4.6 Example

Assume you have opened a leveraged yield farming position with a collateral of $10,000 and a borrowed amount of $5,000. The protocol sets a required collateralization ratio of 150%, meaning your collateral must be worth at least 1.5 times the borrowed amount.

Now, let's say the value of the assets you borrowed (let's call it Token X) experiences a significant drop in price, causing the value of your collateral to fall below the required threshold. In this example, the current value of your collateral drops to $6,000.

Since your collateral value has fallen below the required collateralization ratio, the protocol triggers a liquidation to protect the lender and maintain the system's stability. Let's assume the liquidation discount applied is 10%.

The protocol will automatically sell a portion of your collateral to repay the borrowed amount and cover any outstanding fees. In this case, the liquidation process involves selling $5,000 (the borrowed amount) divided by 1.1 (to account for the 10% discount), resulting in $4,545.45.

After the liquidation, you will be left with $6,000 (your remaining collateral) minus $4,545.45 (the amount sold during liquidation), which equals $1,454.55. This remaining amount is returned to you, but your leveraged position is closed, and you have lost your borrowed funds.

It's important to note that this example is simplified, and actual liquidation processes can vary depending on the specific platform and its rules. Factors such as liquidation fees, slippage, and market conditions can impact the actual outcomes. It's crucial for users to thoroughly understand the risks and terms associated with leveraged positions and closely monitor their collateralization ratios to avoid liquidation events.