Liquidations

In Soul Protocol, liquidations occur when a user's borrow balance becomes too high relative to their collateral value, putting their account at risk. When this happens, any other user (a liquidator) can repay part of the borrower's debt in exchange for seizing a portion of their collateral. Liquidation should be avoided, as it results in the loss of collateral and incurs additional penalties. Maintaining a healthy account balance is crucial to staying safe. On the other hand, liquidators receive incentives for performing this action, helping to maintain the protocol's overall stability.

Why does liquidation happen?

Liquidation helps maintain the protocol's security and ensures it can meet its obligations to all users. If a borrower's debt becomes too risky relative to their collateral, the protocol allows other users to liquidate a portion of the borrower's collateral to repay the debt, preventing further losses and preserving system stability.

How to avoid liquidation:

• Monitor your Health Factor: Regularly check your health factor; it should always be above 1. A health factor of 1.5 or higher is generally safer.

• Repay Borrowed Amounts: Reduce your borrow balance to lower your risk and improve your health factor.

• Add More Collateral: Increasing your collateral boosts your borrowing power and reduces the risk of liquidation.

• Stay Informed About Market Conditions: Collateral value can fluctuate due to price volatility, so it's important to keep an eye on market movements.

Example of Liquidation:

Suppose you've borrowed 400 USDC against ETH worth 1,000 USD as collateral, with a 75% collateral factor and an 80% liquidation threshold. This gives you a borrow limit of 750 USD and a liquidation limit of 800 USD.

If the ETH price drops and your collateral's market value falls to 520 USD, your borrow limit and liquidation limit adjust to 390 USD and 416 USD, respectively. Since your borrow balance (400 USDC) is higher than your new borrow limit, you cannot take additional loans or remove collateral. However, because your borrow balance remains below the liquidation limit, your position is not yet at risk of liquidation.

If your collateral value declines further to 500 USD, your liquidation limit drops to 400 USDC, bringing your health factor to 1. At this point, any further decrease in collateral value will trigger liquidation.

Key takeaways:

• Liquidation occurs to protect the protocol and prevent users from accumulating bad debt (a situation where a user's total borrow balance exceeds their total collateral balance).

• Regularly manage your collateral and borrow balances to maintain a safe health factor.

• Proactively repaying or adding collateral can prevent liquidation, especially during market volatility.

By understanding how liquidations work and taking preventive actions, you can avoid losing collateral and maintain a stable position in the protocol.