Liquidations and Protocol Vault

Overview

The liquidation system ensures protocol solvency by closing under-collateralized positions through a three-stage waterfall: orderbook liquidation, backstop liquidation via the Blink Liquidity Provider (BLP) protocol vault, and auto-deleveraging (ADL). All liquidations use mark price to evaluate account health. No liquidation fees are charged to the liquidatee; a 1% fee on price improvement is paid to the liquidator from the spread between the fill price and the zero price.

Maintenance Margin Calculation

Maintenance margin is the minimum equity an account must hold to keep its positions open. If an account's equity falls below its total maintenance margin requirement, the account enters liquidation.

The maintenance margin rate is derived directly from the maximum leverage allowed for a given position size:

$$\text{IMR}_{\text{max leverage}} = \frac{1}{\text{leverage}_{\max}}$$

$$\text{MMR} = \frac{\text{IMR}_{\text{max leverage}}}{2}$$

For example, a position eligible for 25x leverage has an initial margin rate of 4% and a maintenance margin rate of 2%.

Margin Tiers

Markets define a series of margin tiers, where larger positions are subject to higher margin rates and lower maximum leverage. Each tier specifies a notional lower bound and a maximum leverage. The maintenance margin for a single position is:

$$\text{MM} = N \times \text{MMR}_{\text{tier}} - D_{\text{tier}}$$

Where N is the position's current notional value (size x mark price), and D is a per-tier deduction constant that ensures the margin requirement is continuous across tier boundaries. The deduction prevents a sudden jump in required margin when a position crosses from one tier into the next.

The deduction for tier 0 is zero. For each subsequent tier, it accumulates the difference in margin rates at each boundary:

$$D_0 = 0$$

$$D_n = D_{n-1} + L_n \times (\text{MMR}_n - \text{MMR}_{n-1})$$

Where L(n) is the notional lower bound of tier n. This means that at the exact boundary between two tiers, both formulas produce the same margin requirement.

Account Health

Account health is expressed as the Maintenance Margin Ratio, the ratio of equity to total maintenance margin, in basis points:

$$\text{MMR}_{\text{account}} = \frac{\text{equity}}{\sum \text{MM}} \times 10{,}000$$

For cross-margin accounts, equity is the margin balance plus unrealized PnL across all cross positions, minus any margin allocated to isolated positions.
For isolated positions, equity is the allocated margin plus that position's unrealized PnL, evaluated independently.

Liquidation Flow

1. Healthy Account: An account with MMR at or above 120% is unrestricted and can freely perform any standard actions.

2. Unhealthy Account: When MMR falls between 105% and 120%, the account enters a warning state. Operations that would increase risk are blocked. These include increasing leverage, opening new positions, or placing orders that expand exposure. Existing positions and resting orders are unaffected. The account can freely reduce positions, cancel orders, or deposit additional margin to return to a healthy state.

3. Restricted Account: When MMR falls between 100% and 105%, the account is restricted. All open orders are automatically cancelled to free margin.

4. Orderbook Liquidation: When MMR is between 70% and 100%, liquidation proceeds via IOC (immediate or cancel) orders placed on the orderbook. For each position, a zero price is calculated, which is the price at which closing the position leaves the MMR unchanged:

   $$P_{\text{zero}}^{\text{long}} = P_{\text{mark}} \times \left(1 - M_i \times \frac{\text{equity}}{\sum MM_j}\right)$$

   $$P_{\text{zero}}^{\text{short}} = P_{\text{mark}} \times \left(1 + M_i \times \frac{\text{equity}}{\sum MM_j}\right)$$

   Any fill at a price better than zero price strictly improves account health. Positions are liquidated in priority order by maintenance margin removal potential. Liquidation continues until MMR reaches 105% (100% plus a 5% exit buffer) or all positions are closed. If the account drops below 70% MMR during this process, or insufficient orderbook liquidity exists, the system escalates to backstop liquidation.

5. Backstop Liquidation: When MMR falls below 70%, or orderbook liquidation fails to restore health, the BLP absorbs the account. All cross-margin positions and remaining margin are transferred to the BLP. For isolated positions, only the specific position and its allocated margin are transferred. A solvency check ensures the BLP remains solvent after absorption. If it would not, the system escalates to ADL.

6. ADL: Auto-deleveraging is the last resort, triggered when the BLP cannot absorb a bankrupt account. Positions are force-closed against counterparties at the bankruptcy price of the liquidatee:

   $$P_{\text{bankrupt}}^{\text{long}} = P_{\text{entry}} - \frac{\text{margin}}{\text{size}}$$

   $$P_{\text{bankrupt}}^{\text{short}} = P_{\text{entry}} + \frac{\text{margin}}{\text{size}}$$

   Counterparties are sorted by leverage and unrealized PnL, and validated before ADL execution: they must hold an opposite-side position with positive equity, and their zero price must be aligned with the bankruptcy price such that ADL does not worsen their health.