Liquidation Risk
Below is the current configuration for the collateral assets supported in V1.
ETH
70%
80%
50%
WBTC
70%
80%
50%
USDT
70%
80%
50%
USDC
70%
80%
50%
On initiation of a Murabaha the users DTC cannot exceed the users weighted average Max DTC. Once the debt occurs, the DTC evolves with market conditions. The max DTC for a given asset is mainly a function of its volatility profile.
The difference between the Max DTC and the Liquidation Threshold acts as a protective measure for Murabaha Takers. While the liquidation threshold ensures a buffer of collateral above the debt value, allowing for a bonus/penalty to incentivise liquidators, the assets mentioned are highly liquid on-chain and experience minimal price impact even when sold in large quantities. Though these assets currently share a similar Market Risk profile, it's possible for this to change, prompting the protocol to adjust the parameters highlighted in the table. Users should be aware that such changes might alter their individual Weighted Average Liquidation Threshold, Weighted Max DTC, and Weighted Average Liquidation Penalty. In less favourable situations, this could lead to earlier-than-anticipated liquidations, limit a user's allowable debt, or raise the penalty during liquidation.
Under-collateralised positions are liquidated at 100% of the debt value, this may not be ideal in mitigating liquidation cascades due to large amounts of collateral being sold on the open market. The magnitude of this risk is directly related to the Total Value Locked (TVL) or collateral in the protocol. While supply/debt caps can mitigate this risk, introducing partial liquidations offers an additional layer of protection. As each debt in AZKA is unique, partial liquidations would require more computational complexity. This feature will be tackled in V2 as the associated risk becomes pronounced. The AZKA core team has chosen to manage this risk in V1 through stricter supply/debt caps and sees this risk as negligible while the protocol is in its infancy. The price impact and liquidity constraints of large Murabaha transactions also acts as a natural debt cap.
The liquidation penalty serves as a reward for liquidators, guaranteeing them a profit when they repay the debt. In V1, since partial liquidations (beyond time-based liquidations) aren't supported, the penalty is calculated as a weighted average. Liquidators indicate their preferred order of token acquisition, and the smart contract aims to settle the combined debt and penalty using the tokens in that sequence, fully addressing the amount due from the initial token before proceeding to the next.
As AZKA protocol grows in liquidity and introduces more features, its risk profile will become more pronounced. To address this, AZKA plans to collaborate with a DeFi-centric risk partner to bolster data analysis and refine parameter choices. Potential partners include Gauntlet, Simtopia, and Risk DAO.
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