Note: This article is not financial advice. Hubble Protocol does not endorse any of the tokens mentioned in this article.
Key Takeaways
- The crypto market is extremely volatile and full of surprises.
- Over-leveraged positions can lead to cascading liquidations.
- Maintaining a healthy LTV is an important aspect of borrowing.
Hubble Protocol recently experienced an extensive wave of liquidations. According to chain data, the fallout from UST’s de-pegging event led to 225 users whose accounts were liquidated between May 8th and May 12th.
This article addresses some key issues surrounding liquidations for users who borrow using DeFi. To begin with, it’s probably a good idea to learn a few things about liquidations from a blog instead of learning about how liquidations work firsthand.
When Do Liquidations Happen?
Liquidations usually happen en masse when the market starts bleeding red. There are dozens of reasons why the crypto market suddenly drops in value, and not every reason is easily explained.
Almost no one can predict when Elon Musk will tweet something that the market doesn’t like, but there is a bot that can help warn users when it happens. Who could foretell that civil unrest in Kazakhstan would crash the price of bitcoin? Most likely, no one.
A lot of people predicted that UST would fail one day, but everyone was caught by surprise when it actually happened.
It’s probably a good idea to:
- Remember that a crash can happen at any time.
- Consistently check LTV ratio against risk tolerance.
- Make sure a loan can be repaid at all times.
Liquidations Can Lead to More Liquidations
A side effect of an over-leveraged crypto market is something called cascading liquidations. When a lot of users borrow too much and get liquidated, a lot of tokens re-enter the market at the same time.
When a lot of tokens enter the market at the same time, prices can dip to new lows. When prices take yet another step downward, this sets off another series of liquidations, and the cycle repeats itself.
Along with each batch of forced liquidations during a crash, there are people panic-selling and driving prices even lower. During the most recent crash, panic led to over $200 billion being wiped from the crypto market in a single day.
It’s probably a good idea to:
- Remember that crashes can end up worse than you imagine.
- Borrow conservatively if unfamiliar with DeFi.
- Never deposit more than you can afford to lose.
Liquidation Events Can Make Networks Unstable
When the market is in panic mode, everyone is trying to push transactions through the blockchain at the same time. Users trying to repay loans, withdraw collateral, and sell their tokens are all fighting for the same block space.
At the same time, users are fighting each other for block space, bots are fighting each other to be the first bot to liquidate bad positions. Humans and bots are sending through so many transactions that many transactions begin to fail and/or become cost-prohibitive.
Every network has had users who have sat and watched as their account is liquidated while they are helpless to do anything about it. The community is hoping Solana figures something out soon, so this isn't an issue anymore!
It’s probably a good idea to:
- Understand the risks involved with transacting on a blockchain network.
- Find out ways to bypass common technical difficulties before absolutely needing this information. Is it possible to change to a better RPC node?
- Regularly improve positions by topping up collateral or partially repaying loans instead of waiting for a crash to manage your account.
Liquidations Cannot Be Reversed
When a user is liquidated, they forfeit their collateral, and it cannot be retrieved. It’s gone.
Borrowing protocols operate using smart contracts with terms that every user agrees to, so when the smart contract allows a user to be liquidated according to the terms agreed upon, it’s game over.
Users on Hubble who borrow at a 75% LTV will be returned a minor portion of their collateral after being liquidated, since the liquidation penalty is only 10%. However, if a user borrows at a grandfathered 90.9% LTV, they will lose all of their collateral when they are liquidated.
The good news is that users get to keep the USDH they borrowed when they are liquidated. The bad news is that some users will make sub-optimal choices with what they do with their USDH, so they no longer have the tokens they borrowed against or the USDH they borrowed after liquidation.
It’s probably a good idea to:
- Closely read and understand the terms and conditions of any DeFi protocol that can liquidate accounts.
- Avoid risk when participating in DeFi with borrowed tokens.
- Again: Never participate in DeFi with more than you can afford to lose.
It’s a Good Idea to Always Play It Safe
Informed users who actively manage their accounts and pay attention to their account health can mitigate the risks of being liquidated. However, unfortunately, sometimes a liquidation is unavoidable.
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