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 will be as decentralised as possible, i.e., new users use their capital to liquidate defaulted Borrowers.

When a vault’s collateralization ratio falls below the governance-specified Liquidation Threshold (currently set at 135%, but subject to governance), a user’s vault is liquidated. This threshold is set significantly above 100% for 3 reasons:

1. to provide ample cushion 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 a future buyer of the vault by offering him the residual positive Net Asset Value (NAV) of the vault as compensation for their cost of capital.

In a liquidation, the transaction which the user had originally signed during the latest interaction allows for ownership transfer of the vault's assets to a Liquidator once the vault-undercollateralisation condition has been satisfied, and once a Liquidator has submitted a satisfactory transaction to repossess and recapitalise the defaulted vault. A Liquidation’s profitability is a function of 4 variables:

1. The vault collateralization at the time a Liquidator offers to recapitalize 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 rises as the vault’s collateralization level decreases)

4. The ease at which a Liquidator can buy UNIT at the lowest possible premium to $1 (if he wants to exit the liquidated position)

Our liquidation engine envisions a rich profit-sharing function for BTC liquidators, to encourage them to trade with a novel mechanism. On the flipside, liquidators will also have to take on uncertain duration risk, as liquidators must purchase UNIT elsewhere to fully close their positions. They will also likely have to repurchase UNIT at a slight premium to $1, analogous to how MakerDAO’s DAI stablecoin tends to trade at a greater premium to $1 as more vaults are liquidated.