Health & liquidations

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Health factor

The health factor is a metric that measures the safety of a loan. It is a numerical representation of how safe a loan is from being eligible for liquidation. The health factor of a loan is computed as follow: $$\color{white} \text{Health factor} = \frac{\text{Collateral value} \times \text{Liquidation threshold}}{\text{Debt}}$$ Whenever the health factor of a loan drops below 1, the loan can be liquidated. While the health factor stays above 1, the position can’t be liquidated. The health factor can fluctuate depending on the volatility of the collateral’s value, and the debt’s accumulation of interest. Regular monitoring is essential to ensure that a loan remains sufficiently healthy to avoid liquidation. To improve a loan’s health factor, users can deposit more collateral and/or repay a portion of their debt. For example, in the situation where:

• Collateral_value = $5000
• Liquidation_threshold = 90%
• Debt = $4000

Then: $$\color{white} \text{Health factor} = \frac{5000 \times 0.9}{4000} = 1.125$$ This position can’t be liquidated, as the health factor is above 1.

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Liquidation

Once the health factor of a loan falls below 1, the loan becomes eligible for liquidation. When it happens, anyone can repay the borrower’s debt (denominated in USG), in exchange for the position’s collateral. Since the collateral value is superior to the debt, liquidators are incentivized to process the liquidation, as they can realize a direct profit. In other terms, when a position is eligible for liquidation, liquidators can buy the collateral at a discount, and then sell it to realize an immediate profit. When a position is liquidated, the borrower keeps the USG he borrowed, but can’t get back his collateral. For example, in the situation where:

• Collateral_value = $5000
• Liquidation_threshold = 90%
• Debt = $4600

$$\color{white} \text{Health factor} = \frac{5000 \times 0.9}{4600} = 0.978$$ As the health factor is below 1, the position can be liquidated. Therefore, a liquidator can repay the debt with 4600 USG, to receive $5000 worth of collateral in exchange. He can then sell the collateral to realize a net profit of $400.

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Self-liquidation

It is possible for a loan’s owner to self-liquidate his position, even if the health factor is above 1. In that situation, all the collateral is sold for USG to repay the debt, and if any, all remaining USG are sent back to the borrower. For example, in the situation where:

• Collateral_value = $5000
• Liquidation_threshold = 90%
• Debt = $4300

$$\color{white} \text{Health factor} = \frac{5000 \times 0.9}{4300} = 1.046$$ Following a self-liquidation, the debt of 4300 USG is repaid, and the borrower receives $700 worth of USG.

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Liquidation bots

Anyone can process a liquidation whenever a loan’s health factor falls below 1. Usually, liquidations are proceeded by dedicated liquidation bots. However, these bots will liquidate a position only if the transaction is profitable. In a high gas environment, liquidations might not be profitable due to gas costs, even if the collateral’s value is greater than the debt. Therefore, Tangent runs its own liquidation bot to ensure that liquidations always proceed, even if they aren’t profitable. The bot will liquidate any loan eligible for liquidation by selling the collateral to repay the debt, even if the operation isn’t profitable due to high gas costs.

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Bad debt

Bad debt can occur if the collateral’s value of one or multiple loans drops below the debt’s value. In such a situation, liquidations are unlikely to proceed, as selling the collateral can’t cover the debt, and no rational actor would buy the collateral at a premium. Given the nature of the collaterals onboarded in Tangent’s markets, this situation isn’t expected. However, if it happens, the DAO can seize the collateral of the loans responsible for the bad debt. The bad debt is then registered in the market, and anyone can repay it by burning USG. The DAO will, by any means possible, try to sell the collateral to repay as much bad debt as possible. A market that registered a bad debt continues to function normally. However, all the interest and earnings from this specific market might be used to repay the bad debt, until it is fully recovered.