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Defaulting on a loan (or liquidation) occurs when a position's LTV (loan-to-value) exceeds a threshold close to or at 100%, meaning the borrowed value exceeds the collateral value put up for the loan.
Using the below formula, if the collateral value + accrued fees cause the loan's LTV to exceed 92%, the loan will be liquidated via Chainlink Automations, which relinquishes the user's collateral to the protocol.
The 92% LTV default threshold effectively means a borrower will pay a 8% liquidation fee at the time default occurs.
LTV % = ((loan amount + fees) / collateral value) * 100
LTV of a collateralized loan is a function of the value of the collateral put up for a loan, the borrowed asset value, and amount borrowed (all valued in USD). All assets and values are continuously monitored on-chain using Chainlink Automations which handles executing loan liquidation as needed.
Jay secures a 0.5 ETH loan with a 5% APR using 2 billion PEPE as collateral, valued at 1 ETH. Having borrowed 0.5 ETH, Jay's loan has a 50% LTV ratio. After a period of time, along with accumulating 0.1 ETH in interest fees, the value of PEPE could also change.
If the value of PEPE were to increase to where Jay's 2 billion PEPE collateral is now worth 2 ETH, then the loan's LTV ratio would decrease to 25% allowing Jay to potentially borrow additional funds against the original collateral.
If the value of PEPE were to decrease to where Jay's 2 billion PEPE collateral is now only worth 0.7 ETH, Jay's LTV ratio would then increase to 85%. Jay would need to pay back some or all of the borrowed ETH before the loan's LTV ratio reaches 92% or Jay's loan will default and the 2 billion PEPE will be relinquished to the protocol.
Assets acquired through the defaulting of loans against the protocol owned lending pool are evaluated on a case by case basis by examining the current and future value of each asset to determine the best course of action. Capital gained may be used for a number of things that include, but are not limited to: adding funds to the lending pool, distributing to protocol rewards, marketing or other protocol expenses.
Assets acquired through the defaulting of loans against the HLP lending pool are automatically liquidated with 100% of the liquidated funds being returned to the HLP lending pool. If needed, auto-liquidation can be disabled for a collateral option.