How does liquidation work? How much of my collateral gets liquidated, and which collateral tokens get liquidated?

Hi! I just want to ask a few clarifying questions so I better understand the risks I’m taking.

Let’s say I have a portfolio with 5 ETH and 5000 USDC as collateral. Let’s say ETH is $5000 at T1 (Time 1) for the sake of these questions. I am able to borrow up to 80% of the value of my collateral before liquidation, so $28000. I borrow $20000.

It is now T2 and ETH has dropped to $4500. Now my collateral is worth $27500.

What gets liquidated at T2? $500 of my USDC, or $500 of my ETH? Or does more of my collateral than that get liquidated?

@Emilio would you please answer the questions? Just trying to understand my risks better. Thank you!

Hi @robhaisfield.
First a remark, when having as collateral both ETH and USDC, your LTV and liquidation thresholds are actually a combination of the ones of ETH, USDC, weighted depending on the proportion of amounts of each forming your collateral. ETH and USDC happen to have the same parameters, but for the sake of understanding.
Concerning your question about liquidation, the rule is that up to 50% of the total value of your collateral gets liquidated, and it is the liquidator who chooses which asset to receive. So if you enter in liquidation (health factor below 1), taking into account your example, the liquidator could choose to take part of your ETH (as it is more than 50% of your collateral), or just the whole USDC. In this case it is probably smarter to choose the first, to liquidate and take bonus in as bigger amount as possible.

Thank you for the response. Is there a reason it was designed such that the liquidator chooses what gets liquidated? I would far prefer to rank the collateral myself for what gets collateralized first, and generally that seems more user oriented. I’d love to understand the rationale better.

I’m sure you would prefer that, but it doesn’t make much sense to design it that way.

The general “job” of liquidators is, to keep the protocol solvent and secured. Thus they’re incentivized by liquidation bonuses which differ from asset to asset. But if you look at situations where liquidations are necessary - i.e. high volatility to the downside - it matters what assets you hold as a liquidator. Chances are that if you deem a deposited asset as “okay” to be liquidated and thus less valuable in that situation to yourself, the liquidators see it the same way. They might get a bonus liquidating said asset, but might not be able to flip it fast enough (be it because of low on chain liquidity or generally poor market conditions) to make a profit. If they don’t want to take that risk, they just let the position fall into default, which in turn brings the whole protocol down.
That is why it is good and necessary to let the liquidator decide. You can see it as them paying the loan back for you, so it is just fair for them to decide how you pay for that.

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