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Liquidations

Introduction

A liquidation is a process whereby the collateral deposited in a vault is sold when the Borrow Usage on that vault exceeds 100%. This will happen when the collateral decreases in value or the borrowed debt increases in value against each other. During a liquidation event, the Borrower’s collateral is sold at a discount to a liquidator in return for repaying a Borrower’s debt

Liquidation process

During a liquidation event, the Borrower’s collateral is sold at a discount to a liquidator in return for repaying a Borrower’s debt. Half of the income generated by the liquidator is collected by ARCx, and the other half is retained by the liquidator.
For example, if the Borrower had $100 of debt and $120 of collateral. Then if the position were liquidated with a 10% discount, the liquidator would repay the $100 of debt, and receive
$100/(1−0.1)=$111.11\$100/(1-0.1)=\$111.11
worth of collateral in return. The liquidator then returns $11.11 of profit from the event. From this profit, ~$5.56 is collected by ARCx, and ~$5.56 is retained by the liquidator. For the Borrower, they will correspondingly loose $11.11 of their collateral, and the remaining $8.89 is left in the vault.
This mechanism safeguards ARCx Credit from accruing toxic debt.

ARCx liquidation engine

ARCx Credit has implemented its own liquidation engine to safeguard against the risk of unprofitable liquidations (i.e. toxic debt). By doing so, ARCx Credit is able to maximize the capital efficiency it offers to Borrowers (e.g. up to 100% LTV on WETH) without requiring large discounts to incentivize liquidators, which cuts into profitability.
The contract for our liquidation engine can be found here.
It is recognized that external liquidators may front-run the ARCx liquidation engine. This consideration is factored into our profit modeling.
For more information, see Profit model.

Net profit or loss from liquidations

When a liquidation occurs, the liquidator effectively repays the Borrower’s debt. When that happens, part of the debt is also interest. At that moment, part of the interest goes to ARCx and part goes to the suppliers, just like in a normal repay event.
If there is toxic debt in the system, the amount is deducted from the supply pool by effectively reducing the value of the token (supply pool token arcxLP).