The recent pullback across all cryptocurrencies have been causing more than usual amount of liquidations in the lending market. Liquidation events often creates selling pressure in the collateral assets. This article looks into the liquidation events from Terra’s major UST borrowing platform Anchor, and gives some insights about when liquidations happen and what the impacts could be.
Anchor protocol offers the majority of UST borrowing in the Terra ecosystem. Participants use bonded asset such as bETH and bLUNA as collateral to borrow UST. The maximum loan-to-value (LTV) for each wallet borrowing is 60%. When the value of collateral decreases and the LTV exceeds 60%, a liquidation event is triggered and Anchor proceeds to sell the proportion of the collateral that exceeds the maximum LTV on the liquidation platform Kujira Orca at a discounted price. This helps Anchor cover the additional risk incurred from the decreasing collateral value.
As a participant of the Anchor protocol, it is very important to keep an eye on your LTV to make sure your collateral does not get liquidated from a sudden downside movement in Ether or LUNA. Therefore, it is essential to explore the worst-case scenarios for liquidation on Anchor and understand under what circumstances might significant liquidations occur again.
Past liquidation events
The last major liquidation event measured by the total number of liquidated borrowers occured in May 2021, where a sudden spike appeared in both the number of liquidation transactions and liquidated borrowers. This has been the worst case scenario so far from the historical data where daily liquidation transactions peaked to over 4000 a day and the number of liquidated borrowers to over 2500 a day.
When looking at the total amount of USD being liquidated historically, the peak is also in May 2021. On May 19th 2021, a total amount of $7.7 million equivalent collateral has been liquidated.
Why and when liquidations occur?
Liquidation events occur when the LTV drops below the maximum level of 60%. This usually is caused by the decrease in the underlying collateral value.
The graphs below show the worst case scenario in terms of number of liquidated borrowers coincides with the time when bLUNA and bETH prices dropped significantly.
When looking at the same data in percentage change, it is clearer to see the negative correlation between liquidation and collateral price. The graph below shows the same patterns — whenever the rate of change in collateral price goes down (pink & green dashed line), the rate of change in liquidated borrowers goes up (blue bar). In the recent crash at the beginning of 2022, the same pattern repeated where the number of liquidated borrowers jumped from 33 on January 7th to over 134 on January 8th, a 300% increase in one day .
Liquidation impact
When looking at the distribution of the % change of liquidated borrowers, the tail is heavily skewed to the right, indicating a big impact from collateral price dropping; but when the underlying collateral prices move up, the upside impact is not nearly as much.
Similar to the stock market where the price decreases much faster in a bear market than increases in a bull market, the speed of increasing number of liquidation is also faster when the collateral price drops. Although bLUNA and bETH prices are both skewed more to the upside price change (i.e. upside price movement happens more often than downside movement), the number of liquidations does not benefit much from this upside move because it takes longer for it to drop from a high level than to rise from a low level.
One interesting observation during the recent three liquidation spike is that the increase in the liquidated borrowers in the most recent liquidation is much smaller (15x) than the previous two (57x and 49x respectively). This might be an indication that the participants are much more cautious about the amount they borrow during a downturn, which is a sign of a healthier and lower risk environment.
Conclusion
Based on the historical liquidation data on Anchor, the worst liquidation happened in May 2021 when Ether and LUNA price both dropped significantly. There is a negative correlation between the collateral price change and the % of change of liquidated borrowers. Additionally, it is also observed that the number of liquidation increases quickly when the price of the collateral decreases. However, the opposite side is not the same — when the price of collateral recovers, the number of liquidated borrowers does not drop back as fast as when it rises. It is also observed that Anchor borrowers are more cautious in the recent price crash, resulting in less liquidation than previous events.
