The Liquidations System of the Maker Protocol is a critical element designed to ensure that Dai generated in Maker Vaults remains adequately collateralized. Simply put, it’s central to helping Dai maintain its soft peg to the US Dollar.

In the aftermath of the market collapse of March 12, the community recognized a need for an upgrade to that system. As a result, Maker governance voted to make a number of changes, including risk parameter adjustments. One adjustment increased the duration of collateral auctions to 6 hours. This was done to allow Keepers more time to submit bids in the event of heavy network congestion. 

After those improvements, further changes were discussed to design and implement a more robust system that would enable the Protocol to better deal with a large volume of Vault liquidations when necessary. The complete system upgrade will continue to be released in stages.

The first stage, Liquidations 1.1, went live after a vote last month and introduced a minor upgrade. The latest update to the Maker Protocol, Liquidations 1.2, was approved by Maker governance and executed on August 31, and contains a few more improvements, including throttling the number of auctions that can be held at any given time. The final and most significant upgrade—Liquidations 2.0— will be presented to the community and presumably voted on later this year.

What follows is background on the system, the reasons for changes, and what to expect moving forward.

How Liquidations Help Maintain the Dai Peg

Dai is generated by users against their crypto collateral assets deposited into Maker Vaults on the Maker Protocol. Market supply and demand determine the price of Dai, while the decentralized governance community votes to change incentives that impact Dai supply and demand to maintain price stability. To ensure there is always enough collateral in the Protocol to cover the value of Dai generated against it, each collateral asset is assigned a Liquidation Ratio (LR) determined by Maker governance. ETH, for example, has a LR of 150%, which means that a Vault with 100 Dai debt must have at least 150 Dai worth of ETH backing it. If the value of collateral falls below its LR, the contents of the Vault are auctioned to recover the Dai for the Protocol. 

Keepers are independent actors (typically automated bots) that participate in these collateral auctions by bidding. The winning bidder receives the collateral, while a 13% liquidation penalty is added to the debt and levied on Vault owners. Any funds remaining are returned to the Vault owner. Should no funds remain in the Vault after an auction, the owner will be left only with the Dai they originally generated against their collateral.

An efficient and effective Liquidation mechanism is not only vital to maintaining Dai stability, but also to maintaining confidence in Dai—both for Vault owners and Dai users. Collateral auctions must be carried out in a timely manner, since the longer they take, the higher the risk of collateral asset prices falling further and the Protocol incurring greater debt. They must also occur within a liquid market environment, meaning enough bidders must exist to absorb the collateral being auctioned and thereby recover the full amount of Dai for the Protocol and give Vault owners the best price. 

Oasis.app provides users with vital information for all collateral assets available in the Maker Protocol.

Liquidations 1.2: Stopgap Improvements

In conditions of extreme price volatility, when the value of collateral falls significantly in a short interval, it’s difficult for Keepers to support the amount of assets that need to be bought at auction as a result of liquidations. Not only are there currently a small number of Keepers, but also they have limited funds at their disposal.

Liquidations 1.2 addresses the problem by limiting both the number of auctions that can occur simultaneously and the total value of collateral being auctioned at any one time. This solution allows Keepers the opportunity to recycle capital through exchanges and bid on multiple auctions. Additionally, it provides some protection for Vault owners in the event of a flash crash, since only part of their collateral will be sold. Overall, Liquidations 1.2 aims to do the following: 

1. Ensure confidence in the Liquidation system
   •  Enable strategies that help decrease the number of liquidations
2. Improve system efficiency
   • Maximize available liquidity for auctions
   • Liquidate collateral at the best possible price, giving the Vault owner the best outcome, recovering the full amount of Dai for the Protocol, and minimizing further downside risk for Keepers
   • Reduce the impact of mass liquidations, which put Dai stability at risk
   • Help prevent an oracle attack affecting liquidations 
   • Provide a mechanism to help protect the Protocol in unforeseen circumstances (e.g., a Black Swan event)
3. Improve the overall liquidation ecosystem
   • Update Keeper software to improve quality (stability, reliability, availability, and security) and ensure it continues to function as required under extreme circumstances

Those and other technical details for Liquidations 1.2 can be found in the community discussions on the Maker Forum. 

Liquidations 2.0

Currently, there are efforts toward finalizing Liquidations 2.0, a next-level upgrade of the liquidation system, which will focus on improving efficiency and reliability, simplifying the process of auction participation with the inclusion of Dutch Auction mechanics, and enabling auction access through popular existing decentralized exchanges (DEXs) and other interfaces. Readers may follow the Forum discussions on the topic at A Liquidation System Redesign: A Pre-MIP Discussion. As the community review progresses, the Foundation, to assist with lowering knowledge barriers about the new features, will publish a blog post review on Liquidation 2.0.

Increasing Participation to Safeguard Dai Stability

The redesign of the Maker Protocol’s Liquidations system should increase community participation in collateral auctions through the mechanisms described above, thereby improving decentralization of this critical element of the Maker ecosystem while helping to maintain Dai’s peg to the dollar even during a market downturn. The updates provided by Liquidations 1.2 should improve auctions while progress is made on version 2.0.

To learn more, review the Auctions and Keeper documentation in GitHub, participate in the community discussions in the Maker Forum, or ask specific questions about collateral auctions and becoming a Keeper in Maker’s #keeper channel on rocket.chat.