Profit settlement

Once a Liquidation is completed, the previous vault owner owns some amount of circulating UNIT, offset by an unbeknownst-to-him Liquidator who now controls the BTC collateralising the previous vault owner’s UNIT. To encourage this ‘estranged’ UNIT to be returned, and allow the original vault owner to close their vault, Liquidators will be able to buy UNIT trade on Bitcoin DEXs and L2s, such as BitGet, BitLayer, Babylon, etc. The Protocol will use its Reserve to create UNIT<>BTC liquidity as needed.

A vault owner must buy back sufficient UNIT at the buyback auction before he can collapse their vault and withdraw their BTC. In this manner, all estranged UNIT is at least 135% backed by BTC at all times. 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. Optimizing Liquidators’ experience to minimize duration risk at favorable risk-return ratios for them, while ensuring that all bad debt continually clears, will be an iterative process

Optimizing Liquidators’ experience to minimize duration risk at favorable risk-return ratios for them, while ensuring that all bad debt continually clears, will be an iterative process. An example of how we envision this function is shown below:

In this example, the protocol strongly encourages liquidators to immediately recapitalize liquidated vaults. The “kink” in the curve shows where the Protocol begins sharing that vault’s liquidation tax revenue with the Liquidator to subsidize a third-party liquidation process. Although the Liquidator’s return is positive at all points in the curve, the liquidator receives the best reward when he liquidates a vault at 134.99%. The liquidator’s profit function is:

[Vault_BTC - [Vault_BTC * liquidation_tax] + [Vault_BTC * liquidation_rebate]] / [Vault_Debt * UNIT_mint_min_collat_ratio]

Where:

Liquidation_tax = 15% Liquidation_rebate = a sliding function that kicks in when Vault_BTC <= 125% of Vault_Debt, growing to 100 percent of the vault’s liquidation tax revenue by the time the vault’s collateral level is at 102% UNIT_mint_min_collat_ratio = 160% The exact shape of these curves will be subject to product iteration and governance action to maximize liquidators’ user experience across a range of adverse scenarios.