Dynamic Adjustment of Liquidation Point in Governance

Overview

Through Clynto Governance, users can vote on key parameters that influence the safety and profitability of the protocol. These parameters include:

1. Liquidation Point: The Loan-to-Value (LTV) ratio at which a loan is liquidated.
2. Highest LTV Allowed: The maximum LTV a loan can reach before it is considered too risky.
3. Max Interest Rate: The maximum interest rate allowed on loans, which also serves as a safety threshold.
4. Minimum Duration for Investment Liquidation: The minimum period lenders must wait before they can request the liquidation of their investment.

Dynamic Adjustment Mechanism

When users vote to change the Minimum Duration for Investment Liquidation, the platform automatically adjusts the Liquidation Point to ensure lender safety. Specifically, the liquidation point increases as the minimum duration increases, providing a safety buffer for lenders over time.

Liquidation Point Equation

To achieve this dynamic adjustment, the following formula is used:

Where:

• $( R_{\text{max}} = i.e.\ 90\% )$: The Max Interest Rate for the highest LTV risk tier, serving as the minimum threshold for the liquidation point.
• $( α = 0.01)$: A decay constant that controls how quickly the liquidation point approaches 100% as the minimum duration increases.
• $(D)$: The Minimum Duration for Investment Liquidation in days.

How It Works

• Minimum Threshold: The liquidation point never falls below 90%, ensuring lender safety even in short-duration loans.
• Gradual Increase: As the minimum duration increases, the liquidation point gradually approaches 100%, reducing lender risk over time.
• Cap at 100%: The liquidation point is capped at 100%, ensuring that the risk remains manageable regardless of the duration.

Example Calculations

• Short Durations (e.g., 10 days): The liquidation point is slightly above the max interest rate (90.95%).
• Long Durations (e.g., 365 days): The liquidation point reaches 100%, reflecting the reduced risk over a longer investment horizon.

Why Use the Dynamic Adjustment Formula Instead of Voting on a Random Number?

Problem with Random Voting

Allowing users to vote on a random number between the highest interest rate and 100% to set the liquidation point might seem straightforward, but it introduces several potential issues:

1. Lack of Consistency: Voting on a random number could result in inconsistent and potentially arbitrary liquidation points across different loans. This inconsistency can create uncertainty and confusion for both borrowers and lenders.
2. Risk Mismanagement: The liquidation point directly influences the risk profile of a loan. If users randomly set a low liquidation point, it might expose lenders to unnecessary risk, especially if the market conditions worsen or if the loan duration is long.
3. Missed Opportunity for Risk Adjustment: The liquidation point is a critical tool for managing risk. A dynamic, formula-based approach allows the platform to systematically adjust the liquidation point in response to changes in the minimum investment duration, ensuring that the risk profile of a loan is appropriately managed.
4. Reduced Strategic Voting: If users vote on a random number, it can lead to decisions that are not aligned with the overall risk management strategy of the platform. The dynamic formula ties the liquidation point to the duration and interest rate, aligning the voting process with the platform’s risk management goals.

Benefits of the Dynamic Adjustment Formula

1. Systematic Risk Management: The formula ensures that the liquidation point is adjusted in a way that proportionally reflects the risk associated with different loan durations. It guarantees that as the duration increases, the liquidation point approaches 100%, thereby managing the risk for longer loans.
2. Consistency Across Loans: By using a standardized formula, the platform ensures consistent application of risk parameters across all loans, making the system more predictable and reliable for users.
3. Aligned with Risk Tolerance: The formula ensures that the liquidation point never falls below a certain threshold (e.g., the max interest rate), which aligns with the platform’s risk tolerance and protects lenders from undue risk.
4. Transparency and Predictability: Users can clearly understand how their votes will influence the liquidation point, making the platform more transparent. This predictability is crucial for building trust among users.

Conclusion

While letting users vote on a random number might seem like a simple solution, it lacks the strategic alignment needed for effective risk management. The dynamic adjustment formula provides a structured and systematic way to adjust the liquidation point, ensuring that the protocol remains safe and predictable for all users. By tying the liquidation point to the minimum investment duration and the max interest rate, the formula aligns user voting with the protocol’s broader risk management objectives.