Soft Liquidations
Unstoppable's approach to liquidations differs significantly from common derivative leverage platforms, where liquidity providers essentially bet against traders as liquidations are settled at a fixed price against internal liquidity pools. This model misaligns incentives between liquidity providers and traders and can lead to environments where traders are more likely to lose than win.
In contrast, Unstoppable handles liquidations more akin to over-collateralized lending platforms such as AAVE. Liquidations occur on the open market, which can create price impacts in volatile markets, necessitating a comperable higher liquidation price as a buffer to ensure liquidity providers recover their funds.
However, Unstoppable's system does not always require the complete liquidation (hard liquidation) of a trader's collateral. Instead, it employs a soft liquidation mechanism that incrementally liquidates a position until the leverage ratio is brought back within acceptable limits, often preserving a portion of the trader's collateral.
How Soft 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, and the liquidation engine takes over to sell the position in the open market.
The soft liquidation process follows these steps:
Monitoring Leverage Ratio: The Margin Engine continuously monitors the leverage ratio of each open position in real-time.
Liquidation Trigger: If a position's leverage ratio crosses a predefined threshold, the soft liquidation process is triggered.
Partial Liquidation: Instead of immediately liquidating the entire position, the Liquidation Engine will initially attempt to sell only a portion of the position. The goal is to bring the leverage ratio back within the acceptable range while preserving as much of the trader's position as possible.
Gradual Liquidation: If the partial liquidation does not sufficiently reduce the leverage ratio, the Margin Liquidation Engine will continue to sell portions of the position incrementally until the leverage ratio is restored to a safe level.
Full Liquidation: If a gradual liquidation is not enough to bring the position back into a healthy leverage ratio, a full liquidation may be necessary. However, even in a full liquidation scenario, traders on the Unstoppable Margin DEX may still recover a portion of their collateral, depending on the final liquidation execution price.
Position Recalculation: After the liquidation process concludes, the trader's position is recalculated, taking into account any remaining collateral and applicable liquidation fees.
Collateral Return: Any excess collateral remaining after the liquidation process is completed will be returned to the trader's Margin Engine account.
Let's consider a scenario where 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%, causing the value of the position to drop by $600.
Leverage Ratio Increase: The leverage ratio rises to 25x, considering the $400 remaining collateral (initial $1,000 - $600 loss) against the $10,000 borrowed amount.
Liqudidation:
Soft Liquidation Triggered: The high leverage ratio exceeds the effective liquidation leverage of 20x, triggering a soft liquidation.
Incremental Liquidation: The liquidation engine will incrementally sell off portions of the ETH position at the market price until the leverage ratio is brought back within the acceptable range.
Aftermath:
Position Preservation: If the market price stabilizes or recovers before the entire position is liquidated, the trader may be left with a portion of their position intact.
Liquidation Fees: A liquidation fee of 1% of the liquidated amount is charged and distributed to the protocol's stakers or third-party liquidators.
Collateral Return: Any remaining collateral after the liquidation and fee deduction is returned to the trader.
his example illustrates the potential risks in leverage trading and the importance of understanding liquidation mechanisms. Traders should be aware that in severe market dips and with high leverage, they risk losing a significant portion or all of their collateral.
Leverage Ratio
Unstoppable uses Chainlink's trusted price oracles to calculate the current Leverage Ratio using the following process:
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 unfavorable 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:
| Margin Market | Effective Liquidation Leverage |
|---|---|
USDC / wBTC | 20x |
USDC / wETH | 20x |
wETH / wBTC | 10x |
Note: Effective Liquidation Leverages are subject to change based on market conditions.
Liquidation Fee
A 1% fee is applied to the liquidated amount 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 Unstoppable's 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 lenders' funds.
Unstoppable Liquidation Engine: This primary defense 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. Unstoppable runs several of these engines simultaneously to ensure safe and quick execution.
External Liquidation Engines: 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. The Safety Module absorbs any potential losses, protecting lenders from adverse impacts.
By employing a soft liquidation mechanism and multiple layers of protection, Unstoppable ensures a fair and secure trading environment for both traders and lenders. This approach minimizes the risk of sudden, total liquidations while providing ample opportunities for position recovery and collateral preservation.
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