, liquidated users automatically incur a loss in their UA balances. If their UA balances are not sufficient to absorb this loss and their UA balance drops below 0, they might have their non-UA collaterals seized by liquidators. More precisely, liquidators can buy the non-UA collaterals (e.g. WETH, USDC, etc) of a liquidatee (liquidated user) at a discount on the USD price of said collaterals. This mechanism allows the protocol to maintain its solvency by not leaving too much UA debt outstanding.

In order for a liquidator to be able to seize the non-UA collateral assets of a liquidated user, the following conditions must be met:

  • the liquidatee must have no opened positions (no trading or LP positions on any market)

  • the liquidatee must have a UA debt, i.e. a UA balance < 0

  • then, one of the 2 conditions:

    • either, the liquidatee's UA debt must be larger than uaDebtSeizureThreshold. This value can be updated by the governance, but at the moment of writing it's set as 10,000 USD

    • or, the aggregate value of the liquidatee's non-UA collaterals discounted by their weights and the nonUACollSeizureDiscount ratio must be smaller than their UA debt (example below)

To illustrate this last condition, let's imagine a liquidatee with a UA debt of $5000. If the user has $2000 worth of WETH and $2000 worth of USDC as collaterals, assuming a weight of 0.8 is given to WETH, a weight of 1 is given to USDC and that nonUACollSeizureDiscount is 0.75, then (2000*0.8+2000*1)*0.75 = 2700. 2700 < 5000 so the non-UA collaterals can be seized.

If the USD value of the non-UA collaterals of a liquidatee isn't large enough to cover the liquidatee's UA debt, Increment's insurance steps in and settles the debt to maintain the solvency of the protocol.

The specific flow on how Liquidations take place is described in the guides section.

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