This article discusses Fringe’s new Partial Liquidations Model, which introduces a new innovative mechanism to improve borrowers’ experience. It also aims to increase the stability of the Fringe Finance platform and promote its adoption.
This article also dives into the benefits of this model over Fringe’s existing liquidation model, and those of other lending platforms.
The new liquidation model introduces a unique model of partial liquidations not present in most other popular lending platforms that employ partial liquidations.
Using the Liquidation Query facility, liquidators on Fringe Finance can identify positions below the minimum collateralization level. The new Liquidation Query indicates the minimum and maximum amount of the position that can be liquidated. The maximum amount that can be liquidated is calculated to result in the position returning to a healthy state, i.e., the position returning above the minimum collateralization level not to be subject to further liquidation. The Liquidation Query also indicates the percentage reward the liquidator will receive when they undertake a liquidation. This percentage reward is an inverse function of the health of the position, where the percentage reward grows as the position’s health deteriorates.
The dependence on the percentage reward is inversely proportional to the health of the position, allowing a non-time-based Dutch auction of sorts, where liquidators compete with one another and undertake liquidations as soon as they find the liquidation opportunity financially attractive according to their own criteria. We have designed the liquidation model this way due to this model’s elegance and simplicity, as opposed to models used by other lending platforms that rely on time-based auctions. Time-based auctions, such as those used by the DAI platform, require a third party to initiate them, which is a more complex model that introduces higher costs to borrowers (to incentivize the initiation of auctions.)
All references above to a borrower’s ‘position’ are applicable for Fringe’s upcoming v2 — which uses a model where a single collateral asset secures each loan or trading position. With the release of Fringe v3’s pooled collateral enhancements, all loan and trading positions will be secured by the user’s pool of collateral assets. With this, the notion of ‘position’ solvency will be replaced with the notion of the solvency of the borrower’s overall ‘account.’
New price oracle model
Fringe is also implementing a new pricing oracle model, which, among other benefits, better supports the new liquidation mechanism. Our new liquidation and price oracle models are part of Fringe’s concerted effort to provide optimized liquidation and price oracle infrastructure that best reduces reliance on third parties, further protects lenders’ assets, and reduces costs for borrowers. Fringe has developed these improvements to provide best protections against various actual and as-yet unexploited theoretical attacks.
Fringe’s new price oracle model is described in detail here, though it can be summarized as providing a range of improvements, including the following:
- Reducing price discontinuations into a smoother curve to ensure borrowers receive the best price for their liquidated collateral during any liquidation event.
- Mitigating the threat of downward market price manipulations, where malicious liquidators attempt to lower the price to gain access to borrowers’ collateral at deflated prices.
- Mitigating the threat of upward market price manipulations, where malicious actors inflate collateral prices to gain access to loans at below-market prices.
- In a future release, mitigating the threat of malicious oracles, where a malicious oracle willfully reports incorrect prices and Fringe platform users can act to withdraw their assets before the malicious oracle’s prices come into effect.
Fringe is making it easier for liquidators to liquidate undercollateralized Fringe positions by providing various upcoming resources to help them. These include technical liquidation documentation, the Liquidation Query NPM (node package manager) package that identifies liquidatable positions, example videos of how to install and run the Liquidation Query, and a sample open-source Liquidation Bot that employs the Liquidation Query and liquidates positions, disposing of liquidated assets. With the release of Fringe V2, Liquidators will find links to these resources in our official documentation.
Partial liquidations result in less collateral being disposed of on third-party trading venues, thus resulting in less price impact of such smaller disposals. Borrowers benefit from liquidators being willing to liquidate at a lower liquidator reward percentage, given that liquidators will have lower collateral asset disposal price impact costs. Partial liquidations have the effect of simulating a time-weighted automated market maker (TWAMM), meaning that even if the same volume is sold to the market in total, partial liquidations result in lower price impact as an amount is sold in smaller units over a more extended period, allowing for arbitrageurs to re-equilibrate the price on the open market.
