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Liquidation

What is Liquidation?​

A liquidation event occurs when a position's Health Factor reaches 0%, rendering it insolvent. Consequently, a liquidator seizes a portion of the borrower’s collateral and sells it for the loan asset to repay part of the outstanding loan, restoring solvency. Note that the Silo Protocol does not perform liquidations itself but instead allows external liquidators to execute them.

General concepts​

  • Solvent Position: A borrow position where the debt-to-collateral ratio is below the Liquidation Threshold (LT) defined in the smart contract of each token asset.
  • Insolvency: A borrow position where the debt-to-collateral ratio exceeds the Liquidation Threshold (LT) defined in the smart contract of each token asset.
  • Partial Liquidation: When a position becomes insolvent, the Silo Protocol permits a liquidator to sell a portion of the borrower’s collateral to repay part of the outstanding debt, restoring solvency.
  • Full Liquidation: If the protocol determines that more than 90% of the borrower’s collateral must be sold to restore solvency, it allows a full liquidation event in which a liquidator can seize all collateral to repay the outstanding loan.
  • Liquidation LTV (LLTV): The Liquidation LTV is a protocol-enforced ratio that determines the amount of collateral a liquidator can seize to restore an insolvent position to solvency. For example, if stS in stS-S [3] market has a 95% LLTV, a liquidator can seize enough of the insolvent borrower’s collateral to bring their position to a 95% LTV.

What is the Liquidation Process?​

1. Health Factor reaches 0%​

When a position's Health Factor reaches 0%, the position will be signalled for partial liquidation.

Example of liquidation scenario

In the above scenario, if ETH's price falls to $235.36, this position becomes insolvent and is signaled for liquidation.

2. Liquidator seizes collateral​

The liquidator seizes part of the collateral and sells it for the debt token. In the liquidation scenario described, if the protocol permits the seizure of up to 25% of the borrower’s collateral, 0.025 ETH is seized and sold for a corresponding amount of USDC.

3. Liquidator repays and keeps the liquidation fee​

The liquidator uses the sale proceeds to repay part of the borrower’s outstanding loan, restoring solvency, and retains the liquidation fee. In the above scenario, the liquidator will repay the 20loanandkeep20 loan and keep 3.54.

Why is liquidation necessary?​

If a lending market fails to liquidate positions and the price of a collateral token decreases or the value of a loan token increases, the market may become insolvent. This can result in bad debt, causing lenders to lose some or all of their deposits.

Liquidation prevents market insolvency by restoring insolvent positions to solvency or closing insolvent positions completely (full liquidation event), ensuring lenders can withdraw the full value of their deposits.