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
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
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.
To ensure that at-risk collateral is sold as soon as is required, ARCx Credit has also deployed its own liquidation engine (instead of solely relying on third party liquidation bots).
By managing our own liquidations, all revenue generated from the liquidation is kept by the protocol and can be fed back into the supply pool to recover losses due to toxic debt. Reliance on external liquidators has the benefit of security in times of significant volatility, however it also syphons revenue from the protocol to pay the liquidators. This loss of revenue actually aggravates the potential for toxic debt and the higher the liquidation discount, the lower the LTV threshold is for toxic debt to be left in the system.
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).