Liquidation Process
The liquidation mechanism is a critical component that ensures the USPD system remains solvent and the 1:1 USD peg is maintained. It creates incentives for other Stabilizers to intervene when a position becomes undercollateralized.
When Liquidation Occurs
A Stabilizer position becomes eligible for liquidation when its collateralization ratio falls below a certain threshold. The right to initiate this liquidation is a unique privilege granted to other Stabilizer NFT owners, and the specific collateralization ratio at which they can trigger a liquidation depends on their own NFT ID:
- Owner of Stabilizer NFT #1: Can initiate liquidation if another position’s ratio drops below 125%.
- Owner of Stabilizer NFT #2: Can initiate liquidation if another position’s ratio drops below 124.5%.
- Owner of Stabilizer NFT #3: Can initiate liquidation if another position’s ratio drops below 124%.
- …and so on, decreasing by 0.5% for each subsequent ID.
This hierarchy ensures that there is always a strong incentive for senior stabilizers to maintain system health. A position can become undercollateralized due to a decrease in the price of ETH, which reduces the value of the underlying stETH collateral relative to the fixed USPD debt.
Liquidation Mechanics
When a position is liquidated, the liquidating Stabilizer repays the outstanding USPD debt associated with that position. In return, they receive the position’s underlying stETH collateral at a discount, which provides the financial incentive to perform the liquidation.
This process removes the risky position from the system and ensures that all outstanding USPD remains fully overcollateralized. For a detailed breakdown of the financial incentives and calculations, please see our economics documentation.
Emergency Fund
A portion of the collateral from a liquidation event may be directed to a system-wide emergency fund. This fund serves as a secondary buffer to protect the system against extreme market events and ensure long-term stability.
Best Practices for Stabilizers
- Monitor Position Health: Regularly check your position’s collateralization ratio. To be safe from liquidation by any other Stabilizer, you must keep your ratio above 125%.
- Maintain a Buffer: Add collateral to keep your ratio comfortably above the 125% threshold.
- Understand Market Conditions: Be aware of ETH price movements and their potential impact on your position.
For Liquidators
- As a Stabilizer NFT owner, you have the right to liquidate other positions that fall below the threshold corresponding to your NFT ID.
- Monitor the blockchain for undercollateralized positions that are eligible for liquidation.
- Maintain a reserve of USPD to repay debt during a liquidation.
- Analyze the potential profitability of a liquidation, considering the collateral discount and gas costs.