Understandably, traditional and centralized finance have left people in fear of the consequences of not repaying their loans. But liquidations actually aren’t so scary in the Liquid Loans ecosystem.
In traditional finance, your loan being “liquidated” before you are able to pay it back can have devastating consequences.
The first of these consequences lies in the fact that lenders will inform credit reference agencies that you failed to repay your loan. This information will likely damage your credit record, making it significantly more difficult for you to access financial services. In the US, this information can stay on your credit reports for seven years.
In some instances, you can also be ordered by courts to repay the loan provider by liquidating your assets or having money taken from your paychecks for years. You may even have to pay additional interest, or windfall, on your unpaid loan.
Worse still, it means losing the collateral on your debt.
If you take out a loan by using an investment asset, like a security, the loan being “liquidated” would mean that you lose your financial position and the ability to ever make money from that asset.
Worst of all, if your loan was collateralized against a valuable asset, it will be seized by the bank or financial institution. This could mean losing your car, or even your home.
With such dire consequences in the world of traditional and centralized finance, it’s no surprise that some users are worried about their Liquid Loans Vault being liquidated as well. But here’s why you don’t need to worry.
Liquid Loans has a robust liquidation system. It ensures the integrity of the entire network and keeps everyone’s funds safe at all times by always being overcollateralized.
In exchange for helping Liquid Loans stay overcollateralized, users can earn financial rewards for liquidating undercollateralized Vaults.
A Vault is considered undercollateralized when its collateral ratio dips below 110%—which is why it’s almost a better idea to open your vault with a higher collateral ratio.
This ensures that there is always more $PLS than USDL in the Liquid Loans protocol at all times, which means that anyone can redeem USDL for $1 USD worth of $PLS per coin at any time.
As a result, Liquid Loans is immune to the bank runs, which have taken down countless centralized banks and decentralized platforms.
When your Vault gets liquidated as a consequence of dropping under the 110% minimum collateral ratio, you lose the $PLS that was stored inside your Vault.
Unlike with CeFi or TradFi lending, however, the Liquid Loans code allows you to keep all of the USDL that you borrowed.
While it is easy to prevent your Vault from getting liquidated, this means that even if you do get liquidated, your potential losses would only be marginal.
There are no major consequences from your Liquid Loans vault being liquidated. In fact, in cases where the price of $PLS drops, your Vault being liquidated might even be a blessing in disguise, as the USDL you keep could be worth more than the $PLS you forfeit.
This is part of the core design of the Liquid Loans ecosystem, as people are free to choose to access interest-free lending in whatever way best suits them.
Some users choose to open their Vault with the lowest possible collateral ratio, as they are fine with the possibility of being liquidated. Others prefer to keep their $PLS, and choose to use a higher collateral ratio when opening their Vault.
Whichever use case best describes your needs, you will always be safe with Liquid Loans.
Now, with this major misconception out of the way, it’s time to get ready for Liquid Loans’s highly-anticipated launch.
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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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