Liquidations are an essential tool in maintaining the stability of any collateralized lending agreement. A borrower agrees that, if the value of their collateral falls below some predetermined level (relative to the value of their loan,) the lender can sell the underlying collateral to pay back the loan. The financial news media has actually covered this process extensively in the past week with the meltdown of Archegos Capital. This process is pretty well-defined in traditional finance, but how does it work for cutting edge DeFi protocols like Impermax?
Smart contracts ensure repayment to lenders if prices go down
In order for a collateralized lending market to flourish, trust must be established. In the case of Impermax, this trust comes in the form of smart contracts and the liquidation process. Liquidity providers are willing to lend out their cryptocurrency because they can trust that their deposit will be protected even in adverse market conditions by the process of liquidation, and because they can earn a yield on top of that. So, what does the liquidation process look like for Impermax?
Liquidation systems are well-proven with other permissionless lending protocols
Impermax uses a hybrid model for liquidations that is conceptually similar to Compound Finance, yet which differs in a few key ways. When a position on Impermax becomes liquidatable, the liquidator is paid a set percentage fee in exchange for liquidating (buying out) a position. Anyone can become a liquidator as long as they supply the required funds to the lender. In return, they get an instant reward. A position will become liquidatable when the underlying collateral backing the position is no longer sufficient to cover the amount that has been borrowed; on Impermax, this occurs when the relative price of the LP token pair has passed that of the liquidation price, which is calculated using system parameters that can be found in the whitepaper.
Full liquidation protects the lender
This is where Impermax’s liquidation process differs from that of Compound — on Compound, only 50% of the position is available to be liquidated. On Impermax, 100% of the position is available to be liquidated. This is an intentional design that is meant to reduce gas costs in the long run, and is more similar to other DeFi lending protocols such as Maker. In this way, lenders can be sure that they will always be paid back in full.
Liquidation bots are preferable to manual liquidation since they work immediately
Liquidations on Impermax are performed at the smart contract level — there is currently no frontend for users to perform liquidations themselves. This was also an intentional design, as the liquidation process should be swift and handled automatically, such that no market dislocations are created. To further bootstrap the liquidation process, Impermax also features flash liquidations, which enable a user who does not currently own the cryptocurrency needed to liquidate a position to borrow and repay the amount in the same transaction. If that is not the case, then the transaction will revert. Although liquidation bots are currently active, users who are technically literate enough to code a program which scans Impermax positions that are liquidatable are encouraged to do so in order to maintain system stability and perform orderly liquidations, as well as benefit from the liquidation penalty/premium, which is currently set to 4%.
Liquidation is a key component of permissionless lending services
The relationship between borrowers, lenders, and liquidators in any DeFi protocol is an important one. Impermax has been thoughtfully designed from the start to maintain system stability and ensure that lenders are paid back their full value no matter what, and that liquidations can occur efficiently.