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Liquidations are a two-step process:
- Anyone can start the liquidation process of a Vault when the health factor drops below the liquidation threshold. In return, the liquidator who starts the process receives a percentage of the Vault’s debt.
- The liquidation itself is carried out using a Gradual Dutch Auction: the selling price of the Vault will constantly decrease until a buyer is found. The buyer who liquidates the Vault with the least slippage will be the first one to be profitable. This ensures the optimal liquidation of unhealthy Vaults.
After the vault is sold there are three scenarios:
- 1.In case the final selling price is lower than the open debt, a default event occurs. In this case, the bad debt is recovered from the underlying tokens of the most junior risk tranche.
- 2.In case the final selling price is higher than the open debt, but below the open debt + liquidation penalty cap, there is a surplus that will be distributed according to a fixed ratio to: a) Arcadia Finance's treasury, and b) The most junior tranche.
- 3.In case the final selling price is higher than the open debt + liquidation penalty cap, the liquidation penalty will again be distributed to both the protocol and the most junior tranche. The leftover surplus will go back to the original owner of the liquidated vault.
We rely on MEV bots and keeper networks to liquidate unhealthy Vaults. Also, for the auctions MEV searchers will compete in optimizing the routing of assets to be liquidated, which prevents a single point of failure and guarantees minimal slippage. After launch, Arcadia will open-source a reference implementation of our liquidation bot.