Avoid getting liquidated by tracking your open borrow positions diligently.
A liquidation occurs when a borrower’s borrow-to-collateral ratio exceeds the liquidation threshold. In such an event, the borrower’s loan is signaled for liquidation. During liquidation a liquidator seizes the borrower’s collateral, sells it, and pays off the outstanding debt.
The concept of liquidation is relatively straightforward. Different lending platforms use different approaches to liquidation.
This post explores key liquidation concepts for the Silo protocol.
Loans on Silo are overcollateralized, meaning a borrower must deposit collateral of higher value than the amount they want to borrow.
When a collateral is liquidated, the liquidator seizes the entire collateral and sells it on the open market in order to repay the loan backed by the collateral. If the borrow position is particularly large, this results in slippage upon liquidating the position, causing the sale to return less tokens than expected.
Overcollateralization creates a slippage buffer and increases the likelihood that large positions can be liquidated effectively to fully repay the borrower’s outstanding loan.
The Ethereum blockchain sometimes suffers from congestion, which can affect how quickly liquidations occur when paying off undercollateralized borrow positions.
Overcollateralization also creates a buffer that can compensate for on-chain congestion. This decreases the likelihood of the Silo protocol becoming undercollateralized.
Without overcollateralization, slippage and congestion could create scenarios where a borrower’s position could become undercollateralized. If this occurred, a borrower’s outstanding loan may not be fully paid off, resulting in bad debt. The bad debt could subsequently result in lenders being unable to withdraw the full value of their deposits.