Ensuring System Stability and Mitigating Financial Risks
LOAN HEALTH SCORE, REPAYMENT & LIQUIDATION
If the collateral the user supplies goes down in value compared to the asset they have borrowed then the users have a couple of things they can do to avoid liquidation. First, they can add more collateral to increase the total value they are borrowing against. Second, the user can pay back some of the loans to bring the total debt down. Or the user can ignore the position entirely and the loan will be liquidated, and their debt paid off. The user will lose the collateral they put up but they will be able to keep the assets they borrowed. The user does not default, they simply close the loan.
The interest on the debt is slowly building up the user’s debt over time, and there are no required periodic payments, late fees or similar penalties that are typically associated with traditional debt like mortgages and credit card debt.
Users pay back their loans in crypto which is registered in the MELDapp on the blockchain. When a user wants to pay down their loan position, they will need to convert fiat to crypto or use crypto to pay off their loan.
Loans are issued at a loan-to-value (LTV) ratio based on the risk score of the asset. The risk is calculated based on several parameters such as liquidity in a DEXes, 24-hour trading volume, price fluctuation, market cap and other related market factors.
The maximum amount a user is able to borrow, the loan-to-value ratio, and liquidation threshold of a loan will depend on the collateral and debt assets, and their associated risk parameters.
If the collateral value falls in value or the debt increases, the health score of the loan will worsen until it ultimately opens for liquidation. Before this happens users can opt-in to be notified if the loan-to-value ratio reaches certain critical thresholds, prompting them to add more collateral or repay parts of the loan. Once the LTV passes the liquidation threshold, a liquidation event is triggered where the collateral is converted to USD/EUR stable coins equivalent to the fiat loan plus a percentage fee, and used to pay down parts of the loan. The remaining debt and collateral (if any) are retained by the user following liquidation and transferred back to the customer. The customers keep the fiat they borrowed, and the liquidated debt is considered to be settled.
A user deposits $1,000 worth of crypto and borrows $500 of fiat against it. The value of the crypto falls to the liquidation threshold, which in this case is $600, or a loan to value of around 83% (keep in mind this depends on the risk factor of the crypto). Half of the user’s debt is repaid, and a proportional amount of the collateral is claimed, along with a 5% fee. So the user is left with the $500 of fiat untouched, and a reduced debt of $250, along with $337.5 worth of their collateral. Their loan now has an LTV of 74% and is no longer at risk of liquidation.
This protocol aims to innovate in the debt markets by creating extremely capital-efficient products and services powered by blockchain technology, and by promoting availability, transparency, and empowerment. This will allow the protocol to give the most attractive borrowing rates to customers worldwide.