Editor's Note: The original title was "DeFi Classroom | How Does DeFi Liquidator Work?" 》
Co-produced by Conflux × Odaily Planet Daily, Planet Daily Senior Reporter @ 王 also served as the lead author.
- Global Blockchain, Digital Assets Regulatory Policy and Practice - ASEAN
- Research Report|Can blockchain technology effectively solve the high-risk problem of inclusive finance?
- Video|"8""Qin CEO Yu Xueyu: Let users join the industry through three levels of participation
- Read through the blockchain series-Blockchain architecture from a business economic perspective
- Shanghai: Support the establishment of the fintech company in Shanghai by the Digital Currency Research Institute of the People's Bank of China
- Viewpoint | Blockchain can improve data governance transparency and efficiency, privacy protection still faces challenges
When it comes to DeFi, people pay more attention to mortgage lending, decentralized exchanges, derivatives trading, stablecoins, etc., but few people will pay attention to "liquidation"-an indispensable part of the DeFi ecological closed loop.
"Liquidation" is generally done by "liquidators". "Liquidators" are one of the important roles to ensure the normal operation of DeFi loan agreements. They often work behind the scenes and are often jokingly called "miners" who make a lot of money. But they maintained the solvency of the entire DeFi market.
On March 12, the cryptocurrency market suffered a plunge, and DeFi also encountered the largest on-chain liquidation in history. On March 12, only the DeFi project on Ethereum liquidated more than 23 million US dollars, a record high.
Among them, MakerDAO generated the most liquidation, with a total liquidation of more than 10 million US dollars, followed by Compound and dYdX.
Most DeFi users only know that their mortgaged assets on the DeFi agreement have been liquidated, but they do not know how their assets are liquidated? Who liquidated it? What is the process of liquidation?
In this article today, let ’s discuss how the “liquidators” in the DeFi ecosystem work. How can I become a profitable DeFi liquidator?
Why does DeFi need a liquidator?
In the DeFi mortgage loan agreement, when the value of the collateral exceeds the value of the loan, the mortgage guarantee loan works well, so that the borrower can obtain working capital without having to sell its usually less liquid assets. However, when the value of the collateral falls, rational borrowers will have an incentive to evade repayment, which may put the lender in trouble.
So there is the link of liquidation. The purpose of design liquidation is to protect depositors and prevent their borrowers from defaulting on their loans. This is achieved by taking the borrower ’s collateral at a low discount and turning it into a loan.
In order to reduce the risk, the current main loan agreement is to borrow through over-collateralization, which usually requires a mortgage rate of less than 150%. For example: users borrow a DAI loan from Compound over-collateralized ETH, but it is very unfortunate that during the loan period It happened that the price of ETH fell sharply, making the borrower's collateral value fall below the 133% collateral ratio required for ETH.
If there is no top-up or sale of collateral, the liquidation process will be triggered. In addition, the borrower will also pay a liquidation penalty (generally about 10% of the mortgage principal, MakerDAO is 13%.)
At this time, the liquidator can trigger the Compound liquidation process, and can obtain ETH collateral at a discount of 3%-5% below the market price. Therefore, the borrower repays the loan of the DeFi lending system to avoid debts and bad debts on the DeFi lending platform. The solvency of the system is maintained, and at the same time, the liquidator also obtains a considerable profit, the best of both worlds.
How to become a liquidator?
Before we can understand how the liquidator works, we must first know how to become a liquidator? What are the thresholds for becoming a liquidator?
There is no threshold for being a liquidator, but you need to have some code knowledge and market sensitivity, otherwise you will not be able to grab orders. Moreover, the liquidator itself does not need any investment of original funds, and can complete the liquidation without principal, and finally take a 5% discount, so the liquidation is actually a risk-free arbitrage behavior, and the liquidator does not need to rely on prediction Currency prices rise and fall to earn income, and the cost used by liquidators to complete liquidation can also be borrowed from lending platforms such as MakerDAO and Compound, which means that there is no need to invest too much in the early stage.
Although it does not require too much original capital investment to become a DeFi liquidator, liquidation tools are still indispensable to become a liquidator. Although different protocols have different mechanisms and terminology, they basically need the same components :
1. Robots to monitor pending loans on Ethereum;
2. A set of smart contracts that can automatically clear and sell collateral in a loan;
3. Decentralized exchanges can be used to immediately sell liquidated collateral and ensure the profit of liquidators.
At present, many platforms use Dashborad, which provides clearing robot programs and monitoring, to help clear liquidation. However, it is mainly up to the liquidators to develop automated liquidation tools. Some DeFi loan agreements will also help borrowers liquidate through their own tools, like MakerDAO has its own open source robot.
How does the liquidator work?
Different platforms have different liquidation methods. For the MakerDAO system, when the system is triggered to large-scale liquidation, the system will also have potential debt losses. In order to avoid losses, MakerDAO chose to conduct auctions to CDP holders. For the liquidation of collateral, the auction mechanism can create competition among liquidators and avoid liquidators from taking too low discounts to obtain the borrower's collateral. This auction method can protect the borrower's rights and interests to a certain extent.
