Liquidations

Health Factor and Collateral Management

The Health Factor is a numeric representation of the safety and risk associated with a trader’s margin account. It reflects the relationship between the value of the collateral and the borrowed amount, plus any accrued interest. A Health Factor greater than 1.05 means the account is healthy, while a Health Factor below 1.05 indicates the account is at risk of liquidation.

When traders borrow leverage from Vanna’s lending pool to execute various strategies, the system uses a Health Factor (HF) to continuously monitor the risk associated with their margin account.

Health Factor Calculation:

The Health Factor is calculated using the formula:

Where:

• TVW(t) : Threshold Weighted Value – representing the collateral value, adjusted by the liquidation threshold

• b(t) : Borrowed amount

• interest accrued(t) : Interest that has accumulated on the borrowed funds.

Key Points About Health Factor:

• Healthy Account: When the Health Factor is above 1.05(in case of Vanna), the account is safe, and liquidation is not a concern.

• Risky Account: If the Health Factor drops below 1, the trader’s account becomes eligible for liquidation, meaning the collateral might be sold off to repay the borrowed funds.

• Monitoring: Vanna continuously monitors the Health Factor, and traders can track it in real-time using the Greeks Dashboard, ensuring they have time to manage risk before a liquidation event occurs.

Liquidation Threshold

Each collateral asset in Vanna has an associated Loan-to-Value (LTV) ratio that defines the maximum borrowing limit against the asset. If the total value of the borrowed amount exceeds the allowed LTV, or if market fluctuations reduce the value of the collateral, the Health Factor will drop, and liquidation can be triggered.

The liquidation threshold is defined by the collateral’s specific risk profile, volatility, and the protocol’s safety parameters.

Liquidation Threshold Formula:

Liquidation Process

If a trader’s Health Factor drops below 1.05, the liquidation process begins to ensure the protocol remains solvent and that lenders are protected from losses.

1. Automated Liquidation:

• When the Health Factor falls below 1.05, Vanna automates the liquidation process, allowing external actors (maintainers) to trigger liquidation.

• The trader’s collateral is partially or fully sold to cover the borrowed margin and any accrued interest, and any remaining collateral is returned to the trader.

1. Incentives for Liquidation Participants:

• Liquidators (maintainers) are incentivized to act by earning an arbitrage profit. They can purchase liquidated collateral at a discounted rate, ensuring fast action to protect the protocol from defaults.

• A portion of the liquidated collateral goes into Vanna’s treasury as a liquidation fee, contributing to the protocol’s long-term stability.

Avoiding Liquidation:

Traders can prevent liquidation by taking proactive actions to manage their account’s Health Factor:

1. Adding Collateral: Increasing collateral boosts the Health Factor, reducing the risk of liquidation.

2. Reducing Borrowing or Leverage: Closing some leveraged positions or repaying part of the borrowed margin will bring the Health Factor back above the liquidation threshold.

3. Real-Time Monitoring via the Greeks Dashboard: Vanna’s Greeks Dashboard gives traders real-time updates on their position health, alerts when the Health Factor drops, and insights on adjusting strategies to avoid liquidation.

Conclusion

Liquidations on Vanna Protocol safeguard both the protocol and lenders by ensuring that under-collateralized positions are automatically liquidated before they can incur losses. Traders are provided with real-time tools like the Greeks Dashboard to manage their risk and take actions to maintain a healthy margin account.