How does the DeFi liquidator work?

How do DeFi liquidators work?

Source: Conflux Chinese community

DeFi is often more concerned with mortgage lending, decentralized exchanges, derivatives trading, currency stabilization, and so on, but less concerned with "clearing" -- an essential part of DeFi's ecological loop.

The liquidation is usually done by the liquidators, who are one of the key players in ensuring the smooth functioning of the DeFi loan agreement. They often work behind the scenes and are often referred to as the "miners" who are quietly making a lot of money, but they maintain the solvency of the entire DeFi market.

On March 12, the cryptocurrency market plummeted and DeFi experienced the largest ever chain clearing, with more than $23 million cleared from the DeFi project on ethereum on March 12 alone, an all-time high.

MakerDAO generated the most clearing, with a total of over $10 million, followed by Compound and dYdX.

Most DeFi users only know that the assets they mortgage on the DeFi protocol are liquidated, but they do not know how their assets are liquidated. By whom? What is the liquidation process?

In today's article we'll explore how the "liquidators" in DeFi's ecology actually work. How to become a profitable DeFi liquidator?

& have spent Why does DeFi need a liquidator?

Under the DeFi mortgage lending agreement, when the value of the collateral exceeds the value of the loan, the collateralized loan works well, allowing the borrower to obtain liquidity without having to sell its normally illiquid assets. When the value of the collateral falls, however, rational borrowers have an incentive to avoid repayment, potentially leaving lenders in the lurch.

So there is the liquidation of this link, the purpose of the design of the liquidation is to protect the depositors, do not let their borrowers default on their loans. This is done by taking the borrower's collateral at a discount and converting it into a loan.

In order to reduce risk, the current main lending agreement by excess of mortgage loan, usually require mortgage rates below 150%, such as: users in the Compound excess mortgage ETH lend a DAI loan, but very unfortunate, coincides with the ETH prices fell sharply during the loan, making the collateral value of the borrowers fell below to the requirements of the ETH collateral ratio of 133%.

If the collateral is not made up or sold, the liquidation process is triggered, and the borrower pays a settlement penalty (typically about 10% of the mortgage principal, compared with 13% for MakerDAO).

Liquidator can trigger the Compound at this time the liquidation procedures, can be at below-market prices 3% - 5% discount for the ETH collateral, as a result, the borrower to repay the loan of DeFi lending system, avoid DeFi lending platform debt and bad debts, to maintain the solvency of the system, at the same time, the liquidator has gained considerable income, the best of both worlds.

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& have spent How to become a liquidator?

Before we can figure out how a liquidator works, first we need to know how to be a liquidator. Right? What are the thresholds for becoming a liquidator?

There is no threshold to be a liquidator, but you need to have some code knowledge and market sensitivity, or you can't get orders. Liquidator itself and do not need any original capital input, do not need to complete the liquidation of the principal, finally take a discount of 5%, so the liquidation is a risk-free arbitrage, the liquidator does not need to rely on to predict currency movements to earn profits, and a liquidator used to complete the liquidation costs can also borrow from MakerDAO and Compound lending platforms, that is to say, early don't need too much cost.

Although it does not take much of the original capital to become a DeFi liquidator, a clearing instrument is necessary to become a liquidator. Although different protocols differ in mechanism and terminology, they basically require the same components:

1. Robot, to monitor the pending loans to be processed on ethereum;

2. A set of smart contracts that can automatically clear and sell collateral in a loan;

3. Decentralised exchanges that can be used to sell clearing collateral on the spot and guarantee the liquidators' profits.

Many platforms now use Dashborad, which provides bots and monitors, to help with clearing, though it is largely up to the liquidators to develop automated clearing tools themselves. Some DeFi lending agreements also help borrowers liquidate with their own off-the-rack tools, like MakerDAO, which has its own open source bot.

& have spent How does the liquidator work?

Different platforms have different ways of clearing for MakerDAO system, when the system is triggered massive liquidation, the system will also be a potential loss of debt, in order to avoid losses, MakerDAO chose by auction to holders of CDP clearing of the mortgaged property, the auction mechanism can be generated in the middle of the liquidator competition, avoid the liquidator of low discount for the collateral of the borrowers, this way of auction to a certain extent can guarantee the rights and interests of borrowers.

But in extreme markets, the auction system is crippled by high gas prices, leading to the "DAI 0" auction and bad debts throughout the system. MakerDAO had to announce an auction of MKR to pay off $4 million in debt.

