A temporary increase in the DAI stablecoin earlier today resulted in massive liquidations at the decentralized finance (DeFi) compound.
According to on-chain data analyzed by The Block, the protocol saw $88.4 million in liquidations. However, loan tracker LoanScan shows the liquidations at 103 million US Dollars, incorrect. According to both on-chain data and LoanScan, market conditions also resulted in liquidations at DeFi protocol dYdX worth approximately 8 million USD. Both protocols combined to liquidate more than 96 million USD in collateral.
DAI’s Increase Resulted in Liquidations
In today’s case, the liquidations occurred due to a 30 percent increase in DAI’s price on Coinbase Pro (the source of Compound’s price oracle). This resulted in under-collateralized loans the protocol. In other words, as the DAI price increased. So did the value of DAI borrowed on Compound in comparison to the collateral provided.
How did DAI’s price increase cause the liquidations? Users can borrow funds from Compound, including DAI. A borrowed amount should always be less than the collateral provided.
To put things into perspective, suppose a Compound user borrowed 1,000 DAI at $1 DAI for a total of USD 1,000. However, the DAI price increased to $1.3 during the loan period, increasing the user’s borrowed amount to USD 1,300. However, if the user has less than USD 1,300 in collateral, Compound will consider the loan under-collateralized and allow any other user to liquidate it.
The event also impacted Compound’s COMP token’s so-called yield farmers. Millions of dollars were lost by some farmers.
Liquidations Are A First For Compound
It is worth noting that such massive liquidations have occurred for the first time at Compound. In previous cases, the protocol’s highest single-day liquidations were lower. According to LoanScan, Compound experienced $6.3 million in liquidations in July 2020. While according to the tracker, dYdx had approximately $8.6 million in November 2019.
Due to market conditions, other DeFi protocols, such as MakerDAO and Aave, have previously seen liquidations. MakerDAO, for example, liquidated $15 million in DAI tokens during the Black Thursday event in March, and Aave liquidated $20 million in Chainlink (LINK) tokens in August of this year.
According to Robert Leshner, the founder of Compound, the liquidations affected 124 users. Robert Leshner sympathizes with users who may not have understood the risks, the liquidation mechanism, or the tail risks of market dislocation and encourages the community to find ways to mitigate the event’s impact on them. He also mentioned that there is a lot of talk in the community about risk, liquidation, and prices. According to some, the protocol performed flawlessly, aggressively preventing under-collateralized accounts. Others saw a hostile system to borrowers and were poorly designed by relying on a single exchange.
Hopefully, the community will use this liquidation event to harden the protocol even more, debate the trade-offs of aggressive versus compassionate (e.g., @MakerDAO) liquidation systems, and add additional safeguards as needed.
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