Protocol solvency protection
This documentation is a work in progress!
Liquidation is the act of a liquidator repaying debt on behalf of the creator of a CDP whose collateral ratio (CR) is below the liquidation threshold (LT) in order to bring it above the minimum collateral ratio (MCR). The repaid Kresko Assets are burned and removed from the CDP's debt.
The protocol maintains solvency by ensuring that all CDPs are overcollateralized. CDPs with collateral ratio below the Liquidation Threshold are considered underwater and are subject to liquidations. When a CDP is underwater, the protocol incentivizes liquidators to liquidate a portion of the CDP to bring it back to safer levels.
Liquidation incentives are provided from the CDP being liquidated and in one of the collateral assets which the liquidator picks.
Liquidation Threshold (LT) is a protocol parameter which holds the value for absolute minimum Collateralization Ratio. If the Collateralization Ratio of an account is lower than the Liquidation Threshold, it can be liquidated by the liquidation function in the protocol.
The liquidation threshold is always lower or equal to the MCR. These two values are separate to allow creation of a safety window before accounts are in danger of being liquidated.
While a CDP’s collateral and debt can be composed of several assets, liquidations operate exclusively on one debt asset and one collateral asset at a time.
If the CDP remains below the Liquidation Threshold after a liquidation call, the liquidator can continue to make additional liquidation calls until the CDP has a collateralization ratio equal or greater than the Liquidation Threshold.
Protocol Liquidation Incentive (LI) = 0.05 or 5%
Mint and Borrow
Alice now has $83.33 ($100 / 1.2) worth of krETH in her wallet.
Price of ETH jumps up by 10%.
Alice's krETH debt is now valued at $110 ($100 * 1.1).
Her CDPs collateralization ratio is now 1.363 ($150 / $110) or 136.3%.
Alice CDPs can now be liquidated until the collateralization ratio becomes equal or greater than 1.4 (LT).
The liquidator repaid the maximum ~$7.75 from the krETH debt in Alice's CDPs.
Collateral seized from Alice is ~$6.78 ($7.75 / kFactor * LI) worth of KISS.
Alice's CDP has KISS collateral valued $143.22 ($150 - $6.78).
Alice's CDP has krETH debt valued $102.25 ($110 - $7.75).
Alice's CDP has collateralization ratio of 1.40 ($143.22 / $102.25) or 140%.
Alice's krETH in wallet is now valued at $91.66 ($83.33 * 1.1).
Alice's krETH remaining debt requires $85.21 ($102.25 / 1.2) worth krETH to repay.
Alice now has no debt, $6.45 of krETH in wallet and $143.22 of KISS.
Alice's net worth is $149.67 - losing $0.33 to the liquidation.