Liquidations
Unstoppable's approach to liquidations differs significantly from traditional perpetual platforms, where liquidity providers essentially bet against traders and with liquidations settled at a fixed price against internal liquidity pools. This model misaligns liquidity providers and traders and incentivises platforms to shape environments where traders lose more than they win.
In contrast, Unstoppable handles liquidations more akin to over-collateralized lending platforms such as AAVE. Here, liquidations occur on the open market. This method can create price impacts in volatile markets, necessitating a higher liquidation price as a buffer to ensure liquidity providers recover their funds.
However, this system typically does not require the complete liquidation of a trader's collateral but only enough to bring the leverage ratio back within acceptable limits, often preserving a portion of the trader’s collateral.
How Liquidations Work
A trader's position is subject to liquidation if their leverage ratio exceeds the protocol's maximum allowed limit. When this limit is breached, the liquidation process is automatically triggered.
The liquidation engine will then take over and sell the whole position in the open market.
Example: A trader begins with a $1,000 USDC deposit, aiming to long ETH with 10x leverage, creating a total position value of $10,000.
Order execution:
The trader borrows $10,000 USDC from liquidity providers, with the initial $1,000 USDC held as collateral by the Margin Engine.
Scenario:
Market Dips: ETH's price falls by 6%.
Impact: The value of the position drops by $600.
Result: The leverage ratio rises to 25x, considering the $400 remaining collateral (initial $1,000 - $600 loss) against the $10,000 borrowed amount.
Liquidation:
The high leverage ratio exceeds the effective liquidation leverage of 20x, triggering a full liquidation.
The entire ETH position is sold off at the market price.
Aftermath:
The sale proceeds and collateral security are used to repay the borrowed funds.
A liquidation fee of 1% of the total order size is distributed to the protocol's stakers.
In severe market dips, the trader risks losing all their collateral.
Any leftover funds, if available, are returned to the trader after the liquidation.
This example illustrates the risks in high-leverage trading and the importance of understanding liquidation mechanisms.
Leverage Ratio
We're using Chainlink's trusted price oracles in order to calculate the current Leverage Ratio utilizing following process:
Determine Position Debt: Evaluate the total borrowed funds used for the trade.
Current Position Value: Assess the current market value of the position.
Profit and Loss (PNL) Calculation: Determine the trade's PNL by subtracting the Position Debt from the Current Position Value.
Net Asset Value (NAV): Calculate NAV, which includes the deposited collateral and any unrealized gains or losses.
Leverage Ratio Formula: The leverage ratio is derived by dividing the Position Debt by the NAV.
Example: A trader has a total debt of $10,000 whose NAV is $2,000; their leverage ratio would be 5x ($10,000 / $2,000).
This ratio helps assess the level of risk and exposure in a leveraged trade, with higher ratios indicating greater leverage and potential risk.
Effective Liquidation Leverage
The calculation of the liquidation price utilizes the Leverage Ratio to determine the Effective Liquidation Leverage. As a position becomes unfavourable for the trader, their leverage ratio increases. Once this ratio reaches the Effective Liquidation Leverage specific to the market where the trade was executed, liquidation occurs.
Effective Liquidation Leverage may vary by margin market:
Note: Effective Liquidation Leverages are subject to change based on market conditions.
Liquidation Fee
A 1% fee is applied to the total order size during a liquidation event on the Unstoppable Margin DEX. This fee distribution varies depending on who executes the liquidation:
Protocol Stakers: If the position is closed by our in-house liquidation engine, the fee is allocated to protocol stakers as a reward.
Third-Party Liquidators: In cases where external liquidation engine providers successfully close the position, they receive this fee as a bounty.
This fee structure incentivizes both internal and external parties to ensure efficient liquidation processes, contributing to the overall stability of the platform.
Redundancy Layers in Liquidation Protection
Unstoppable employs multiple redundancy layers to safeguard against scenarios where a trader's position loses more than their deposited collateral, ensuring the safety of LPs' deposits.
Unstoppable Liquidation Engine: This primary defence mechanism is an off-chain engine that constantly monitors all trading positions in real-time. It automatically liquidates positions if their leverage exceeds the market's maximum allowed limit. We run several of these engines simultaneously to ensure safe and quick execution.
External Liquidation Engine: If the primary system fails to liquidate a position in time, this secondary layer enables third parties to step in and liquidate the position, earning a profit in the process.
Safety Module: This final layer acts as a contingency in the rare case that the internal and external liquidation engines fail to address a risky position in time.
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