Liquidation

Understand how Clone's Comet Liquidity System handles the liquidation of unhealthy comets to maintain overall system stability.

The process of liquidation in the Comet Liquidity System is essential to maintain the system's overall stability and collateralization. This operation involves de-risking unhealthy comet positions, i.e., those with a health score of zero. In these instances, external actors known as liquidators can perform certain actions to improve the health score of a comet and stabilize the system.

What is Liquidation?

In the context of Clone's Comet Liquidity System, liquidation is a process to address comets at risk of becoming undercollateralized. It takes place when a comet's health score drops to zero, signifying that the position is out of alignment with current market conditions and potentially threatens our system's stability. Liquidation is performed by liquidators, who are incentivized to de-risk the system by performing certain actions.

Liquidation Process

When presented with an unhealthy comet. Liquidator's must first choose which liquidity position they would like to liquidate. Once this is determined, liquidators must choose which of the position's impermanent loss debts to pay off:

1. Collateral Impermanent Loss Debt: In this route, the comet liquidity position's debt is neutralized directly using the comet's collateral. The liquidator plays a key role by activating this process. In this scenario, the liquidator doesn't provide any external capital.

2. clAsset Impermanent Loss Debt (ILD): For this option, the liquidator directly injects clAssets to mitigate the impermanent loss debt. By contributing a portion of the debt amount, they directly improve the health of the comet.

After the chosen debt has been addressed, the comet liquidity position's liquidity is brought down to zero, ensuring there's no lingering risk of future liquidation. Lastly, the liquidator is rewarded. In the case where the liquidator has paid off the clAsset impermanent loss debt, they first receive compensation that's equivalent to the amount of impermanent loss they settled from the comet's collateral. For both scenarios, an additional reward is provided from the collateral. This reward, determined by the Clone DAO, is a percentage based on the debt that was addressed.

Liquidation is a critical element of the Comet Liquidity System that helps maintain the system's stability by handling unhealthy positions and minimizing system-wide risk.

The Insurance Fund

Clone's Comet Liquidity System includes an additional safety net to maintain the stability of the system: the Insurance Fund. This fund acts as a secondary line of defense against the potential risk of undercollateralized positions that have not been liquidated in time. The Insurance Fund's primary function is to pay of the debt of undercollateralized positions, ensuring system stability even in the rare case that liquidations lag behind. The Insurance Fund accrues resources from small trading fees collected on Clone.