Liquidation and Physical Delivery

This section explains the liquidation process on the TSI platform, which occurs when a borrower's collateral value falls below a certain threshold or when a loan is not repaid by maturity, triggering a risk mitigation process to protect lenders.

LTV Thresholds and Risk Management

TSI employs a multi-tiered Loan-to-Value (LTV) threshold system to manage risk and ensure the security of lenders' assets. These thresholds trigger specific actions at different stages, providing a structured approach to risk management.

LTV Thresholds (numbers are examples)

Key LTV Thresholds

• Initial LTV (ILTV):

  • This is the maximum allowed LTV when a borrower places an order.

  • For order placement, the collateral value must be sufficient to ensure that loan LTV ≤ Initial LTV.

  • This threshold helps establish a safe starting point for loans with adequate collateralization.

• Maintenance LTV (MTLTV):

  • This serves as the margin call threshold.

  • When loan LTV ≥ MTLTV, the TSI system automatically sends a margin call notification to the borrower.

  • Upon receiving this notification, borrowers must either add additional collateral or repay a portion of the loan to reduce the LTV below this threshold.

  • This early warning system helps prevent liquidations by prompting borrowers to take action before their position becomes too risky.

• Liquidation LTV (LLTV):

  • This is the critical threshold that triggers the liquidation process.

  • When loan LTV ≥ LLTV, the liquidation protocol is automatically initiated.

  • The TSI system sends notifications to both the lender and borrower informing them of the liquidation.

  • At this point, the collateral is automatically prepared for liquidation as described in the Liquidation section.

• Physical Delivery LTV (PDLTV):

  • This is the threshold for physical delivery of collateral.

  • When loan LTV ≥ 1, the physical delivery process is triggered.

  • The TSI system sends notifications to both the lender and borrower about this action.

  • This threshold represents a situation where the collateral value has fallen to or below the loan value, necessitating immediate action to protect the lender.

Importance of LTV Thresholds

These LTV thresholds form a progressive risk management system that:

• Provides multiple opportunities for borrowers to maintain healthy collateralization

• Creates a structured approach to handling deteriorating loan positions

• Ensures lenders' assets are protected through timely interventions

• Maintains the overall stability and security of the TSI platform

Initial LTV (ILTV)

Initial Loan-to-Value (Initial LTV or ILTV) is a critical parameter in the TSI system that helps manage risk for both borrowers and lenders. It serves as a buffer to prevent excessive risk exposure and frequent liquidations.

Definition and Purpose

The ILTV represents the allowable ratio between the loan amount and the collateral value when a borrower is placing the order. This ratio is expressed as a percentage and varies depending on the market and the specific collateral type being used.

Initial LTV Implementation

Order Placement Constraint

• When a borrower places an order with collateral, the TSI system automatically checks if the order's LTV is lower than the ILTV for the specific market and collateral combination.

• If the calculated LTV is equal to or higher than the ILTV, the borrower cannot place the order. The system will reject the order and prompt the borrower to either:

  • Increase the collateral amount

  • Decrease the borrowed amount

  • Use a different collateral type with a higher ILTV

Liquidation Completion Requirement

• Whenever a liquidation is triggered, the liquidation process must result in the loan's LTV being lower than the ILTV after execution.

• If the liquidation cannot reduce the LTV below the ILTV threshold, the liquidation will fail, and the system may proceed to alternative resolution methods such as physical delivery.

• This requirement ensures that partial liquidations result in a healthier position rather than leaving the loan in a vulnerable state.

Variable Initial LTV by Market and Collateral

• Each market with different collaterals has a unique Initial LTV setting based on:

  • The volatility of the collateral asset

  • The liquidity of the collateral asset

  • The correlation between the borrowed asset and the collateral

  • Market depth and trading volume

• For example:

  • Stablecoin collateral for stablecoin borrowing might have a higher ILTV (e.g., 90%)

  • Volatile cryptocurrency collateral for stablecoin borrowing might have a lower ILTV (e.g., 70%)

Benefits of ILTV

• Reduced Liquidation Frequency: By maintaining a buffer between the current LTV and liquidation threshold, the system reduces the likelihood of frequent liquidations due to minor market fluctuations.

• Enhanced System Stability: ILTV helps maintain overall platform stability by preventing excessive risk accumulation.

• Improved User Experience: Borrowers benefit from clearer risk parameters and reduced chances of unexpected liquidations.

• Protection for Lenders: Ensures that loans are adequately collateralized, providing greater security for lenders' funds.

