While liquidation is absolutely crucial part of the process, it also has a cascading effect on flash crashes, where risky loans get liquidated, and then liquidated luna is sold off, that then dumps the price even lower, which then liquidates loans that were reasonable and considered “safe”. I think we all can agree that is not a positive chain reaction.
Also the protocol absolutely depends on there being borrowing demand, at the moment we rely on incentives, but we should be actually thinking how to make the borrowing itself a good, safe experience for the long term sustainability.
I think in defi borrowing now completely depends on incentives that are minted by the protocol. With the terra ecosystem, anchor is in a position to not only provide better savings account, but also better borrowing platform.
I think there’s 3 things that can improve borrowing without bringing risk to the protocol.
Automatically pay part of the loan with money in the savings account, to keep the LTV healthy.
The money is here, you as a borrower were responsible and you have money to cover in case of collateral value going down. But it’s silly to get liquidated just because you were asleep in the 4 hours of market volatility. The unnecessary liquidations have the mentioned cascading effect.
There’s a distinction between collateralized bLuna and non-collateralized bLuna. Non collateralized bLuna still earns you staking rewards, the only thing you lose from regular staking is airdrops.
To protect myself from liquidation, it’s reasonable to have a lot of bLuna in case of dumps, but not keep all of it as collateral. Instead you would just keep the collateralized bLuna at some reasonable level, and let the rest of it earn staking rewards.
But similarly, managing this is a manual process is meaningless. In case of rapid market movement you can be liquidated just for not being available for a few hours. Even if you were completely prepared with the capital to provide more collateral.
So it would be great if the protocol was able to do this automatically. Like let’s say instead of manually needing to “provide/withdraw”, it automatically let’s you earn staking rewards for collateral that is bellow certain LTV threshold.
There’s a similar system in Nexo now, where as the value of your collateral changes it automatically uses more of your account as collateral on dumps, and it returns you collateral to earn rewards on pumps.
There’s some thoughts on how to give more breathing room before liquidating here:
Dynamic liquidation LTV
This proposal actually does introduce some manageable risk because it actually changes liquidation point, instead of just automatically moving the funds for you.
The first two options also encourage people to go deeper into the terra ecosystem, by having more value in anchor that is automatically managed to keep healthy LTV.