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8. What is Liquidation?
When you borrow tokens from Donkey, liquidation may occur now and then based on the fluctuations of the token value. Let’s find out more about it.

Liquidation: selling off collateral assets to collect loans

Let’s say you entrusted your 3 billion won apartment in Seoul as collateral and the bank lent you 2 billion won. You used that money to buy a 2 billion won yacht of your dreams. However, the price of your apartment in Seoul drops to 2.5 billion won. Then the bank tells you to quickly repay the 2 billion won loan. Yachts don’t sell quickly.
So the bank puts the apartment in Seoul on sale for 2 billion won, lower than the market price. Of course it’s going to sell quickly. The bank collects the 2 billion won that it lent. Since the bank collected the loan it needed to, you no longer have any obligation to sell the yacht or pay back to the bank. The process of collecting the loan by selling off the entrusted collateral is referred to as liquidation.

Liquidation in Donkey: the process of collecting loans by selling off tokens

Donkey also has this kind of liquidation process. If you deposit ETH in Donkey, 70% of its value will be recognized as collateral. Let's say that Person A deposited 1 million won worth of ETH. Person A can now borrow 700,000 won worth of tokens based on the collateral. Any tokens can be borrowed.
So Person A borrows 700,000 won worth of HUNT. The next day, however, HUNT price remains the same, but the ETH price drops. Since the value of the collateral drops more than that of the loan, the situation becomes similar to the example above of the apartment in Seoul being urgently sold by the bank.
So Donkey puts the collateralized ETH on the market lower than the market price. Anyone who pays back to Donkey the HUNT that Person A had borrowed can receive the ETH that is sold lower than the market price as a reward. Then, Donkey successfully collects the loaned HUNT as is, and the person who helped collect the HUNT can purchase ETH at a price lower than the market price and send it to the exchange immediately to make a profit.
The opposite case where the ETH price remains the same, but the price of HUNT rapidly increases, is also subject to liquidation. Changes in the relative value between the collateral and loan asset will always raise the risk of liquidation.

Loan-to-value (LTV) ratio differs by token.

As of September 15, 2021 (12:00 KST), Donkey started offering token loans that accept all deposited assets as collateral.
Each of the tokens are subject to a differential loan-to-collateral ratio or LTV ratio. You can check the current ratio here.
Currently, the LTV ratio of WBTC, ETH, and USDT is up to 70% (ex. 100 won worth of token A is collateralized for a loan of token B worth up to 70 won). If there’s a wallet that is the target of liquidation, the above three collateral assets can be offered at a price 5% lower than the market price.
Assets such as CHZ, TON, and MANA have an LTV ratio up to 10%. This means that if you deposit 100 won worth of MANA tokens, only 10% of the value will be accepted as collateral and hence can borrow up to 10 won worth of other tokens. If the value of the loan executed is equal to or higher than the total recognized collateral value ​​of deposited assets, the wallet becomes a target for liquidation immediately.
When a wallet becomes a target for liquidation, it is displayed in real time in the Liquidation menu at the top of the Donkey service platform. Anyone can then select the wallet subject to liquidation, the token that he or she wishes to receive at a discounted price among the collateralized tokens in that wallet (deposited assets are automatically collateralized when a loan is executed), and then select the token that he or she intends to repay in order to execute liquidation and receive the collateralized tokens at a discounted price.
Let’s say someone pays back 100 million won worth of HUNT borrowed for a wallet subject to liquidation and wants to receive ETH among the collateralized assets in the wallet. Since the liquidation discount rate applied to ETH is 5%, the person will receive 105 million won worth of ETH for paying back 100 million won of HUNT. That’s a profit of 5 million won.
Let's now assume that a wallet--that has a 100 million won loan of ETH with a deposit of 1 billion won worth of HUNT as collateral--is being liquidated. Since the liquidation discount rate for collateralized HUNT is 10%, the liquidator will pay back 100 million won of ETH and in return receive 110 million won of HUNT. That is a profit of 10 million won.
Be mindful that there is always the possibility that the profit from the liquidation discount rate can be less than expected considering the Ethereum gas fee at the time and the potential changes in the token price during the time it takes to transfer to the exchange the liquidated asset you received in our wallet .

Always borrow much less than your deposit!

There is no liquidation risk when you only make deposits with Donkey and don’t take out a loan at all. However, if you take out a loan excessively compared to the amount of tokens you entrusted, the liquidation risk will be higher when the value of the borrowed asset increases or that of the collateral drops. Hence it is advised that you keep a low ratio of your loan to your collateral.

How to execute liquidation

Now let's find out how to pay off someone else’s loan and receive tokens at a discounted price in Donkey. Please select the Liquidation menu.
The screen below is a list of wallets that are subject to liquidation as of September 9th (06:00 KST). Anyone can view this list and participate in the liquidation process in real time.
In Step 1, you can select the wallet eligible for liquidation. In Step 2, you will be able to see the list of tokens that this wallet borrowed. In Step 3, if you pay back these tokens on behalf of the borrower, you will get to pick out and obtain tokens that are deposited in the wallet as collateral.
As shown below, if you repay $133.41 worth of MANA on behalf of the borrower, you can get $146.75 worth of CBK. The person participating in this liquidation earns about 10% in profit.
If you pay off $25.27 worth of CHZ on behalf of the borrower, you can get $27.8 worth of CBK. Participating in this liquidation will result in a profit margin of about 10%.
As the liquidation process also requires Ethereum gas fees, please be mindful when participating. In some cases, the gas fee may be higher than the profit from liquidation.