Additionally, smaller liquidations result in less likelihood of cascading liquidations that would have a larger price impact on the overall market for those collateral assets.
Fringe’s Maximum Liquidation Amount for any partial liquidation limits the profitability of attackers manipulating collateral asset prices downward, reducing the likelihood of such downward price manipulation attacks.
Given that partial liquidations tend to spread out over time without introducing extra risk for the protocol, this allows more liquidators to participate in a slower-moving Fringe liquidation arena. It also increases competition amongst liquidators and thus achieves higher-priced collateral liquidations, a benefit for borrowers.
Under the new model, some benefits improve borrowers’ experience by incurring a lower penalty for liquidation, often resulting in the borrower retaining some of their loan or trading position. Borrowers are only charged the liquidator reward fees associated with the partial liquidation to bring the loan back above the minimum collateralization level. This contrasts the liquidator reward fees on a full liquidation, as with Fringe’s old liquidation model. Additionally, the borrower retains the remaining open loan or trading position they entered into (now partially liquidated) and thus is still positioned according to their original intent of long exposure to the collateral asset and short exposure to the lending asset. These benefits will tend to result in higher user adoption.
Partial liquidations invite more liquidators to participate, given lower secondary market liquidity requirements to dispose of collateral won in a liquidation. This makes Fringe’s liquidation process more efficient and is expected to reduce the likelihood of positions becoming insolvent, improving Fringe’s stability.
Even for loan positions that become insolvent, our new liquidation model still allows liquidators to perform partial liquidations profitably. This reduces the platform’s exposure to any further downside of the long/short asset pair. And, given insolvent positions ultimately fall on Fringe’s treasury to settle, this will tend to result in less liability and benefit governance token holders.
As you may be aware, loan-to-value ratios (LVRs) assigned to a collateral asset are used by lending platforms to mitigate the risk of sudden downward price movements to ensure there is always ample collateral securing a loan. The greater efficiency of liquidations that arise with our new liquidation model means that Fringe can materially increase the loan-to-value ratios (LVR) offered for collateral assets. This increases the capital efficiency for borrowers and promotes adoption.
As the above points outline, multiple benefits for borrowers and the Fringe platform arise from our new liquidation model. By way of summary, benefits include the following:
- Higher collateral prices for borrowers due to simulating the effects of a TWAMM.
- Increased liquidator competition by allowing less-capitalized liquidators to compete.
- Reducing the size of insolvent positions to the absolute minimum necessary.
- Mitigating the likelihood of cascading liquidations.
- Minimized impact of downward price manipulation by only liquidating the minimum necessary percentage of a loan to achieve minimum collateral ratio.
- Minimized deleveraging of a borrower’s position to the minimal amount to achieve a minimum collateral ratio, leaving the remaining position intact according to the borrower’s original investment intent.
- Lower incentives for downward price manipulation attacks by reducing the opportunity of buying the collateral asset cheaply once a liquidation has occurred.
- Spreading out auctions over a longer period, providing an opportunity for more liquidators to compete.
- Higher loan-to-value ratios for collateral assets.
The new Fringe liquidation model will bring greater stability to our platform (especially in times of high market volatility), benefit users, promote adoption, and have a positive knock-on effect of allowing higher LVRs that increase capital efficiency for borrowers. Since releasing our core lending platform in mid-2022, this new liquidation model is just one more of the material improvements Fringe is delivering that aims to add utility to our platform and further differentiate Fringe from its competitors.
Fringe Finance. DeFi for Everyone.
About Fringe Finance
Fringe Finance is a decentralized money market designed to unlock the capital spread in crypto assets regardless of their capitalization and supported network. With a next-generation DeFi lending & borrowing ecosystem, Fringe aims to unlock the dormant capital from traditional financial markets and all-tier cryptocurrencies.
For more information on Fringe Finance, visit our website.