When providing collateral to borrow on the Earn platform, it is important to maintain collateralization ratios within the stated bounds. If a user's account becomes under-collateralized, they may face a liquidation event where a portion of their collateralized deposits are liquidated to repay part of their outstanding loan. Exchange rates are a key variable in the collateralisation ratio and volatility in digital currency markets is significantly higher than fiat currency markets.
Each market specifies a maximum loan to value ("LTV") ratio that a user must observe in order to avoid a liquidation event. If a user exceeds the LTV ratio, a portion of their outstanding loan becomes eligible for liquidation. There is the option to repay currency borrowed or add collateral, but if a user fails to do so, other users can pay off a portion of the loan at a discounted rate (10% discount) and seize collateral.
Assumption: maximum LTV ratio is set at 80% for the assets being used as collateral.
Good standing = the collateral supplied satisfies the loan to value rate of borrowed currency.
Recoverable Default = borrowed currency levels are covered by collateral available without risk of loss.
Unrecoverable Default = deposited collateral cannot cover the underwater or bad liquidation.
This chart describes the flow Earn uses to manage liquidations.