Restless Magenta Mallard
Medium
Liquidation can be triggered once the loan defaults, meaning the borrower fails to pay after loan duration expires. The liquidation will be triggered by the interested liquidators to acquire the collateral token assets in exchange of principal token loan payments.
However, liquidators won't simply trigger the liquidation for the sake of "acquiring collateral assets", there should be profit in order to encourage the liquidators to do that. In the protocol pertaining to the loan bids under LenderCommitmentGroup_smart (LCG) contract, there is situation that it can't be profitable due significant deviation of USD price between collateral token and principal (loan) token. In this case, the principal (loan) token increase significantly compared to collateral token in terms of USD price. This can greatly affect the sentiment of liquidators and delay the liquidation.
In other words, the liquidators won't pay for example 1 WETH principal (loan) token in exchange of 10,000 doge (collateral) coins if the current exchange rate increase significantly from 10,000 doge coins to 100,000 doge coins per 1 weth since the loan started. That's 10x more expensive.
The lender LenderCommitmentGroup (LCG) contract may try to close the loan during this special situation in order for at least recover the collateral, just in case liquidation take too long but this contract has no capability to retrieve it.
In one last desperate attempt, the developers may apply to upgrade the contracts affected in order to "retrieve the collateral", however i see this as a complex process and not easy to do specially if there so many loan bids affected. The contract or contracts to be upgraded may undergo several iterations, tests, audits before it will deployed again securely live on-chain. This will probably take long time like weeks to complete. If collateral is locked in the contract for more than a week, it can be considered as valid issue as per Sherlock ruling.
Even if the collaterals are retrieved, there is still problem need to solve. The collateral tokens need to be sold in trading market to convert it to principal token. Remember the lenders as liquidity providers in LCG contract, the principal tokens are the tokens they provided, so in essence if they will convert their shares, they should receive principal tokens. So conversion of retrieve collaterals into principal tokens is necessary step in order to properly distribute the principal tokens to the lenders when they convert their shares.
With all of these above processes involved, this is definitely will take a lengthy time and can take weeks or months while the lenders are waiting indefinitely.
Liquidation process do not have capability to change the price of the loan (reduce the quantity of principal tokens) in order to encourage the liquidators to acquire the collateral assets in affordable way. To prove this, let's check all these liquidations functions.
1. liquidateDefaultedLoanWithIncentive - this is quite expensive , the loan to pay even starts with about 7x of amount due plus amount due initially if minimumamountdifference is more than zero. Aside from this, is the high usd price of principal token compare to collateral token. This will definitely turn away liquidators.
2. liquidateloanfull - this can be triggered after 24 hours since default and the total amount need to be paid is principal token plus interest but again it pertains to quantity of principal token. If the usd price of principal token is very high compare collateral, liquidators won't definitely pay for it.
The protocol implement the pricing based on "quantity of the principal tokens" but did not consider the impact of significant USD pricing deviation between principal token and collateral token (high usd price of principal token against collateral token). Liquidators will never pay a very high loan for acquiring low valued collateral assets so liquidation may never happen.
No response
- Significant increase in USD price of principal token compared to collateral token since the loan started.
This can be the scenario
- Loan has been created and Lender Commitment group contract (LCG) serves as a lender.
- Due to the sudden increase in usd price of principal token loaned, the borrower defaults on deadline repayment.
- Liquidation is open for liquidators.
- Liquidators can't do it due to imminent large loss. The loan payment is much higher than the collateral assets to be acquired in terms of USD. Take note I did not include here the additional liquidation premium (about 7x at initial stage of liquidation) to simplify the explanation. If we add it, the principal token loan value is much higher.
- Liquidation is delayed and the collateral remain in the vault.
- Weeks passed and still no liquidators are interested due to high loan price.
- Lenders under LCG finally decided to close the loan and at least retrieve the collateral. However, the LCG contract as a lender, don't have access to close the loan and recover the collateral.
- In one last desperate attempt, the lenders seek help from developers to upgrade the contract so the collateral can be retrieved. However, there are "other group of lenders" who are also affected, and the developers can't accomodate all at once. The lenders have no choice but forced to wait longer.
- Even if the collateral is already retrieved, another step should be done and it should be converted into principal tokens and deposit to the LCG, so the lenders are finally able to exchange their shares and receive principal tokens.
Significant delay in liquidation which basically "locked" the collateral until the liquidation process is completed. This could take weeks or months depending on market condition. No liquidator is interested to pay a very high loan compared to collateral assets.
See attack path
The liquidation process for LCG loan bids should have option during special situation wherein it can adjust the price of principal loan token (deduct some loan tokens to lower the price) which is comparable to the collateral assets to be acquired by liquidator in terms of USD.Make sure both parties (lenders and liquidators) has benefited from this liquidation process.