Profit settlement

Once a liquidation is completed, and before the vault can be collapsed and the BTC withdrawn by the Liquidator, the Liquidator must return the currently ‘estranged’ UNIT debt, which was incurred by the previous vault owner, to the vault. In other words, the Liquidator has acquired both the assets and the obligations of the vault.

To encourage the return of this estranged UNIT and allow the vault to be closed and the BTC withdrawn, Liquidators will be able to purchase UNIT on Bitcoin DEXs and Layer 2 networks. The Protocol will ensure that UNIT/BTC liquidity is available as needed.

Before a Liquidator can recover the BTC from a liquidated vault, they must first deposit enough BTC to recapitalise the vault to the minimum overcollateralisation ratio required at minting (currently 160%, subject to governance). Once this is done, the vault is transferred to the Liquidator, who now owns both the BTC and the outstanding UNIT debt. To fully close the vault and unlock the BTC, the Liquidator must then repay the UNIT debt by purchasing and returning an equivalent amount of UNIT to the vault. Only after this repayment is completed can the Liquidator collapse the vault and redeem the underlying BTC.

This ensures that all circulating UNIT remains fully backed by BTC at all times, and that bad debt does not accumulate in the system. Our liquidation engine includes a robust profit-sharing mechanism for BTC Liquidators, designed to incentivise participation through a novel trading model. On the flipside, Liquidators must also take on uncertain duration risk, as they are required to purchase UNIT elsewhere in order to fully close their positions.

Optimising the Liquidator experience to minimise this duration risk, while offering favourable risk–return dynamics and ensuring that bad debt is consistently cleared, will be an iterative process.

An example of how this function is envisioned is shown below:

In this example, the Protocol strongly encourages Liquidators to immediately recapitalise liquidated vaults. The “kink” in the curve marks the point where the Protocol begins sharing the vault’s liquidation tax revenue with the Liquidator to subsidise third-party liquidation. Although the Liquidator’s return remains positive across the curve (assuming the UNIT/USD exchange rate is 1.00), the Liquidator receives the highest reward when liquidating a vault at 134.99%.

The Liquidator’s profit function is:

[Vault_BTC × Vault_net_BTC_recovery_factor] − [Vault_Debt × UNIT_USD_rate]

The Liquidator’s return is this profit divided by the total cost to the Liquidator, expressed as:

([Vault_BTC × Vault_net_BTC_recovery_factor] − [Vault_Debt × UNIT_USD_rate]) ÷ ([Vault_Debt × UNIT_mint_min_collat_ratio × UNIT_USD_rate] − [Vault_BTC × Vault_net_BTC_recovery_factor])

Where:

• Vault_BTC = The amount of underlying BTC collateral in the liquidated vault before recapitalisation by the Liquidator.

• Vault_net_BTC_recovery_factor = The proportion of Vault_BTC recoverable by the Liquidator after the liquidation tax is deducted and any rebate is applied:

Vault_net_BTC_recovery_factor = 1 − Liquidation_tax + Liquidation_rebate

• Liquidation_tax: 15%

• Liquidation_rebate: A sliding function that activates when a vault’s collateralisation ratio falls below 135%, and increases progressively. The rebate reaches 100% of the liquidation tax when the collateralisation ratio falls to 102%.

• Vault_Debt: The amount of UNIT outstanding in the vault. This must be repaid (by purchasing UNIT on the open market) before the Liquidator can collapse the vault and withdraw the BTC.

• UNIT_USD_rate: The market price of UNIT in USD. A rate of 1.02 means the Liquidator must pay $1.02 to buy 1 UNIT.

• UNIT_mint_min_collat_ratio: The minimum collateral ratio required to mint UNIT, currently 160%.