Liquidation

Maintaining a lower collateral rate allows you to mint more zAssets for less collateral, but does not come without its risks. A CDP can be liquidated when it falls below the minimum collateral ratio. At this stage, if the owner does not quickly act and deposit more collateral or burn zAssets to deleverage their position, other users may purchase their CDP's collateral at a discount.

The protocol will raise the CDP's collateral ratio by burning zAssets it recovers from liquidating its collateral. Let $a$ be the amount of the zAssets paid (up to the amount minted by the CDP) and $d$ be the zAsset's liquidation discount rate. The buyer can expect to receive:

$$\min\bigg(\frac{a}{1-d}\times\frac{P_z}{P_c},Q_c\bigg)$$

The remainder of the collateral not sold is returned to the CDP's owner.

The liquidation process can be continues until either the CDP's collateral ratio is restored to a level above the zAsset's minimum collateral ratio OR the number of borrowing zAssets is completely burned, which closes the position. Because this provides almost risk-free profit, participants are incentivized to liquidate the entire liquidated position when possible to maximize their profits.

Example

To illustrate, let zXXX be priced at 1 USD. Assume the asset has a minimum collateral ratio of 150% and a liquidation discount rate of 20%. A user has opened a CDP to mint 100 zXXX at the collateral ratio of 150%, depositing 150 DAI as collateral.

If the CDP is being liquidated with the liquidator paying 100 zXXX to liquidate the position, one should receive:

$$\min\bigg(\frac{100\text{zXXX}}{ 1-0.2}\times\frac{\text{1USD/zXXX}}{1\text{USD/DAI}},150\text{DAI}\bigg)$$

Working over the math, one should receive around 125 DAI, making about 25% profit. The CDP owner would receive the remaining 25 DAI.

Note that the CDP owner would still retain his 100 zXXX, meaning along with the 25 DAI they would keep around 125 USD of value out of their initial 150 DAI deposit.

To avoid liquidation, users should aim for a collateral ratio that factors in the known price dynamics of the reflected asset. A safety buffer of at least 50% above the zAsset's minimum is usually recommended. Users with open positions should actively monitor price activity that threatens the safety of their CDP and respond accordingly either by burning zAssets (or closing the position altogether) or depositing more collateral to reduce the possibility of liquidation.