How is a CDP liquidated?

Defi 101 Course
#1

I understand that a DAI position has to be collateralized by at least 150% with the underlying asset such as ETH.

So, for our example’s sake, let’s say the current ETH price is at $150 which entitles a borrower up to 100 DAI tokens. So far, 100 DAI tokens are backed by 1 ETH.

If the market price of ETH drops below $150, what exactly is happening, step by step?

Do bidders bid on the entire collateral amount in DAI and then those DAI tokens are burned? Is that the right idea, that as collateral prices dip, there is not enough value to back outstanding DAI so the DAI token supply has to decrease?

I’m sure there’s a lot more to this so I’m happy to discuss.

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#2

Hello sir, here is the basic structure on how DAI-Vault Liquidations works:

  1. A vault is automatically liquidated if the collateral value (in USD) falls too low.
  2. Part of the collateral is auctioned off by the protocol to cover the outstanding debt + penalty fee.
  3. DAI is then burned by the protocol to decrease the supply.
  4. Vault owner receives the leftover collateral.

So in your example, if ETH price = 150$, you borrow 100 DAI, your liquidation rate is really low (high risk), so if the price of ETH drops below 150$, you will “lose” your locked ETH on your vault, since it will be auctioned by the protocol to cover the outstanding debt. This works automatically.

Hope you find this useful! :slight_smile:

If you have any doubt, please let us know so we can help you!

Carlos Z.

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#3

I guess I’m curious about the auction process.

Why would someone want to buy someone else’s collateral in DAI as opposed to just buying ETH off the market?

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