Liquidations

Introduction

Panoptic enables leveraged options through undercollateralized trading. This cutting-edge approach necessitates a robust mechanism to maintain the health and stability of the protocol, with liquidators playing a pivotal role. These entities are crucial in managing the risks associated with undercollateralized positions, ensuring the system's resilience and reliability.

Understanding Collateral in Panoptic

Collateral Mechanics

In Panoptics, collateral is the backbone that supports leveraged options trading. It's a safeguard that provides a buffer against potential market volatility and adverse price movements. All traders must deposit collateral to cover any potential losses from their positions.

Collateral Requirements

Two critical components of liquidations are the Buyer Collateral Requirement (BCR) and Seller Collateral Requirement (SCR). These requirements are carefully calibrated to match the risk profiles of both options buyers and sellers, ensuring that each party is adequately protected against market fluctuations. You can learn more about the collateral requirements by reading about our pool parameters.

Liquidation Thresholds

An account becomes liquidatable in a specific pool when its collateral falls short of the required collateral requirement thresholds. This situation typically arises when market movements are unfavorable to the position held by the account, causing the required level to exceed the collateral's value. At this juncture, the account is deemed liquidatable and is subject to being closed out.

Liquidation Bots

Monitoring and Reporting

Liquidation bots continuously monitor open positions in a pool to assess the collateral status of each position. Bots are programmed to identify accounts that become liquidatable, flagging any account that falls below the required collateral thresholds.

Liquidation Process

Upon identifying a liquidatable account, liquidation bots trigger an alert. Liquidators can then engage by interacting directly with the smart contracts governing the pool. This direct interaction facilitates the liquidation of underwater accounts, thereby mitigating risk and preserving the integrity of the pool.

Open Source

Users are encouraged to run liquidation bots in order to protect pool capital and get rewarded with liquidation bonusees. Panoptic will make its liquidation bot open source and available to the public.

Technical Details

Maintenance Margin Requirement

For options that have been minted out-the-money (OTM), the buying power requirement is simply given by the sell and buy collateral ratio. As the price evolves and an option becomes in-the-money, risks may increase, and the deposited amount of collateral may need to increase to mitigate those risks.

For example, selling an OTM put option initially requires 20% collateralization. As the price decreases below the strike price, the buying power requirement will increase above 20%. The exact buying power requirement for a short put at strike $\mathtt{K}$ when the current price is $\mathtt{S}$ and an initial collateral ratio of $\mathtt{C_i}$ is given by:

$$\mathtt{Buying\ Power\ Requirement = notionalSize \cdot \left(100\% - frac{S}{K}\right)}$$

In contrast, the in-the-money amount (or the amount of funds necessary to cover the option) is always lower than the buying power requirement, and it is defined as $\mathtt{ITM\ amount = notionalSize \cdot\left(100\% - \frac{S}{K} \right)}$. So, selling a 1000 ETH-USDC put will start with a buying power requirement of 200 USDC when the price is above 1000 but will increase to 500 USDC if the price decreases to 625, whereas the ITM amount will be 375.

Short Put Buying Power Requirement

The buying power requirement of a short put is limited by the notional value of the option.

              Short put BPR = 100% - (price/strike)
BUYING        
_POWER                       
_REQUIREMENT  ^                    .
              |           <- ITM   .  OTM ->
       100% - |--__                .         
              |    ¯¯--__          .
              |          ¯¯--__    .     
        SCR - |                ¯¯--______ 
              |                    .
              +--------------------+--->   current
              0                  strike     price

Short Call Buying Power Requirement

The buying power requirement of a short call can exceed the notional value of the minted option.

              Short call BPR = SCR + (price/strike) 
BUYING                                           
_POWER           <- OTM  .  ITM ->            _-¯
_REQUIREMENT  ^          .                 _-¯
              |          .              _-¯
       100% - | -   -   -. -   -   - _-¯  -  - 100%
              |          .        _-¯  .
              |          .     _-¯     .   
              |          .  _-¯        . 
 SELL_RATIO _ |___________-¯           .
              |          .             .
              +----------+-------------+--------> current
              0         strike       2 * strike    price

However, users can deposit the asset as collateral in order to mitigate those risks. In this case, the Buying Power Requirement for short calls (with 100% of the collateral denominated in the asset) is:

BUYING         Short call BPR (covered) = 100% - (100% - SCR)*(strike/price) 
_POWER                   .
_REQUIREMENT     <- OTM  .  ITM ->
              ^          .                        100%
       100% - |  -   -   . -   -   -   -   - _____------ 
              |          .      ___----¯¯¯¯¯¯
              |          .  _-¯¯
              | min BRP  . -     
 SELL_RATIO _ |___________¯
              |          .
              +----------+----------------------> current
              0         strike                     price

Account Liquidations

To determine whether an account is solvent, the Panoptic protocol computes and adds up the collateral requirement for each position. The protocol will then compare the amount of user-deposited collateral with the account's total collateral requirement.

Because users can deposit both types of tokens for a token pair to be cross-collateralized, it is the actual value of the required collateral and of the collateral balance that are compared. Based on this calculation, an account can be liquidated if Total value of collateral < collateral requirement

Liquidation Bonus

The liquidation bonus for liquidating an account is determined by two factors:
i) Account Insolvency: Accounts with greater insolvency offer bigger bonuses, but the bonus is capped at half of the collateral balance. ii) Collateral Balance: Higher collateral balances increase the maximum potential bonus.

The formula for calculating the liquidation bonus is as follows: Bonus = min{Collateral Balance / 2, Collateral Requirement at TWAP - Collateral Balance at TWAP}

The goal of the liquidation system is to incentivize Panoptic Liquidity Providers to be liquidators as well, since a healthy liquidation system means the pool will never incur a loss.