Compared with MakerDAO, the Compound clearing mechanism is simpler and more direct. As long as the liquidator discovers that the mortgage rate of the borrower is too low by monitoring the contract, the liquidator will immediately start clearing once the clearing process is triggered, and the process is simple and rough.

Tom Schmidt, junior partner at Dragonfly Capital, a blockchain investment fund, has analyzed and interpreted the clearing mechanisms of several major DeFi lending platforms. Let's take MakerDAO as an example to see how liquidators work.

MakerDAO's liquidation process is divided into two parts: bite and bust.

This is similar to the auction logic of traditional financial markets: first the debt is collected, then the auction is conducted to repay the lender. In Maker's system, debt collection is triggered by requesting bite, and then liquidation is triggered by requesting bust on its set of smart contracts.

Let's look at a liquidation of "CDP17361" through two transactions, the first and second involving three participants: the consignee (0xc2e), we call Ralph; The borrower (0x9c3), we call Brittany, the liquidator (0x5a2), we call Larry.

Brittany used her 0.1 ETH collateral to borrow 8.5 DAI, which was well within the 150 percent mortgage rate required by MakerDAO at $170. (170 * 0.1/8.5 = 200% mortgage rate) unfortunately, on December 27, the ETH price fell to $125, which left CDP undermortgageable (125 * 0.1/8.5 = 147%), allowing Ralph to make a bite request for the CDP to reclaim ownership of CDP from SaiTub (which holds all active CDP contracts) CDP to SaiTap (which contracts execute the liquidation of the CDP collection).

At this point, the system is still undermortgaged. In the Maker system, there are more DAI outstanding than ETH to support the value of the desired ratio of DAI. Luckily, the liquidator Larry found this CDP, paid 8.5 DAI, and got 0.067 ETH in the CDP pool, which is about 0.07 ETH. This removes DAI from the market, raises collateral rates and keeps the system solvent.

Larry then buys ETH for $121 / ETH, which is a good discount to the market rate, and immediately sells ETH on Uniswap for DAI to lock in a profit of 0.002 ETH.

But although Ralph spent the gas fee to bite the risky CDP and initiate the liquidation, he didn't actually make any money from it. Larry was rewarded with ETH at a 3% discount. While there are plenty of robots that will bite and bust CDP to make a profit, only half of the bites will be taken by the same robot through liquidation.

& have spent Image courtesy of medium&cake; & have spent

So, are there plenty of Good samaritans running the bite CDP program for free? While a few seem to be doing this, most of the busts appear to be robots because they can't find the right price to exchange for discounted ETH at liquidation.

But with the "3.12" market plunging, a Keeper won the auction with 0 DAI's bid, despite having no competition.

Usually, the final auction price is very close to the target settlement price due to the sufficient number of keepers participating in the auction. But after the extreme event, DAI became illiquid, with a premium of more than 10%. In addition, the starting price of MakerDAO clearing auction is 0, and the increase in gas fee further leads to a sharp decrease in the enthusiasm of users to participate in the auction. At the same time, ethereum experienced massive congestion, and most of the keepers could not participate in the auction in time, while a small number of them had the opportunity to get the mortgage assets at the price of 0DAI by paying high Gas fee.

The root cause of DAI 0 was the ETH's rising gas charge, and ethereum congestion exposed the problem. Of course, MakerDAO also took a series of measures to remedy and improve after the incident.

For example, by introducing an auction circuit breaker, if the collateral auction fails to raise enough DAI to pay the Treasury's outstanding debt, the deficit will be converted into the system debt agreed to by Maker. The system debt is assumed by the Maker system through the DAI of the stabilization fee surplus. If DAI in the surplus is still insufficient, the agreement will initiate a debt auction. During a debt auction, the system casts MKR (the total MKR in issue circulation), DAI in the repo market.

A circuit breaker would further reduce auction risk by suspending collateral auctions when markets are volatile, giving liquidators more time to raise capital and participate in bidding on collateral.

In the "3.12" plunge, although Compound did not appear as MakerDAO large-scale debt, but Compound is the second largest liquidation project after MakerDAO, the liquidation amount of more than $6 million. To encourage more people to participate in clearing and avoid MakerDAO's "0 DAI" incident, the Compound team recently announced an 8% settlement discount instead of 5%.

In general, the DeFi is still a very early in the market, although the DeFi clearing mechanism in "3.12" market crash has exposed some shortcomings, but with the expansion of the DeFi market scale and settlement mechanism, perfecting DeFi ecological future is bound to attract more and more of the liquidator to enter, so as to maintain healthy DeFi lending market operation.

Original link:https://mp.weixin.qq.com/

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