The Liquid Loans launch was a multiple-year, overnight success.
The result was hundreds of users borrowing against their $PLS in just the first few hours.
But what some users are doing will shock you, and, in some cases, just IRRESPONSIBLE.
As of Dec 4th, a total of 61 vaults have been liquidated for 6.3 Billion PLS!
This is great yield for the Stability Pool, but an avoidable loss for those who were liquidated.
If this is you, this post will help you get educated and take the proper action now!
Most users are not living life on the edge.
Which is why the total system state of Liquid Loans has a collateral ratio floating above 200%.
But some users are flirting with liquidation.
Let’s look at the first page on Liquidations inside the dApp.
There are 11 vaults under 112% collateral ratio and dozens below 120%.
Let’s do some math.
For a vault with a 112% collateral ratio, the price of $PLS only needs to drop 1.785% for their vault to be liquidated.
This kind of drop is not only possible, it’s commonplace, and can happen within minutes.
For a vault at 120% collateral ratio, the price of $PLS only needs to drop 8.33% to be liquidated.
This will insulate the borrower more than the 112% vault, but an 8.33% drop in the price of $PLS is far from outlandish in a short time frame.
When a vault drops below 110% ICR, they are nearly instantaneously liquidated due to strong financial incentives.
During a liquidation:
Let's say a vault had 11,000 USD worth of PLS locked and 10,000 $USDL minted.
If they are liquidated, they lose just below 11,000 USD worth of $PLS, but keep $USDL.
In effect, this user has essentially traded 11,000 USD worth of $PLS for 10,000 USDL (likely worth 10,000 USD) and taken an instant value haircut of 9.1%.
Let me reiterate. A liquidation will result in an instant loss of value of roughly 9.1%.
This is not the end of the world of course.
If you have been in crypto for long enough, then you’ve undoubtedly lost more than 9.1% in a few hours at least once.
But… if you can avoid it, you should.
This vault here, who’s address will remain unidentified, has borrowed 59,419 USDL and has only collateralized a little over 1 Billion $PLS.
This puts their individual collateral ratio at 112.5%.
After doing some quick math, if the price of $PLS drops 2.23% before they can make any adjustments, their vault will be liquidated.
This liquidation will result in roughly 97.6 million PLS being lost and distributed to the Stability Providers.
Not ideal – at least not for the owner of the vault.
While 40-50% price reductions in one day are very rare, 2-10% price reductions in just a few hours are common.
If you want to be as capital efficient as possible, and maintain your vault close to 110% collateral ratio, you’ll want to constantly monitor it.
Remember, you can always pay back some or all of your debt to improve your collateral ratio.
You can also add more $PLS to your vault without borrowing more $USDL, which will also improve your collateral ratio.
In the near future, I am sure some savvy users will create a bot which monitors your vault, and improves your collateral ratio when it goes close to liquidation levels.
Every user wants to maximize capital efficiency and extract as much value from their $PLS as possible.
But this can backfire if they’re not careful.
Liquid Loans is one of the most capital efficient systems that exists in finance and it is this way because of instantaneous liquidations.
A liquidation will result in an instantaneous loss of 9.1% which is not the end of your investing career, but it’s also not optimal.
If you’re going to flirt with low collateral levels, understand the risks and understand how to save your vault before liquidation.
And of course, nothing in this post is financial advice, the aim is to provide education so you can make the best decisions possible within the ecosystem.
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Disclaimer:Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.
Connor is a US-based digital marketer and writer. He has a diverse military and academic background, but developed a passion over the years for blockchain and DeFi because of their potential to provide censorship resistance and financial freedom. Connor is dedicated to educating and inspiring others in the space, and is an active member and investor in the Ethereum, Hex, and PulseChain communities.
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