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We use a two-sided approach where we also adjust up the market value of a borrower's liabilities by taking into account the borrow factor. This approach allows us to factor in the asset-specific risks of both downside and upside price movements. These risks are encapsulated in asset-specific Loan to Value Ratio (as on Compound) and borrow factors.
Ultimately, this approach means that the liquidation threshold of every borrower is tailored to the specific risk profiles associated with the assets they are borrowing and using as collateral.
To give an example, suppose a user has $1,000 worth of USDC, and wants to borrow APT. How much can they borrow?
If USDC has a collateral factor of 0.9, and APT has a borrow factor of 0.7, then a user can borrow up to $1,000 * 0.9 * 0.7 = $630 worth of APT. At this level of borrowing, the risk-adjusted value of their collateral is $1,000 * 0.9 = $900, and the risk-adjusted value of their liabilities is $630 / 0.7 = $900. If APT increases in price, then the risk-adjusted value of their liabilities will also increase to >$900, and then they will be eligible for liquidation. The buffer allowing for liquidation is $1,000 - $630 = $370.
Liquidation occurs when a user's total borrow has reached a threshold, i.e. the risk factor is greater than or equal to 100%.
Risk factor represents the overall liquidation risk for a given user. When the users add more collateral into the protocol, the risk reduces. Conversely when the users borrow more, the risk increases.
When a user has reached its liquidation threshold, up to 50% (in terms of market value) of the total borrowed asset is sold to the liquidator at a discounted price to repay a portion of the loan.