Liquidation mechanism

To protect the collateral of Credit LPs and mitigate risk, Twyne takes on the role of first-order liquidator, ensuring that the borrower’s position — boosted by CLP collateral — is resolved or made healthy before being liquidatable on the underlying protocol.

Twyne uses a special liquidation process — termed liquidation by inheritance — inspired by Liquity’s fallback liquidation mechanism (which kicks in whenever their Stability Pool is out of funds). More on this in the next section.

In cases of extreme price volatility and swift downward market pressure, there might be situations where nobody has inherited a risky debt or triggered a liquidation on Twyne. In such a scenario, the underlying protocol kicks in as the fallback liquidator, which would likely (though not always) incur losses for the Credit LP. More on this in the [Fallback liquidation mechanism] section.

Liquidation by inheritance

Whenever there is a distressed position within Twyne, liquidators can either choose to clear risky debt or add collateral to stabilize and inherit the debt position. What we’re dubbing liquidation by inheritance allows lenders on Twyne and anyone with excess borrowing power to join the protocol as de-facto liquidators.

‘Inheriting’ means the liquidator can practically step into the borrower’s shoes, take over their unhealthy position, and themselves add collateral, thereby increasing LTV. This doesn’t require a swap or complex technical setup — only excess credit to participate.

Advantages:

• Retains as much capital as possible within the protocol by making liquidators act as users first.
• Because inheritance doesn’t necessarily require a swap, liquidations should be more easily executable by a wider range of entities.

How it works

Whenever a borrower (Alice) is found to have an LTV greater than Twyne’s defined liquidation threshold (λ_twyne > λ_liq_twyne), any user with collateral on Twyne can trigger an inheritance of the borrower’s entire position.

Example:

• Alice deposits $100 as collateral and borrows $80. Her maximum allowed LLTV is 95%.
• Bob deposits $20 collateral and opts in to absorb incoming liquidations.

• Prices move against Alice, causing her debt to rise to $95.01, exceeding her 95% LTV limit. She becomes eligible for liquidation.

• Liquidation occurs: Alice’s entire position ($100 collateral + $95.01 debt) is automatically transferred to Bob.

• After the transfer, Bob’s new position:
  • Collateral: $120 ($20 original + $100 from Alice)
  • Debt: $95.01
  • Resulting LTV: ~80% (safer and healthier).

Bob effectively gains ~$5 in net worth because he acquires Alice’s collateral at a discounted rate (below market value). He can:

• Repay the debt immediately to secure profit, or
• Keep the position open, betting on a price recovery.

If another borrower (Bob) acts as liquidator, he inherits Alice’s collateral, her liabilities, and retains the same CLP-reserved assets (for which he is charged the borrower siphoning rate).

Relevant parameters:

• B_Bob = Bob’s outstanding borrow
• B_Alice = Alice’s outstanding borrow
• C_Bob = Bob’s collateral
• C_Alice = Alice’s collateral

After inheriting Alice’s position:

λ_Bob_Twyne = (B_Bob + B_Alice) / (C_Bob + C_Alice)

If the liquidator is a CLP (Charlie), they agree to become a borrower, engaging part of their unused assets (C_extra_LP) as collateral to execute the liquidation:

λ_Charlie_Twyne = B_Alice / (C_extra_LP + C_Alice)

In all cases, Twyne smart contracts pre-check that a liquidator has enough collateral to safely execute the inheritance.

Fallback_old

If liquidation on Twyne is delayed, the underlying lending market (e.g., Euler) where the borrower operates will trigger its own liquidation, which may impact both Alice and the CLPs backing her loan.

If the underlying protocol seizes the liquidation process, Credit LPs may incur losses. However, there are scenarios where the underlying liquidation happens safely, and the CLP is made whole.

For instance, Euler would liquidate the combined position near a 90% LTV. As long as Euler’s liquidation incentive isn’t higher than ~10%, Alice’s original collateral should cover the debt plus the liquidator fee.