Account Liquidation
Learn how accounts are liquidated, what happens during liquidation, and who stakeholders are.
Last updated
Learn how accounts are liquidated, what happens during liquidation, and who stakeholders are.
Last updated
A comprehensive understanding of the liquidation rules is essential for efficient trading on the Gamma Options platform. In this chapter, we provide you with a deeper insight into the risks associated with margin trading.
By design, the margin account health is kept above 125% to maintain system stability at all times. This percentage is called the recovery threshold, and the system rejects any action by the user that results in a reduction in health below it. Additionally, there is a liquidation threshold set at 120%. If the Margin Account Health drops beneath the liquidation threshold, the system will deem that Margin Account liquidatable. The buffer between recovery and liquidation threshold allows the user to improve his health by depositing additional assets, closing out unfavorable positions, or repaying a part or the entire debt.
A liquidated account is one whose health is below the liquidation threshold and is being liquidated. It can hold assets (USDC, ETH) and positions (options, LP positions, and futures).
The account performing the liquidation. A liquidator account will receive all of the positions and entire debt of the liquidated account, plus the appropriate reward for executing the liquidation and thus, keeping the system in check. The only requirement for the liquidator account is that its health remains above the recovery threshold upon liquidation execution.
An insurance fund is a special account funded by insurers' deposits, platform profits, and successful liquidations. Its purpose is to represent an additional layer of protection for all Gamma Options platform participants. You can take a deeper dive into the Insurance Fund mechanics here. The insurance fund can be the liquidator.
When all of the conditions for the liquidations are met, the liquidator account assumes all of the positions and the entire debt of the liquidated account. Additionally, the liquidated account will be penalized by 10% of the debt, out of which half goes to the liquidator account and the other half to the insurance fund. Please note that the insurance fund can also perform the liquidation, in which case it would acquire the entire 10% of the reward. After the liquidation process, the liquidated account will be left with no positions, no debt, and some or no assets.
However, there are exceptions to this scenario. For example, the liquidated accounts' entire liquidity is in positions. In that case, the insurance fund gets nothing, and the liquidator might receive more than a 10% reward. That is why Gamma Options has established the following liquidation rules:
The liquidator always takes all of the positions and the entire debt of the liquidated account
Insurance fund net profit should not exceed 5%
If the liquidated account has more than 105% in positions, the insurance fund will take as much as possible without breaking rule 2. *Please notice that this is the scenario where the penalty can potentially exceed 10%
The liquidator never ends up with less than a 5% reward
Let us look at some “exception” examples to better illustrate these rules.
The liquidated account has above 110% in positions and 0% in assets (eg. 114% in positions)
In this case, the liquidator account would have the entire liquidity, the insurance fund would not be rewarded, and the total penalty would amount to 14% of the debt.
The liquidated account has above 110% in positions and has assets (eg. 118% in positions and 1.5% in assets)
In this case, the liquidator account would receive 118% of the positions, the insurance fund would receive 1.5% of the assets, and the total penalty would amount to 19.5% of the debt.
The liquidated account has 104% in positions and 7% in assets.
In this case, the liquidator account would receive 104% of the positions + 1% of the assets, the insurance fund would receive 5% of the assets, and the total penalty would amount to 10% of the debt.
One thing to notice from these examples is that penalties higher than 10% of the debt occur when the liquidated account predominantly holds positions compared to assets. This is by design because it makes the entire liquidated position more risky, and consequently, the reward becomes higher.
Unsuccessful liquidations are related to rule no. 4 - The liquidator never ends up with less than a 5% reward. If that is the case and the liquidator is not the insurance fund, the insurance fund is responsible for reimbursing the liquidator account. Also, if the insurance fund is the liquidator, and the total health is below 100% of the debt, the insurance fund is responsible for covering the difference. Those are the situations where a system actor (insurance fund) loses money. The buffer zone between the liquidation threshold and liquidator reward (120% - 105%) is deliberately wide, leaving a comfortable amount of time for all parties of interest to perform a successful liquidation. Those parties are:
The insurance fund - loses money in case of an unsuccessful liquidation, but gains money in case of a successful one.
Any lender to the Margin Pool - keeps the system safe and safeguards the Margin Pool + receives a liquidation reward.
Any other account - receives a liquidation reward.
In the case of the black swan event, where liquidation is so catastrophically unsuccessful that the entire insurance fund gets depleted trying to compensate losses, the remaining losses are shared by the Margin Pool liquidity providers proportionally to their share of the pool.