Proposal: Update Liquidation Fees to align with increase of protocol fee from 2% to 20%

Proposal: Update Liquidation Fees to align with increase of protocol fee from 2% to 20%

Problem: There’s a need to increase protocol fees in order to generate long-term sustainable revenues. By going from a 2% to 20% protocol fee depending on the amount of loan interest that has been accrued at the time of liquidation, there will be less collateral available after paying the debt (Loan + accrued interests), and the new protocol fees (20% of loan interest) to pay the liquidator.

To compensate for that, a higher liquidation fee % will need to be applied to the remaining collateral to ensure that the liquidator still gets at least the same liquidation value he would have got if the liquidation fee was still at 2.5 % (current state)

Example:

Collateral = 10000 ADA

Loan = 3600 ADA

Interests accrued at the time of liquidation = 1440 ADA

Remaining collateral after liquidation (with protocol fee at 2%) = 10000 – (3600 + 1440 + 2% * 1440) = 4931.2 ADA

  • Liquidator fee = 2.5% * 4931.2 ADA = 123.28 ADA

Remaining collateral after liquidation (with protocol fee at 20%) = 10000 – (3600 + 1440 + 20% * 1440) = 4672 ADA

  • Liquidator fee = 2.5% * 4672 ADA = 116.8 ADA

In this simplified example, we see a lower value for the liquidator when we increase protocol fees to 20%. To ensure the liquidator doesn’t lose value in this example, it would be needed to increase the liquidation fee from 2.5% to 2.64%

Solution:

Set a new liquidation fee at 5% that will guarantee that even with the increase of protocol fee to 20%, the incentive to liquidate bad debt will not be lower than with the current situation (2.5% liquidation fee).

In order also to not overinflate those fees to cover unlikely situations, a proposed tradeoff is to cover a worst-case scenario where:

  1. The liquidation occurs when the interests accrued represent 38% of loan value after 1 year.

This aligns with Mantas’ proposal update of Interest Rate parameters that will set the borrowing rate around 38% APR for a Utilization Rate of 80%, making it quite unlikely to accrue more than 38% of loan value as interest after 1 year of keeping same loan.

  1. The liquidation occurs for a loan backed by the lowest LT (Liquidation Threshold), which is 1.3. This is the least favourable LT to consider as it gives (in %) the lowest collateral margin available after liquidation.

  2. The liquidation is not performed just after Health Factor (HF) goes below 1 for a LT = 1.3 but instead when HF = 0.85 for LT = 1.3 (liquidation not efficient)

Below the representation of the new liquidation fee to apply when LT = 1.3 (most critical case) depending on % accrued interest when liquidation occurs

main

Analysis:

The new Liquidation fee (to have at least the same value for the liquidator as with the 2.5% liquidation fee) when we pass Protocol fees at 20% can be estimated with the following analysis:

x = New liquidation fee to apply (on remaining collateral after liquidation) to compensate for a 20% protocol fee instead of 2%

Equation to solve to calculate “x”

Screenshot-from-2024-03-12-20-15-33

HF = collateral / ((loan + interest)/LT) <=> collateral = HF * LT * (loan + interest)
Hypothesis: interest = alpha * loan where “alpha” is the % of interests accrued
collateral = HF * LT *(1 + alpha) *loan

x*(collateral - loan - interest - 0.2interest) = 0.025(collateral - loan - interest - 0.02interest)
x
(HF * LT - 1 + (HF * LT - 1.2) alpha) * loan = 0.025(HF * LT - 1 + (HF * LT - 1.02)*alpha) *loan
Screenshot-from-2024-03-12-20-15-47
The new liquidation fee depends on HF, LT and the amount of interest accrued over time (alpha)

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0 voters
14 Likes

Fully support the raise in liquidation fee

12 Likes

Very good proposal. It’s time!

7 Likes

Definitely a yes for me. Much needed IMO

5 Likes

Yes. Fully support this detailed proposal.

3 Likes