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 in 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 $674.99, which is too low to safely back 500 UNIT under the 135% collateralization requirement.

3. Liquidation Tax:

   • The protocol applies a 15% liquidation tax (about $101.25 of BTC) to the vault, which is then escrowed.

   • After the tax, the vault holds $573.75 of BTC supporting the 500 UNIT debt.

4. Liquidator Action:

   • Bob, a liquidator, steps in by adding $226.25 of BTC to help bring the vault back to a safe level.

   • Essentially, Bob is buying Alice’s $500 debt using the vault’s $573.75 (which gives him a net asset value of $73.75) plus his own funds.

5. Bob’s Return:

   • Bob makes a profit of about 32.5% (a gain of roughly $73.80 on a total investment of $264.50).

   • He will need to acquire additional UNIT later to completely unwind the position.

6. Protocol’s Role:

   • The protocol keeps the liquidation tax revenue.

   • If Bob were to bid on a more distressed vault, the protocol might share some or all of the tax with him to lower his risk.

This breakdown shows how a sudden market drop can trigger liquidation and create opportunities for liquidators like Bob, while the protocol uses liquidation taxes to help manage the risk.