Arbitrage: Liquidations

Demand Dynamics due to Liquidations

Liquidations: Creating Market Demand and Corrective Action

Liquidations occur when a borrower’s collateralization ratio falls below the liquidation ratio, a threshold that defines when liquidators can step in to purchase synthetic assets and liquidate collateral.

Narrow Spread Between Ratios: A narrow spreadbetween the borrowing ratio and liquidation ratio increases the likelihood of frequent liquidation events. This happens because small changes in collateral value or synthetic asset prices can quickly trigger liquidations.

Impact on Peg Stability: When liquidators purchase synthetic assets from the market to liquidate a loan, they create demand for the assets, driving the market price upward. Frequent liquidations due to a narrow spread between the ratios result in more frequent peg corrections, ensuring the market price remains closely tied to the protocol price.