Basic Mechanics

Liquidations are the key mechanism by which UNIT's supply is kept in balance with the amount of exogenous collateral (BTC), thereby preventing the accumulation of bad debt.

The Protocol’s liquidation process is fully decentralised, with no whitelisting, no preferred liquidators, and no off-chain intervention. Anyone can use their capital to repay undercollateralised UNIT positions in exchange for discounted BTC, all enforced natively on Bitcoin.

When a vault’s collateralisation ratio falls below the governance-specified Liquidation Threshold (currently set at 135%, but subject to change via governance), the vault is liquidated. This threshold is set significantly above 100% for three reasons:

1. To provide a buffer in the event of a sudden, sharp drop in BTC’s price.

2. To fund a Liquidation Tax, which finances the Protocol.

3. To incentivise future buyers of the vault by offering them the residual positive Net Asset Value (NAV) as compensation for their cost of capital.

In a liquidation, the transaction originally signed by the user during their most recent interaction allows for the transfer of ownership of the vault’s assets to a Liquidator once two conditions are met: the vault undercollateralisation condition has been satisfied, and a Liquidator has submitted a valid transaction to repossess and recapitalise the defaulted vault.

A liquidation’s profitability is a function of four variables:

1. The vault’s collateralisation ratio at the time a Liquidator offers to recapitalise the vault

2. The liquidation tax rate

3. The liquidation tax rebate rate (a tax offset in which the Protocol shares profits with the Liquidator. This rate increases as the vault’s collateralisation level decreases)

4. The ease with which a Liquidator can buy UNIT at the lowest possible premium to $1, if they wish to exit the liquidated position

Our liquidation engine includes a rich profit-sharing mechanism for BTC Liquidators to incentivise participation in this novel process. On the flipside, Liquidators must also take on uncertain duration risk, as they are required to acquire UNIT elsewhere to fully close their positions. They will likely have to repurchase UNIT at a slight premium to $1, similar to how MakerDAO’s DAI stablecoin often trades above $1 when multiple vaults are being liquidated.