The need for better liquidation incentives
As of today there have been 2 loans totalling 66,7 ETH that exceeded their borrow limits and have not been liquidated yet. The loans are still over collateralized, however the issue lies in how the protocol handles liquidations when only a single NFT is supplied as collateral.
How current liquidations work?
In order for NFT to be liquidated, the liquidator needs to repay borrower’s debt. However, the single token debt needs to be equal to the NFT valuation after the discount.
For example, if NFT is worth 100 ETH and discount is 10%, debt needs to reach 90 ETH (90% of NFT value), even when the borrowing limit is set at 60% — 60 ETH.
In case when 2 or more NFTs are supplied, the liquidation threshold is equal to LTV (Loan to Value) parameter which ranges between 30–60%. Multiple NFTs can be liquidated without issues, since debt of 2 NFTs is usually exceeding the value of 1 discounted NFT.
More information on current liquidation mechanisms can be found here.
Issues with current implementation.
Many protocol users are using single NFT as collateral which creates a liquidation threshold at 90–80% of the floor. Although they can’t borrow more, when collateral falls in value, the debt amount can keep exceeding the borrowing limit.
Solution: liquidation contract upgrade
With a new proposed upgrade it will no longer be required for the debt to reach 90% to liquidate NFT.
Liquidators would still have to pay the discounted NFT value, however the remaining change will be split between borrower and protocol reserves.
Example
NFT is worth 100 ETH, discount is 10%, debt is 70 ETH, borrow limit is 60 ETH.
Liquidator pays 90 ETH, 70 ETH goes to repay the debt, 20 ETH change is left.
10% — 2 ETH of the 20 ETH change is sent to protocol reserves, remaining 18 ETH is sent to the borrower’s wallet.
Proposed liquidation fee is 10%. Note that this fee is NOT applied to the amount paid by the liquidator, but only to the change that remains after debt repayment.
It will allow more robust liquidations and will give the right incentives to mitigate risky loans positions from happening.
Upgrade implementation
The code for the upgrade has already been successfully tested.
A new liquidation proxy contract will be connected with a comptroller and will allow more flexible liquidation upgrades in the future.
Upgrade will be deployed after a positive snapshot vote.
Snapshot vote
Following the snapshot vote liquidation contract will be upgraded on 7th of September.
Voting starts Sep 5th 12pm UTC, ends Sep 7th 12pm .
https://snapshot.org/#/dropsdao.eth/proposal/0xb96dc69a7ae35127e6d107a9cff95be31423708e4e43f010776e558c9d8022bc
