Understanding Liquidations in DeFi

How Preon’s Stability Pool Protects Borrowers

In decentralized finance (DeFi), liquidations are a critical safeguard ensuring that all borrowed funds remain fully backed by collateral. Collateralized Debt Position (CDP) protocols use liquidations to prevent undercollateralization, ensuring stability in the ecosystem. When a borrower’s Loan-to-Value (LTV) ratio surpasses a designated threshold, liquidation mechanisms automatically trigger to maintain solvency.

Preon Finance employs a structured liquidation system integrated with its Stability Pool, offering an innovative approach to managing risk while benefiting users. Let’s break down how liquidations work in DeFi, their role in Preon, and how borrowers and Stability Providers can leverage Preon’s unique model for a safer, more sustainable borrowing experience.

How Liquidations Work in CDP Protocols

LTV, or Loan-to-Value Ratio measures the amount of debt relative to the value of the deposited collateral. An example of this would be if a user deposits $1,000 worth of ETH and borrows $500, then their LTV ratio is 50%. Each CDP protocol has a specific liquidation threshold (typically 70-90%). When collateral prices drop, causing LTV to exceed this threshold, liquidation is triggered to prevent bad debt.

So as a step-by-step process, collateral value drops when the borrower's LTV surpasses the liquidation threshold. An automatic liquidation event is triggered, and the smart contract sells a portion or all of the collateral to cover outstanding debt. Debt repayment then takes place, where liquidation proceeds are used to settle the borrower’s debt, canceling their obligation. Finally, the borrower keeps the borrowed stablecoins, but loses the liquidated collateral.

Traditional CDP protocols rely on forced sell-offs, often leading to cascading liquidations in volatile markets. Preon mitigates these risks through its Stability Pool, ensuring a more predictable and fair liquidation process.

Preon Finance’s Liquidation Model

Preon’s Nebula Vaults allow users to borrow the $STAR stablecoin against their deposited collateral. However, if a vault’s LTV surpasses the maximum limit, it becomes eligible for liquidation to maintain the protocol’s solvency.

How Liquidations Work in Preon is that, when a Nebula Vault is liquidated, the debt is canceled, and the collateral is transferred to the Stability Pool. Unlike traditional finance, there are no penalties beyond the loss of collateral. Liquidated collateral is distributed to Stability Providers, allowing them to acquire assets at a discount.

Preon’s Stability Pool acts as a first line of defense, ensuring smooth liquidations while protecting the ecosystem.

The Role of the Stability Pool in Absorbing Liquidations

The Stability Pool benefits users in multiple ways. Users deposit $STAR into the Stability Pool to help absorb liquidations. When a liquidation occurs, Stability Providers receive liquidated collateral at a discount, creating a profit opportunity, and $STAR is burned, reducing overall system debt and enhancing protocol stability. It is worth noting that, if the Stability Pool lacks sufficient $STAR, collateral and debt are redistributed to active Nebula Vaults based on their TVL (Total Value Locked).

This mechanism enforces $STAR's overcollateralization during times of insufficient STAR in the stability pool.

Preventing Liquidation Cascades: Recovery Mode

In extreme market conditions, if total protocol LTV exceeds the maximum limit, Preon enters Recovery Mode to stabilize the system:

• Vaults with the highest LTVs (above 71.4%) are liquidated first.
• New $STAR minting is paused until the system stabilizes.
• Borrowers are incentivized to repay debt or deposit more collateral, restoring health to the ecosystem.

Recovery Mode prevents large-scale sell-offs, ensuring Preon remains solvent even in volatile markets.Why Preon’s Liquidation Model is a Safer AlternativePreon’s approach to liquidations prioritizes borrower protection, capital efficiency, and system stability, setting it apart from traditional DeFi protocols.

• Overcollateralization reduces risk compared to margin trading and CeFi lending.
• The Stability Pool prevents liquidation cascades, absorbing liquidations smoothly.
• No hidden fees or interest charges, providing greater transparency.
• Liquidations are structured to benefit Stability Providers, ensuring a fairer process.

A Smarter Way to Manage Liquidity in DeFi

‍Liquidations are a necessary mechanism for maintaining the health of CDP protocols. However, Preon’s structured liquidation model, combined with its Stability Pool, provides a more sustainable and borrower-friendly solution. By utilizing overcollateralization, interest-free borrowing, and a resilient liquidation system, Preon Finance ensures a secure and efficient DeFi lending experience.To explore Preon’s Nebula Vaults and Stability Pool, join our community today and experience DeFi borrowing without hidden risks.