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Liquidation Mechanisms

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Liquidation Mechanisms

Liquidation is a critical process in the Clynto Protocol, designed to protect lenders while maintaining fairness for borrowers in its decentralized lending ecosystem. When a loan’s risk profile becomes unsustainable—due to collateral value drops or repayment delays—liquidation mechanisms ensure that lenders can recover their funds by selling the borrower’s collateral. This section provides a detailed overview of Clynto’s liquidation rules, processes, and scenarios, offering clarity for community members participating in the system and investors assessing its risk management framework.

1. Introduction to Liquidation

In decentralized finance (DeFi), liquidation safeguards the integrity of lending pools by mitigating losses when loans become undercollateralized or overdue. Clynto’s liquidation mechanisms are community-governed, balancing the need to protect lenders with the flexibility borrowers require to manage their loans. This dual approach—early warnings and instant actions—ensures stability while fostering a user-centric ecosystem, with all processes executed transparently via smart contracts.

2. Liquidation Scenarios

Clynto supports two primary liquidation types: Early Liquidation Notice and Instant Liquidation, each tailored to specific conditions and timelines.

2.1 Early Liquidation Notice

This scenario allows lenders to initiate liquidation before a loan reaches critical thresholds, providing borrowers with a chance to respond.

2.1.1 Eligibility Conditions

  • LTV Threshold: The Loan-to-Value (LTV) ratio must be below the governance-defined liquidation point (e.g., 90%).
  • Loan Duration: The loan term must not have expired.
  • Minimum Investment Period: Lenders must have held their investment for a governance-set minimum duration (e.g., 10 days) before issuing a notice.

2.1.2 Notice Period

  • Duration: Set by governance, with a minimum of 7 days (e.g., a 30-day notice means 30 days before liquidation can occur).
  • Interest Freeze: Lenders stop accruing interest during the notice period, incentivizing timely borrower action.
  • Example: A 7-day notice means no interest is earned for those 7 days if liquidation proceeds.

2.1.3 Process

  • Issuance: A lender triggers the notice via the Loan Agreement Contract, notifying the borrower.
  • Borrower Response: The borrower can repay the loan or add collateral to lower LTV below the threshold.
  • Execution: If unresolved after the notice period, the lender can liquidate their portion of the collateral.

2.2 Instant Liquidation

This scenario allows immediate action when a loan’s risk becomes critical, protecting lenders without delay.

2.2.1 Conditions

  • Loan Duration Expiry: The loan term, optionally set by the borrower, has passed without full repayment.
  • LTV Threshold Reached: The LTV equals or exceeds the governance-defined liquidation point (e.g., 90%).

2.2.2 Process

  • Trigger: Any lender can initiate instant liquidation upon meeting either condition.
  • Execution: The Collateral Management Contract swaps and transfers the necessary collateral to the lender’s wallet.

2.3 Partial Collateral Liquidation

  • Description: In both scenarios, only a portion of the collateral required to cover the lender’s outstanding balance (principal plus accrued interest) is liquidated.
  • Purpose: Preserves remaining collateral for the borrower if possible, balancing fairness and recovery.
  • Example: A 5,000loanwith5,000 loan with 10,000 collateral at 90% LTV might liquidate 4,500worthtocoveralender’s4,500 worth to cover a lender’s 4,000 balance plus fees, leaving $5,500.

3. Liquidation Process Details

3.1 Early Liquidation Steps

  1. Notice Issued: Lender submits a liquidation notice if LTV is below 90% and minimum duration is met.
  2. Notification: Borrower receives an alert (e.g., “7-day notice: repay or add collateral”).
  3. Waiting Period: Interest accrual pauses for the lender; borrower has 7 days to act.
  4. Resolution: If LTV drops (e.g., via repayment), the notice cancels; otherwise, liquidation proceeds.
  5. Swap and Transfer: Collateral is sold, and proceeds cover the lender’s balance.

3.2 Instant Liquidation Steps

  1. Trigger Detection: LTV hits 90% or term expires, flagged by the Loan Health Monitoring System.
  2. Initiation: Any lender calls the liquidation function in the smart contract.
  3. Swap and Transfer: Collateral is immediately liquidated to repay the lender’s share.

3.3 Fees

  • Early Liquidation: 1% of the lender’s total owed amount, deducted from proceeds.
  • Instant Liquidation: 1% of the outstanding balance, paid by the borrower from collateral.

4. Governance Role

Liquidation parameters are set by CLY token holders through governance:

  • Liquidation Point: Default at 90% LTV, adjustable to balance risk (e.g., 95% for more borrower flexibility).
  • Minimum Duration: Defines the waiting period before early liquidation (e.g., 10 days).
  • Notice Period: Sets the early liquidation timeline (e.g., 7-30 days), ensuring fairness.

This community control ensures liquidation rules reflect user consensus, adapting to market conditions and ecosystem needs.

5. Importance for Users

5.1 For Borrowers

  • Flexibility: Early notice periods provide time to adjust (e.g., repay or add collateral), reducing liquidation risk.
  • Fairness: Partial liquidation preserves some collateral, softening the impact of defaults.
  • Transparency: Clear conditions and alerts enable proactive management.

5.2 For Lenders

  • Protection: Instant liquidation at 90% LTV or term expiry safeguards funds.
  • Control: Early notice option allows preemptive action before critical thresholds.
  • Predictability: Defined rules and fees ensure consistent returns.

6. Example Scenarios

  • Early Liquidation:

    • Loan: 5,000,Collateral:5,000, Collateral: 10,000, LTV: 50%.
    • Collateral drops to $6,000, LTV: (5000 / 6000) * 100 = 83.33% (Yellow).
    • Lender issues a 7-day notice; interest pauses. Borrower adds $2,000 collateral, LTV drops to 62.5%, notice cancels.

  • Instant Liquidation:

    • Loan: 5,000,Collateral:5,000, Collateral: 10,000, LTV: 50%.
    • Collateral falls to $5,500, LTV: (5000 / 5500) * 100 ≈ 90.91% (Red).
    • Lender triggers instant liquidation; 4,545ofcollateralissoldtocover4,545 of collateral is sold to cover 4,500 (principal + interest).

7. Ecosystem Impact

Liquidation mechanisms ensure:

  • Stability: Prevents systemic risk by addressing undercollateralized loans promptly.
  • Trust: Transparent processes build confidence for lenders and borrowers.
  • Balance: Governance-tuned rules maintain fairness, supporting a sustainable lending environment.

8. Conclusion

Clynto’s liquidation mechanisms are a cornerstone of its risk management strategy, protecting lenders while offering borrowers opportunities to avoid collateral loss. Early notices provide flexibility, instant liquidation ensures security, and partial liquidation balances outcomes. For community members, this system clarifies the rules of engagement, while for investors, it demonstrates Clynto’s commitment to ecosystem stability and user protection, reinforcing its robustness in the DeFi space.

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