Example

Imagine you’re following a real-world scenario where Alice uses her BTC as collateral and things don’t go as planned. Here’s what happens step by step:

1. Vault Setup

  • Alice deposits $800 of BTC into a vault.

  • She borrows 500 UNIT (the maximum allowed) and spends it outside of Ducat.

2. Market Drop

  • BTC’s value falls by 15.7% in one minute.

  • The vault’s BTC is now worth $674.40, which is too low to safely back 500 UNIT under the 135% collateralisation requirement.

3. Liquidation Tax

  • The protocol applies a 15% liquidation tax (about $101.16 of BTC) to the vault, which is escrowed.

  • After the tax, the vault holds $573.24 of BTC, still backing the 500 UNIT debt.

4. Liquidator Action

  • Bob, a Liquidator, steps in by adding $226.76 of BTC to bring the vault back to the required 160% collateralisation level.

  • In effect, Bob takes on Alice’s $500 debt and gains control of a vault holding $573.24 in BTC. This gives him a net asset value of $73.24.

5. Liquidation Rebate

  • In this example, Bob recapitalises the vault at a collateralisation level of 134.88%. Since the liquidation rebate does not begin until the vault falls below 124%, Bob does not receive any rebate from the protocol.

6. Bob’s Return

  • To withdraw the BTC from the vault, Bob must first repay the 500 UNIT debt by purchasing UNIT on the open market.

  • Assuming a UNIT/USD exchange rate of 1.00, the cost to acquire 500 UNIT is $500.

  • Bob’s profit from recovering the BTC (after taxes and rebate) is $73.24, as calculated in Step 4.

  • His total cost is $500 to acquire UNIT, plus $226.76 to recapitalise the vault, totalling $726.76.

  • Bob earns a profit of $73.24 on a total investment of $726.76, giving him a return of approximately 10.1%.

7. Protocol’s Role

  • The protocol retains the liquidation tax revenue, after paying out any rebate.

  • In more distressed vaults, the protocol may share a larger portion or all of the liquidation tax with the Liquidator to offset higher risk.

This breakdown shows how a sudden market drop can trigger liquidations and create opportunities for Liquidators like Bob, while the protocol uses liquidation taxes and rebates to manage the risk of bad debt accumulation.

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