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Liquidation

Morpho has a liquidation mechanism to mitigate the risk of default and protect lenders' capital.

When an account becomes unhealthy, meaning its Loan-To-Value (LTV) on a given market exceeds the market's Liquidation Loan-To-Value (LLTV), the account's position can be liquidated. Anyone can perform this liquidation by repaying the account's debt in exchange for the equivalent amount in the market collateral asset, along with an incentive.

To avoid being liquidated, borrowers can track their LTV in real-time and either repay their loan, partially or entirely, or add more collateral to their position.

How to calculate the LTV of a position?

To compute the LTV of a position on Morpho, use the following formula:

LTV=BORROWED_AMOUNT  ∗  ORACLE_PRICECOLLATERAL_AMOUNT  ∗  ORACLE_PRICE_SCALE\text{LTV} = \frac{\text{BORROWED\_AMOUNT} \space\space * \space\space \text{ORACLE\_PRICE}}{\text{COLLATERAL\_AMOUNT} \space\space * \space\space \text{ORACLE\_PRICE\_SCALE}}

where:

  • BORROWED_AMOUNT = the amount of borrowed assets of the user,
  • ORACLE_PRICE = the oracle price returned by the oracle of the market,
  • COLLATERAL_AMOUNT = the amount of collateral assets provided by the user,
  • ORACLE_PRICE_SCALE = 1e36.

Also, you can find:

How Liquidations Work

Liquidations on Morpho are quite simple: liquidators can liquidate up to 100% of the account's debt and receive the corresponding collateral value, plus the relative incentive.

No fee is taken by the Morpho protocol at this level. The entire Liquidation Incentive Factor (LIF) goes to the liquidator.

The LIF depends on the LLTV of the market, according to the following formula:

LIF=min⁡(M,1β∗LLTV+(1−β)), with β=0.3 and M=1.15.\text{LIF} = \min(M, \frac{1}{\beta*\text{LLTV}+(1-\beta)}), \text{ with } \beta = 0.3 \text{ and } M= 1.15.

Liquidation Incentive in function of the Liquidation Loan-To-Value.

Example

Liquidation Step-by-Step

  1. Initial Position: A borrower deposits $100 of collateral in market A (LLTV = 80%) and borrows. Over time, its interests accrues and the position reach to a point where the loan is above $80, like $80.0001 (or more)

    • Position status: LTV = 80.00001% > LLTV (80%) → Liquidatable

  2. Liquidation Process:

    • Liquidator identifies the unhealthy position
    • Liquidator repays the $80.00001 debt
    • LIF calculation: 1.06 (for 80% LLTV market)
    • Seized collateral: $80.00001 × 1.06 = $84.80001

  3. After Liquidation:

    • Borrower: Debt cleared, retains $15.19999 of collateral
    • Liquidator: Spent $80.00001, received $84.80001 in collateral
    • Profit for Liquidator: $4.8 minus gas fees and any swap costs

  4. Practical Consideration: For this liquidation to be profitable, the liquidator must ensure: $4.8 > (Gas fees + potential Swap fees + potential Price slippage costs)

Liquidation FAQ

At what price are liquidations done?

Liquidations occur at the current oracle price when a position's LTV exceeds the market's LLTV. The oracle price determines both when a position becomes liquidatable and the exchange rate during the liquidation process. The liquidator receives collateral valued at debt amount × LIF according to this oracle price, regardless of market conditions or price volatility elsewhere.

What happens if the collateral price continues to fall?

If the collateral price continues to fall after a position becomes liquidatable:

  • The position becomes increasingly attractive for liquidators as they can seize a larger percentage of the collateral relative to its real market value
  • Liquidators are incentivized to act quickly to capture this value
  • The protocol's design encourages prompt liquidations to minimize systemic risk
  • There is no price floor - the position remains liquidatable until someone repays the debt

What happens if the price recovers before liquidation happens?

If the collateral price recovers sufficiently before liquidation occurs:

  • The position's LTV may drop below the LLTV threshold
  • The position will no longer be liquidatable
  • The borrower retains their full collateral and remains responsible for their debt
  • This scenario highlights why borrowers should maintain a safety buffer below the LLTV

How do competing liquidators interact? Is it first-come-first-served?

Yes, liquidations operate on a first-come-first-served basis:

  • The first transaction that successfully executes the liquidation claims the opportunity
  • There is no auction or bidding mechanism
  • In competitive environments, this can lead to MEV (Maximal Extractable Value) opportunities and potential gas price wars
  • Advanced liquidators may use flashbots or other private transaction methods to secure their liquidation

Is there partial liquidation?

Yes. Liquidators can choose to liquidate any amount of the borrower's debt up to the full amount. This allows for optimizing gas costs against liquidation profits, especially for large positions where full liquidation might cause significant market impact.

Bad Debt

Morpho has different mechanisms for accounting for bad debts.

Morpho Vaults v1.0 - Bad debt realization

The Morpho Vaults created with the MetaMorpho Factory v1.0 have a mechanism to account for and realize bad debt in the event it arises.

Typically, in other lending pool designs, accrued bad debt remains in the market forever until manual intervention to pay down the bad debt. If small enough, the markets can continue functioning. If it is significant, the market becomes unusable.

Morpho Vaults v1.0 treat bad debt differently. When a liquidation leaves an account with some remaining debt, and without collateral to cover it, the loss is realized and shared proportionally between all lenders.

As bad debt is realized at the time it occurs, a market can be used in perpetuity.

Morpho Vaults v1.1 - No bad debt realization

The Morpho Vaults created with the MetaMorpho Factory v1.1 have a different mechanism to account for as it does not realize bad debt and behave as other lending pools with accrued debt remaining in the market forever until manual intervention to pay down the bad debt.