The ILTV mechanism works alongside other risk management features in TSI to create a robust and secure borrowing and lending environment.

Maintenance LTV (MTLTV)

The Maintenance Loan-to-Value (MTLTV) ratio is a critical risk management threshold within TSI's lending ecosystem. It serves as an early warning system for both borrowers and lenders, triggering proactive measures before a position approaches liquidation.

Definition and Purpose

The Maintenance LTV represents the threshold at which a loan is considered at risk but still salvageable before liquidation procedures begin. When a loan's LTV ratio reaches or exceeds the MTLTV (e.g., set at 0.8 or 80%), the TSI system automatically initiates a margin call process.

Margin Call Process

When a loan's LTV crosses the MTLTV threshold, the following actions are taken:

• Automated Notifications: Both the borrower and lender receive immediate notifications through the TSI platform, alerting them to the margin call situation.

• Required Actions for Borrowers: The borrower must take one of the following actions to reduce their LTV ratio below the MTLTV threshold:

  • Add Collateral: The borrower can deposit additional collateral to increase the collateralization ratio and decrease the LTV.

  • Partial Repayment: The borrower can choose to repay a portion of the loan to reduce the outstanding debt and lower the LTV ratio.

Monitoring and Visibility

• Real-Time Dashboard: The TSI platform provides real-time visibility into the current LTV of all active loans, allowing borrowers to monitor their positions proactively.

• Proximity Alerts: The system can also be configured to send alerts when a loan's LTV approaches the MTLTV, giving borrowers additional time to take preventive measures.

Liquidation LTV (LLTV)

Liquidation Process

1. Liquidation Triggers: The liquidation process can be initiated under two conditions:

   1. Collateral Value Decline: If the current Loan-to-Value (LTV) ratio rises above the predefined liquidation threshold (liquidation LTV or LLTV). For example, if the liquidation LTV is set at 85%, liquidation would be triggered when the loan value becomes greater than 85% of the collateral value.

   2. Maturity Default: If the borrower fails to repay the loan before the maturity time.

2. Market Monitoring: The TSI system continuously monitors both the market price of collateralized assets and loan maturity dates.

3. Notification:

   1. Margin Call: When the LTV ratio approaches the risk threshold MTLTV but has not yet reached the liquidation trigger, the TSI system will send a margin call notification to the borrower, alerting them to add more collateral or partially repay the loan to avoid liquidation.

   2. Liquidation Notice: If the LTV crosses the liquidation threshold or the loan reaches maturity without repayment, all relevant parties (lender and borrower) are notified of the impending liquidation.

4. Liquidation Process Initiation:

   1. The whitelisted liquidator (bot) initiates the liquidation by:

      1. Approving to transfer the debt to the lender

      2. Calling the smart contract to execute the liquidation

5. Smart Contract Execution:

   1. The smart contract orchestrates the asset transfers according to the predetermined priority order:

      1. Transfers the liquidated collateral payment (less reward) to the lender, covering their principal and interest

      2. Transfers the collateral being liquidated to the liquidator

      3. If sufficient funds remain, transfers the penalty fee to TSI

      4. Returns any remaining collateral to the borrower

6. Distribution Priority:

   1. Lenders receive first priority to recover their principal and interest

   2. Liquidators receive their reward for executing the liquidation

   3. TSI receives the penalty fee (if sufficient funds remain)

   4. Borrowers receive any remaining collateral after all other obligations are satisfied

7. Automated Process: The entire liquidation is executed through smart contracts with no manual intervention required:

   1. The collateral is automatically unlocked in the lender's wallet based on their pre-approval during loan creation

   2. The liquidator swaps the collateral for debt tokens at a discount

   3. All transfers occur directly between wallets, not through an intermediary

8. Transaction Monitoring: All parties can monitor the status of the liquidation transactions in the Transfers page.

Liquidator Initiates a Liquidation Trade at the Accepted Price

Lender Transfers Collateral to Liquidator in Exchange for Payment

Liquidation and Maturity Time

In situations where liquidation occurs near the loan maturity time, the liquidation process takes precedence over the standard repayment process. The smart contract ensures that either the liquidation or the repayment is completed, but not both.

For borrower protection, the TSI system employs a precise liquidation mechanism. This mechanism ensures liquidations occur when necessary while minimizing losses to borrowers. The system calculates the optimal liquidation amount, and if there exists an amount where, after the liquidator repays the debt and covers both liquidator incentives and protocol penalties, the post-liquidation LTV approaches the maintenance LTV (0.8), then partial liquidation will be executed. This design allows borrowers to retain the maximum possible collateral while restoring their position to a healthy state.

