Liquidation

Liquidation in Nexus Money Market is a risk management mechanism designed to keep the protocol solvent by ensuring that all loans remain sufficiently collateralized. If a borrower's Health Factor (HF) falls below 1, their position becomes eligible for liquidation. This typically happens when the value of their collateral drops significantly relative to the borrowed amount, increasing the risk of default.

How Liquidation Works

• When a borrower’s collateral value falls below the liquidation threshold, a portion of their collateral is sold to repay part of the debt.

• Liquidators—participants who help stabilize the protocol—can purchase the liquidated collateral at a discount, incentivizing them to step in and maintain system health.

• The borrower keeps any remaining collateral after the liquidation process is completed.

Example

Imagine a user supplies 10 wETH as collateral, valued at $30,000 (assuming 1 wETH = $3,000), and borrows 15,000 ZBU. At the time of borrowing, 1 ZBU is priced at $5, so 15,000 ZBU is worth $75,000 in total.

Since the Loan-to-Value (LTV) ratio for wETH is 75%, the user’s maximum borrowing capacity is $22,500 (75% of $30,000). However, the user has borrowed only $15,000 worth of ZBU (15,000 ZBU × $5 = $75,000 in ZBU, but the borrowed value in USD terms is still $15,000).

Now, if the price of wETH drops from $3,000 to $2,000, the total collateral value falls to $20,000. This reduces the Health Factor (HF), bringing it closer to the liquidation threshold. If the HF falls below 1, liquidation is triggered.

At this stage:

• A portion of the user’s wETH collateral is liquidated at a discount to repay part of the 15,000 ZBU debt (which still has a USD value of $15,000, assuming ZBU's price remains stable at $5).

• The borrower keeps any remaining collateral after liquidation but must repay more debt or add additional collateral to prevent further liquidation.

How to Avoid Liquidation

Borrowers can take proactive steps to avoid liquidation by:

• Repaying part of the loan to improve their Health Factor.

• Adding more collateral to increase their borrowing capacity.

• Monitoring market volatility to anticipate price fluctuations and manage risk accordingly.

Liquidation ensures that Nexus Money Market remains financially secure, protecting both lenders and borrowers while maintaining a stable lending environment.