Lecture 8.0.0. Warning!! Liquidation Is Bad Business
The Borrow Limit meter tracks what portion of your Borrow Limit you have used. If this meter reaches maximum or more (that is, ≥100%), your account will be partially liquidated. That is, your account becomes insolvent.
What this means is that part of your collateral will be sold off to repay the deficit.
Liquidation of your account can occur for any of the following reasons:
• when the value of your collateral declines
• when the borrowed assets increase in value
If your account is in liquidation, community members can repay the deficit that will bring your account out of liquidation. Your collateral will be sold off to these community members at a discounted rate of 8%.
This 8% is the liquidation incentive.
Here is an example. Let’s say your account is in liquidation and requires 200 BAT tokens to bring it out of liquidation. One or more community members can repay the 200 BAT deficit at a discounted rate of 8%.
That is, the following will be deducted from your collateral to bring your account out of liquidation and compensate the community members that have paid the liquidation cost.
(a). 200 BAT deficit
(b). 8% liquidation incentive, which is calculated as 8% of 200 BAT and that is 16 BAT tokens.
Thus, a total of 216 BAT (that is, 200 + 16) will be deducted from your collateral to remedy the deficit. In other words, you are paying a penalty of 16 BAT tokens that you could have avoided if your account did not become insolvent.
Therefore, liquidation is bad business as it reduces your collateral and you should avoid it.
You may ask, what if I decide to borrow beyond the Borrow Limit and disappear with the money? The answer is that remember there is a maximum amount the system allows you to borrow against your collateral.
There is always 20 to 25% of your collateral that you cannot use. When you reach the maximum Borrow Limit, this 20 to 25% of your Collateral balance is what will be liquidated to pay off the deficit. Indeed, you cannot cheat blockchain system!