When a staker's Collateralization Ratio (C-Ratio) falls below the liquidation ratio, they are subject to liquidation, a risk management mechanism crucial for maintaining the protocol's stability. If the staker's C-Ratio doesn't improve within a certain period, protocol users will take action to rectify the situation by liquidating a portion of their staked SNX.
Upon falling below the required C-Ratio (see Current Protocol Parameters), stakers enter a period during which they must rectify their C-Ratio. Failure leads to one of the following scenarios, each with distinct implications and penalties:
- 1.Forced Liquidation:
- If a staker does nothing after being flagged, the protocol enforces liquidation. A penalty applies not to their total staked SNX but to the amount that is liquidated to bring their C-Ratio back to the target.
- This penalty, often around 60%, is redistributed within the protocol, incentivizing active participation and penalizing negligence.
- Stakers proactive in managing their stakes may opt for self-liquidation, incurring a smaller penalty, typically around 50% on the portion of SNX being liquidated.
- This approach offers a less punitive measure for those seeking to exit their positions or reduce their exposure deliberately.
- 3.Rebalancing to Avoid Liquidation:
- Stakers who adjust their C-Ratio promptly, either by burning sUSD or by additional staking to elevate their C-Ratio above the protocol's target, will avoid any liquidation process.
- It demonstrates responsible staking behavior, contributing positively to network stability.
- 4.Option for Self-Liquidation at Any Time:
- The protocol may offer mechanisms for stakers to initiate self-liquidation even before reaching critical thresholds, providing greater control over their staking positions and potential outcomes.
Liquidations serve multiple essential functions:
- They enforce discipline among stakers, ensuring that everyone within the network maintains adequate collateral levels.
- Active network participants can help stabilize the overall network C-Ratio by initiating liquidation processes for at-risk stakers.
- They help address the issue of 'zombie' wallets, which, due to lost keys or abandonment, no longer contribute actively to network health.
Consider a staker, Bob, who begins with a healthy position but experiences market volatility that jeopardizes his C-Ratio:
Bob stakes 1000 SNX and mints 1000 sUSD. With SNX at $2, his collateral is worth $2000, and his C-Ratio is 200%. If the SNX price drops to $1.50, his collateral value falls to $1500, pushing his C-Ratio down to 150% and triggering the liquidation process.
If Bob's position is forcibly liquidated (scenario 1), the protocol will determine how much SNX needs to be sold to restore Bob's C-Ratio to the 400% target. The penalty applies to this portion, not the entirety of Bob's staked SNX. For instance, if 250 SNX needs to be liquidated, a 60% penalty means losing 150 SNX, with the remaining 100 SNX used to repurchase sUSD and burn it to restore the C-Ratio.
If Bob opts for self-liquidation (scenario 2), he might face a 50% penalty on the liquidated SNX, reducing his loss slightly in the process of C-Ratio restoration.
Alternatively, if Bob manages to rebalance his stake (scenario 3), by adding more SNX or burning some sUSD, he could maintain or even improve his C-Ratio, thus avoiding any penalties.