Liquidation Risk

What is liquidation risk?

Liquidation risk comprises two categories:

• Liquidation risk of minters: When users mint BITU using risky assets as collateral, continuous declines in the collateral's value can potentially lead to the liquidation of the user's mint position.

• Liquidation risk of BitU: When a user's collateral ratio drops below the liquidation threshold, BitU needs to liquidate the user's position. This involves selling volatile collaterals in the open market to convert them into stable assets, ensuring sufficient value support for the circulating BITU. Delayed liquidation may result in collateral's value being less than that of circulating $BITU's value.

The first risk category has been previously explained. The focus now shifts to the second risk category, where delayed liquidation leads to the collateral's value being less than the minted BITU's value.

How do we manage liquidation risk?

BitU sets the liquidation threshold for risky assets at 110%, triggering liquidation when the collateral's value falls to 110% of the minted BITU's value (collateral ratio of 110%).Under normal circumstances, ALMM's liquidation module sells the collateral in the open market to obtain stable assets. However, obstacles may arise during this selling process:

• Severe price drops often lead to blockchain congestion, slowing down transaction execution.

• Continuous price declines may result in actual selling prices being lower than expected, causing the sale value to remain below BITU's value.

These two scenarios are the primary causes of liquidation risk. In the first scenario, ALMM's liquidation module isn't solely dependent on on-chain transaction execution. Since users' collateral is held in custody, the module can utilize centralized exchanges for liquidation.

Off-chain transaction execution often withstands market volatility and isn't impacted by high gas fees like on-chain transactions.

Furthermore, off-chain transaction execution usually leads to better prices and lower slippage.

If the market rapidly declines, causing the collateral's value to drop by more than 10% in a short time (in a few seconds), the actual liquidation rate may fall below 100% despite the liquidation threshold being set at 110%.

Here's an example:

• A user mints 1,000 BITU using BTC worth $2,000, resulting in a collateral ratio of 200%.

• During severe market fluctuations, BTC's price rapidly drops by 55% within seconds.

• The collateral's value then becomes $900(calculated as $2,000 * (1-55%)).

• Assuming ALMM's liquidation module couldn't liquidate at higher prices during the earlier decline, liquidation is completed after the 55% drop.

• As a result, the user's 1,000 BITU only has a value endorsement of $900, causing $BITU stablecoin to lose its USD peg.

In such potential cases, BitU immediataly initiates a compensation from the insurance fund to cover the gap in the circulating 1,000 BITU. The specific compensation amount is $1,000 - $900 = $100. Therefore, the insurance fund allocates $100 USDT to the custody address, ensuring sufficient value support for all circulating $BITU.

However, these are black swan events. In most liquidation cases, ALMM's liquidation module will successfully sell the collateral from risky mint positions in the open market, providing $BITU with adequate value support. As the liquidation threshold for risky assets is set at 110%, liquidation typically generates around a 10% profit. This profit is transferred to the insurance fund for compensation in case of unsuccessful timely profitable liquidations.

In addition to individual user liquidation processes, BitU incorporates a comprehensive risk management module. When the collateralization ratio of all risky assets within the protocol drops below the designated risk threshold, BitU triggers Safe mode.

Safe mode

In Safe mode, all new $BITU minting is temporarily halted. This operational pause affects the BitU ecosystem in several ways:

• Risk Mitigation: Users whose collateralization rates are nearing the minimum threshold are encouraged to increase their collateral or return the minted $BITU to avoid potential liquidation.

• Market Fluctuations: The prices of collateralized assets may continue to fluctuate, either increasing or decreasing.

During this mode, BitU’s ALMM actively liquidates positions that are below the critical collateralization rate, aiming to restore the overall collateral rate of risky assets above 130%.