However, if the calculated partial liquidation cannot effectively reduce the LTV to a healthy level, or if the remaining debt after partial liquidation would be less than 1 Million USD but greater than 0, the system will opt to liquidate the entire debt. This rule both prevents the system from accumulating too many small debt positions and ensures economic efficiency in the liquidation process.

Liquidation Penalty Calculation

The TSI system calculates a penalty to be applied during the liquidation process. This penalty ensures fairness and incentivizes timely actions. The calculation steps are as follows:

1. When a position becomes under-collateralized and meets the liquidation threshold (LLTV of 0.9), the liquidation process is triggered.

2. The system calculates the optimal debt amount to liquidate using a precise mathematical formula. This formula determines the minimum liquidation needed to restore the position's health, bringing the LTV back to the maintenance threshold: $L_a = \frac{D_t - \text{MLTV} \times C_t \times \frac{P_c}{P_d}}{1 - \text{MLTV} \times 1.05}$

   Where:

   • $L_a$ = Liquidation Amount
   • $D_t$ = Total Debt
   • $C_t$ = Total Collateral
   • $P_c$ = Collateral Price
   • $P_d$ = Debt Price
   • MLTV = Maintenance LTV Ratio (0.8)

   • 1.05 = Factor accounting for the 5% liquidation penalty

3. If the calculated remaining debt after partial liquidation would be less than 1 Million USD but greater than 0, the entire debt is liquidated instead. Additionally, if the calculated liquidation amount exceeds the total outstanding debt, the liquidator will liquidate the entire debt.

4. Upon liquidation, a 5% penalty is applied to the liquidated debt value:

   • 4% of the liquidated debt value is awarded to the liquidator as compensation

   • 1% of the liquidated debt value is allocated to the Term Structure Protocol as a fee

5. The liquidator repays the determined portion of the borrower's debt, and in return receives collateral equal to the debt amount plus the 4% liquidation bonus.

6. Any remaining collateral after debt repayment and penalty deduction is returned to the borrower.

Example 1: Standard Partial Liquidation

Let's consider a position with the following parameters:

• Total collateral value: 5000 ETH (worth 10,000,000 USDC at current prices)

• Outstanding debt: 9,200,000 USDC

• Current LTV = 0.92 (Exceeding the liquidation threshold of 0.9)

• ETH price (collateralPrice) = 2,000 USDC

• USDC price (debtPrice) = 1 USDC

Using our formula:

liquidationAmount = (9200000 - 0.8*5000*2000/1)/(1 - 0.8*1.05)
liquidationAmount = (9200000 - 8000000)/(1 - 0.84)
liquidationAmount = 1200000/0.16
liquidationAmount = 7,500,000 USDC

1. Liquidation amount: 7,500,000 USDC Convert To ETH: 7,500,000 / 2000 (ETH Price) = 3750 ETH

2. Liquidator incentive: 3750 ETH x 4% = 150 ETH

3. Protocol fee: 3750 ETH x 1% = 37.5 ETH

4. Total ETH the liquidator receives: 3750 ETH + 150 ETH (as incentive) = 3900 ETH

5. Remaining debt: 9,200,000 USDC - 7,500,000 USDC = 1,700,000 USDC > 1 Million USD

6. Remaining collateral: 5000 ETH - 3900 ETH - 37.5 ETH = 1062.5 ETH (2,125,000 USDC)

7. New LTV = 1,700,000 / 2,125,000 = 0.8 (exactly at the target MLTV)

Example 2: Full Liquidation Due to Minimum Debt Rule

Let's consider a smaller position:

• Total collateral value: 800 ETH (worth 1,600,000 USDC at current prices)

• Outstanding debt: 1,500,000 USDC

• Current LTV = 0.9375 (Exceeding the liquidation threshold of 0.9)

• ETH price (collateralPrice) = 2,000 USDC

• USDC price (debtPrice) = 1 USDC

First, calculate the minimum liquidation amount to reach target MLTV of 0.8:

liquidationAmount = (1500000 - 0.8*800*2000/1)/(1 - 0.8*1.05)
liquidationAmount = (1500000 - 1280000)/(1 - 0.84)
liquidationAmount = 220000/0.16
liquidationAmount = 1,375,000 USDC

Check if remaining debt would be below minimum threshold:

