Unit Protocol uses an efficient liquidation process for the benefit of the whole system in which every USDP is fully backed by the Collateralized Debt Position (CDP) set up by the user.
If a user's debt/collateral ratio exceeds the Liquidation Ratio (LR) for a CDP, it will be subject to liquidation. This is why it's essential that users set their collateralization ratio carefully and keep an eye on their positions to ensure they're not at risk of being liquidated.
The liquidation ratio is different for different assets based on their liquidity and market capitalization. This provides long-term stability and allows the implementation of a flexible risk approach for every asset.
Anyone can trigger liquidation by sending a trigger transaction. There are liquidation bots that consistently scan CDPs and trigger liquidations. After a CDP is triggered for liquidation, a Dutch auction starts for underlying collateral with a linear decrease in price. Liquidation fees differ for different assets in order to compensate buyers for the liquidity risks connected to a particular asset.
Within Unit Protocol every loan has to be paid in USDP.
Every participant can buy out a part of the collateral for the current price by paying off the USDP debt for the liquidated CDP. USDP debt is equal to the amount of USDP borrowed plus the liquidation fee as a % of this amount.
Once the collateral has been realised, the remainder is returned to the borrower's address. After that, the USDP debt is burned, and the liquidation fee goes straight into the governance pool address to be distributed to stakers later.
Check this section to see the case with an example of the above scenario:
When a liquidation is triggered, the collateral deposited is sold to cover the user's debt, and the liquidation fee will be triggered.
The duration of an auction differs depending on the network. The block time differentiates for varied blockchains.
Block time is a measure of the time it takes to generate one extra block, or data file in a blockchain network.
Let’s have a look at examples per every blockchain available within Unit Protocol: Ethereum, the average block time is 15sec. Devaluation period for the any token, but a stablecoin is 1100 blocks, for a stablecoin the value is 3 300 blocks. 15 * 1 100 = 16 500sec = 275min = 4.6h – an auction duration for any token, but a stablecion 15 * 3 300 = 49 500sec = 825min = 13.8h – for a stablecoin
The equation above tells us in what amount of time the cost of an asset (collateral) will be equal to zero in case no one buys it out before the auction ends.
Thus, bidding starts from the initial asset price and with every block the price decreases till the lowest point - zero.
The price decremental step can be different for various assets, but for the most assets it's a ~0.09% decrease per block.
BSC (Binance Smart Chain), the average block time is 5-6 seconds. Devaluation period for the token is 6 600 blocks.
5 * 6 600 = 33 000sec = 550min = 9.2h
Fantom, the block time is 1 second. Devaluation period for the token is 18 000 blocks.
1 * 18 000 = 18 000sec = 300min = 5h
Liquidation is necessary to ensure that USDP can maintain its price peg with the US Dollar. Key to achieving this is ensuring that USDP is backed by enough collateral value to maintain this peg. Liquidation ensures that vaults that are under collateralised are closed out.