Liquidations & Bad Debt

Liquidations

Liquidations happen when a borrower's health factor goes under a certain value, meaning their collateral value can no longer cover their loan. This happens either because the debt has increased past a certain threshold or because the collateral value has fluctuated.

Should a borrower need to be liquidated, some of their collateral is sold off to pay back the debt. Liquidations are handled in one of two ways on Mystic:

• Liquidators (oftentimes bots) buy/redeem the collateral at a discount and return the original loan principal with a difference to the lender.

• 3rd parties insterested in the collateral asset buy it at a discount and restitute the loan principal plus the difference to the lender.

It is important to note that liquidations on Mystic respect the underlying asset's permissions, meaning only a whitelisted user can take liquidated collateral. In addition, since RWA tokens have very different liquidity conditions and redemptions methods, the chosen liquidation method is different per asset and per pool.

Bad debt

In a situation where there is extreme volatility, a market's LTV might increase too quickly before it can be liquidated. In such a scenario, the borrower defaults and liquidators are not incentivized to honor the debt, and so the protocol gets bad debt. Bad debt is extremely unlikely in Mystic Finance, due to the stability of the underlying assets we make markets for. However, should a bad debt event occur, some lenders may not be able to withdraw their assets.