• Liquidation amount: 1,375,000 USDC

• Expected remaining debt: 1,500,000 - 1,375,000 = 125,000 USDC

• Since 125,000 USDC < 1 Million USD but > 0, the entire debt is liquidated instead (Rule #3)

Full liquidation process:

1. Liquidation amount: 1,500,000 USDC (entire debt) Convert To ETH: 1,500,000 / 2000 (ETH Price) = 750 ETH

2. Liquidator incentive: 750 ETH × 4% = 30 ETH

3. Protocol fee: 750 ETH × 1% = 7.5 ETH

4. Total ETH the liquidator receives: 750 ETH + 30 ETH = 780 ETH

5. Remaining debt: 1,500,000 USDC - 1,500,000 USDC = 0 USDC

6. Remaining collateral: 800 ETH - 780 ETH - 7.5 ETH = 12.5 ETH (25,000 USDC)

7. The borrower receives back 12.5 ETH (worth 25,000 USDC) after the full liquidation.

The full liquidation ensures that the protocol doesn't maintain positions with economically insignificant debt amounts, while still returning any excess collateral to the borrower.

Physical Delivery (PDLTV)

In certain scenarios where the standard liquidation process cannot be completed successfully, TSI implements a physical delivery mechanism to protect lenders and ensure they receive compensation. Physical delivery transfers the borrower's collateral directly to the lender as a form of settlement.

It's important to understand why standard liquidation might fail. Typically, liquidation bots will not perform liquidation when they determine there's no profit to be made, especially when the price of collateral has dropped dramatically. In such cases, the cost of executing the liquidation (including gas fees and operational costs) may exceed any potential profit from the price differential, making liquidation economically unfeasible for the bots. This is a key reason why the physical delivery mechanism exists as a failsafe.

Physical delivery is triggered under two specific conditions:

1. Default at Maturity

   1. If the borrower fails to repay the loan before the maturity time, liquidation is automatically triggered.

   2. If no liquidation bot successfully completes the liquidation process within a 2-hour liquidation window after triggering, the system will initiate physical delivery.

   3. The collateral is transferred directly from the borrower to the lender as compensation for the unpaid debt.

2. Physical Delivery LTV (PDLTV) Threshold

   1. If at any time before the borrower repays the debt, the Loan-to-Value (LTV) ratio reaches or exceeds the PDLTV, physical delivery will be triggered.

   2. The PDLTV is set to 100% or 1 by default.

   3. This situation occurs when the value of the collateral falls to or below the value of the loan, making liquidation impractical or impossible.

   4. The system bypasses the standard liquidation process and initiates direct transfer of the collateral from the lender to the borrower.

Physical Delivery Process

• Notification: Both the borrower and lender are immediately notified when physical delivery is triggered.

• Automatic Transfer: The TSI system and the smart contract automatically executes the transfer of collateral from the lender's wallet to the borrower's wallet.

• Debt Settlement: Upon completion of the physical delivery, the loan is considered settled, and the borrower's debt obligation is fulfilled.

• Transaction Recording: The physical delivery transaction is recorded in both parties' transfer histories for transparency and record-keeping.

Important Notes for Lenders:

• Automatic Process: All collateral transfers during liquidation are executed automatically based on your pre-approval during loan creation. No action is required from you.

• Debt Recovery: The liquidation process prioritizes returning your principal and interest first before distributing any remaining value to other parties.

• Potential for Loss: While liquidation aims to protect lenders, there is still a potential for loss if the collateral value depreciates significantly during the liquidation process.

• Physical Delivery Benefit: The physical delivery mechanism provides additional protection by ensuring you receive the collateral directly if standard liquidation fails, allowing you to manage the asset according to your own strategy.

• Monitoring: While the process is automated, it's good practice to monitor your loan positions to stay informed of any liquidation events.

Important Notes for Borrowers:

• Liquidation Prevention: Maintain a healthy collateralization ratio by either adding more collateral or partially repaying your loan when market conditions change.

• Repayment Deadline: Ensure loan repayment is completed before the maturity time to avoid automatic liquidation.

• Loss of Collateral: In the event of liquidation, you may lose some or all of your collateral. If physical delivery is triggered, your entire collateral will be transferred to the lender.

• Threshold Monitoring: The TSI platform provides tools to monitor your position's health and proximity to liquidation thresholds.

• Remaining Value: If your collateral value exceeds the debt amount plus liquidation costs, you'll receive the remaining value back after the liquidation is complete.