🟧Liquidation

In this section, we’ll take a closer look into liquidation, demystifying the concept to make it simpler to understand. But first, let’s recap a few terms that will be used in the next section:

• Your Debt Value is the value of the borrowed tokens

• Your Position Value is the value of your farming position, which is equal to your collateral + borrowed assets + yields (also known as the value of your LP tokens)

• The Debt Ratio is your Debt Value divided by the Position Value

• Your Equity Value is your Position Value minus your Debt Value (All values above are displayed in the borrowed token)

The Risk of Liquidation

As senior Camel, it’s our duty to teach you younglings about any risks at the farm, of which the most common is liquidation. So what is that? Well, when you open a leveraged position, borrowing up to 3x the funds you add, the protocol needs to make sure you’ll be able to pay back that loan. So the amount you add from your funds acts as collateral, which grows as you accumulate yields(minus borrowing interest).

That collateral has to remain above the amount you owe (plus a margin of safety to account for potentially quick price movements) or the protocol may close your position to pay back lenders, which is called liquidation. You want to avoid liquidation because at that time, 5% of your remaining position value would be paid to the liquidator bot as a reward for closing your position and ensuring lenders were paid back.

Liquidation is a risk, but only at certain times. When you first open a position, you typically do not have to worry about liquidation.

So when would you have to worry about it? Well, since you’ve deposited crypto tokens, the value of your collateral is volatile, able to change as token prices move. What’s more is that when you borrow funds, you are holding them and taking on the potential gains(and losses) of those assets while your position remains open.

Now, it’s important to note that another term for your collateral is Equity Value. It’s that equity value that needs to stay above a certain threshold to avoid liquidation. To be specific, if your Debt Ratio exceeds a threshold called the Liquidation Threshold, your position could be liquidated by a liquidation bot — meaning the bot would close your position, repay the debt, and return the remaining amount to you (denominated in the borrowed tokens).

Why would you get liquidated at the liquidation threshold? Because that’s when your collateral(equity value) has become low enough that if it continues to drop in value, there may be some risk that you couldn’t pay back your loan. So liquidation is necessary to protect Lenders. It’s what gives lenders the confidence to lend their assets to you in the first place, so you can farm profitably.

So that’s the general overview of liquidation. However, as leveraged farmers and investors, we are mostly concerned about price. So let’s go into that next, putting liquidation in perspective with asset prices.

Liquidation Example

1. Aaron opens a WETH-USDC yield farming position using 3x leverage

2. He supplies 10 WETH of his own assets(worth 25000 USDC), which is his Equity Value.

3. He borrows 50000 USDC (2x what he supplied, when combined with the 25000 he added himself, that makes 3x total)

4. The protocol then converts all deposited and borrowed tokens into a 50:50 proportion for creating the LP tokens for farming: 15 WETH + 37500 USDC or 30 WETH worth, which is her Position Value. (In reality, it would be slightly lower due to price impact from swapping and trading fees. Aaron's net exposure is long 10 WETH.)

5. Aaron's Debt Ratio (Debt / Position Value) is ~66% (50000 USDC / 75000 USDC)

6. If at some point, WETH price drops > 40%, then Aaron's Debt Ratio will exceed 83.3% (the Liquidation Threshold for the WETH-USDC pool). A liquidation bot would then call the smart contract to close her position, repay the loan, and return any remaining assets to his wallet.

Please note that this example ignores the impact of yield farming rewards and trading fees which over time, would increase Aaron's position value and make her position safer. It also ignores the borrowing interest rate which would increase the debt value, moving his debt ratio higher.

Avoiding Liquidation to Keep Farming Profitably

Here are a few things you can do to avoid liquidation.

• Monitor your Safety Buffer: The Safety Buffer in the Your Positions dashboard tells you how close you are to potential liquidation. Once it reaches zero, you can be liquidated. You can also scroll over it to see how much your primary asset has to drop in price for the safety buffer to reach zero.

• Add collateral: If you see your Safety Buffer dropping, you can choose to add collateral, the button to the right of your open position, to increase your safety buffer and avoid liquidation.

• Farm less volatile assets: If you are farming stable coins, liquidation becomes extremely unlikely. What’s more, is farming less volatile, high market cap assets like WBTC is safer than new low-cap tokens. Of course, the trade-off here is you earn smaller APYs.