However, in extreme market conditions, this auction mechanism is paralyzed due to the high gas fee, resulting in the occurrence of the "0 DAI" auction event, which in turn leads to bad debts for the entire system. MakerDAO had to announce the auction of MKR to repay $ 4 million in debt.
Compared with MakerDAO, Compound's liquidation mechanism is simpler and more straightforward. As long as the liquidator finds that the borrower's mortgage rate is too low through the monitoring contract, the liquidator will immediately initiate liquidation once the liquidation process is triggered.
Tom Schmidt, the junior partner of the blockchain investment fund Dragonfly Capital, once analyzed and interpreted the clearing mechanisms of several mainstream DeFi lending platforms. We take MakerDAO as an example to see how the liquidators work.
MakerDAO's liquidation process is mainly divided into two parts: "bite" and "bust".
This is similar to the auction logic of traditional financial markets: first, debt recovery, and then auctions to repay the lender's debts. In Maker's system, debt recovery is triggered by requesting bite, and then liquidation is triggered by requesting bust on its smart contract set.
Let's take a look at the liquidation of "CDP17361" through two transactions. The first and second transactions involve three participants: the receiver (0xc2e), which we call Ralph; and the borrower (0x9c3), which we call Brittany, liquidator (0x5a2), we call it Larry.
Brittany borrowed 8.5 DAI with her 0.1 ETH collateral. The loan was fully within the 150% mortgage rate required by MakerDAO, when the price of ETH was $ 170. (170 * 0.1 / 8.5 = 200% mortgage rate) Unfortunately, on December 27th, the price of ETH fell to US $ 125, which put CDP in a state of insufficient mortgage (125 * 0.1 / 8.5 = 147%), which allows Ralph initiates a bite request for the CDP and reclaims the ownership of the CDP from SaiTub (SaiTub holds all active CDP contracts) to SaiTap (the SaiTap contract executes the liquidation of the CDP).
At this point, the system is still in a state of insufficient mortgage. In the Maker system, there are more outstanding DAIs than ETH to support the value of the required ratio DAI. Fortunately, the liquidator Larry discovered the CDP and paid 8.5 DAI, thereby obtaining 0.067 of the pooled ETH in the CDP, which is approximately equivalent to 0.07 ETH. This removes DAI from the market, improves the mortgage rate, and maintains the solvency of the system.
Larry then bought ETH at the price of 121 USD / ETH, which is a good discount to the market interest rate. Larry immediately sold ETH on Uniswap in exchange for DAI to lock in its 0.002 ETH profit.
However, although Ralph spent the gas fee bite the risky CDP and initiated liquidation, he actually did not make money from it. Larry received a 3% discount on ETH as a reward. Although a large number of robots will use bite and bust CDP to obtain revenue, but only half of the bites will be profited by the same robot through liquidation.
(Picture from Medium)
Therefore, are there a large number of Good Samaritan (for the courageous) to run the bite CDP program for free? Although a few seem to be doing this, most bites that are bust seem to be robots because they cannot find the right price to exchange for the discounted ETH during liquidation.
However, in the "3.12" market plunge, a liquidator (Keeper) won the auction with a bid of 0 DAI without competitors.
Usually, because there are enough keepers participating in the auction, the final auction price is very close to its target liquidation price. However, after the occurrence of extreme market conditions, DAI liquidity was lacking and the premium reached more than 10%. In addition, the starting price of the MakerDAO liquidation auction is 0, and the increase in gas fees further leads to a sudden decrease in the enthusiasm of users to participate in the auction. At the same time, there was a large-scale congestion in Ethereum. The vast majority of Keeper could not participate in the auction in time, and a small number of Keeper saw the opportunity. By paying a high Gas fee, the corresponding mortgage asset was finally captured at the price of 0DAI.
The root cause of the "0 DAI" incident is still due to the increase in the gas fee of ETH, and the congestion of Ethereum has exposed the problem. Of course, after the incident, MakerDAO also took a series of measures to remedy and improve.
For example, the auction fuse mechanism is introduced. If the collateral clearing auction fails to raise enough DAI to pay the outstanding debt of the vault, the deficit will be converted into the system debt of the Maker agreement. The system debt is offset by the Maker system through the stable fee surplus DAI. If the DAI in the surplus is still insufficient, the agreement will start a debt auction. During the debt auction, the system will cast MKR (the total amount of additional MKR in circulation) to repurchase DAI on the market.
Adding a fuse mechanism can further reduce the auction risk, and can suspend the collateral auction when the market fluctuates sharply, allowing the liquidator to have a longer time to raise capital and participate in the collateral auction liquidation.
During the "3.12" plunge, although Compound did not have large-scale debt like MakerDAO, Compound is the second largest liquidation project after MakerDAO, with a liquidation amount of more than US $ 6 million. In order to motivate more people to participate in liquidation and avoid MakerDAO's "0 DAI" event, the Compound team recently announced that it will adjust the liquidation discount from the original 5% to 8%.
In general, DeFi is still a very early market. Although DeFi's clearing mechanism exposed some shortcomings in the "3.12" market plunge, with the continuous expansion of the DeFi market and the continuous improvement of the clearing mechanism, the future of DeFi ecology is bound to be Attract more and more liquidators to enter the market, thus maintaining the healthy operation of the DeFi lending market.
· "Liquidators: How to Make Great Profits on DeFi"