Clarification on Liquidation Grace Period Reduction and 7-day Minimum Stake Time

February 14, 2024

Clarification on Liquidation Grace Period Reduction and 7-day Minimum Stake Time

We appreciate the valuable discussion we’ve received regarding the recent update on Liquidation Grace Period Reduction and the 7-day Minimum Stake Time, and we want to take a moment to provide further clarity on this matter.

Why the liquidation delay change is necessary:

This parameter change better leverages the new liquidation system, which introduces more collateral management efficiency in the protocol. Please read more details about the updated liquidation mechanism here.

With the new self-liquidation system available, combined with the ability to now fully liquidate accounts (including escrow rewards), and with stakers now getting almost all the liquidation rewards, an update to the parameters which include a lower liquidation ratio to 160% and a reduction in liquidation delay to 12 hours now allows the protocol to significantly increase its capital efficiency and robustness to price volatility.

This subsequently will allow the system to more comfortably lower the issuance ratio to 500% or lower, increasing capital efficiency of stakers, which means that for the same HZN collateral, users are able to take out a larger, interest-free, and yield-generating loan of zUSD, leveraging their capital even more. zUSD can then be used further to generate additional profits via trading spot, futures, and liquidity provision.

While concerns for stakers to ‘suddenly’ be liquidated without time to respond are valid, this change in practice will have little effect for relatively responsible stakers. Below are the most extreme cases:

Black Swan event that triggers a rapid HZN price drop:

Given the current issuance ratio of 600%, the price would have to drop over 73% for a staker who is at the target to be flagged for liquidation. The HZN oracle utilizes a TWAP (Time-Weighted Average Price), so the price would have to drop this amount and hold this price for a significant time for the full 73% price drop to be reflected in the system.

However, if this event did happen, a subsequent built-in system would likely trigger first, the Circuit Breaker system, which would trigger after a 66.67% drop between the time between any mint or burn action taking place. Once the Circuit Breaker system is tripped for HZN, all mint, burn, AND liquidation functions will cease to work, preventing users from getting liquidated and protecting the system until an investigation is conducted and the system is restored. Only the multi-sig-owned protocol owner can restore a circuit breaker trip.

It is also important to consider that if the majority of the circulating HZN supply is staked in the system behind active stakers, the likelihood of having enough circulating supply to be sold onto the open market and cause a black swan event price drop (73% in the example) is significantly reduced. I.e. if 75% of the circulating supply is staked and locked, the most HZN that could be sold at any given moment is 25% of the circulating supply. While all this supply could still be used to temporarily ‘manipulate’ the price across the exchanges, this would also create extreme arbitrage opportunities to profit from and the TWAP oracle makes the price and stakers much more resilient to this kind of attack.

The price moves down such that is doesn’t trigger the circuit breaker:

If the user’s C-Ratio is at or above the target C-Ratio, it would take a considerable amount of time, likely several days, for the price to gradually move down, be reflected in the TWAP of the oracle, and not trigger the circuit breaker before the flagging period can even be started. At an extreme hypothetical, let’s say starting price is $1.00 and the price drops to $0.27 (73% drop) in 1 second, the TWAP price would update and become $0.96 in that moment, and if the price stayed at $0.2 across all exchanges, it would take 20 hours for the TWAP to be $0.27 and trigger the flag, giving the user 32 hours (20 + 12) to respond in the worse case.

If the user’s C-Ratio is already below the target, then the window of time does decrease, depending on what C-Ratio they are sitting at. Given the TWAP and a starting ratio of 400%, it would take about 10 hours for the price to trigger the liquidation flag (given the same price scenario above), so in practice, a ~22 hour window (10 + 12) would be near the worst case-scenario for this user.

If the user is very close to the liquidation ratio, then the time to flagging will be much less, with it possible to happen within 1–2 hours if the price change is enough to trigger the liquidation flag, even with TWAP. So the absolute worst case for a user who basically doesn’t care about their C-Ratio and doesn’t watch it at all, would be 12–13 hours. These users who allow their C-Ratio to hover around the liquidation ratio are not considered responsible stakers and are potentially a threat to the system.

A note worth mentioning is with the Liquidation Ratio set at 160%, it is now 20% HARDER to get liquidated than before, which offsets the increased risk from decreasing the time of the liquidation delay.

Lastly, it is important to remember that it is in the responsible staker’s interest to rid these irresponsible stakers from the system as ALL stakers are carrying the burden of their debt. By liquidating out these stakers, all others stakers will carry LESS debt, which means the responsible staker’s C-Ratio will go up, making it easier to maintain their position, claim more staking rewards AND they will get the liquidated collateral as rewards. The faster this happens, the better off the protocol is and collectively all of its users. 12 hours was chosen to have the most value in keeping the protocol healthy while giving a reasonable enough time to react after any black swan events play out. The time for the events itself to play out should also be factored in, not just liquidation delay value itself. There is certainly a balance to this of course but the protocol should invariably lean more towards the collective safety of the protocol as this number has also been reliably tested in other systems.

Why the minimum stake time change is necessary:

This change will eliminate any possible unfair distribution of rewards via reward snapshotting. This change makes it so that a week’s worth of rewards are given to users who stake at least 1 week and not any less. While it does make non-exploitive users who wish to unstake from the system have to plan ahead more, it is worth it for all users in the protocol to eliminate the unfair distribution of rewards to users who plan to not participate fairly.

Concerns about the rapid parameter change, the team’s rationale and opportunity:

Many system parameters needed to be changed, and new ones were introduced with the system update. It was the original plan once the protocol was updated on the mainnet to ‘jump’ to this new baseline state with all new system settings all at once as some old parameters were not compatible with the new system, and then tweak from there via HIPs. While all settings were visible on the network settings page and tested on the testnet, and many articles were released about the protocol feature changes, the team could have certainly communicated better about the planned parameter changes for the V2 upgrade and their impacts to the community.

Moving forward, we will enhance our communication regarding any changes to parameters that could affect the interaction between staker/trader and the protocol.

It should be of note that the team has been working extremely hard to make these updates possible in a secure way. The large contract upgrades and migration was an absolute success on a protocol level and has set the protocol on a completely new direction and potential future.

Potential courses of action:
Should the community strongly think this parameter change is too fast, the team proposes to change the liquidation parameters from the previous to the current values at a more gradual rate. We can define 3-stages of change over a 2-month period that transitions from the prior 200% liquidation ratio to the current 160% and the prior 72-hour liquidation delay to the current 12 hours.

Alternatively, should the community still believe, after sufficient discussion and debate, that the liquidation parameters should be increased to another value, the team is also willing to take such action.

We hope this may address the community’s concerns. A strong community is a loud community and we appreciate all the discussion. We look forward to hearing back from you all.

Horizon Protocol is a DeFi platform that facilitates the on-chain trading of synthetic assets that represent the real economy. Horizon Protocol seeks to provide exposure to real-world assets risk/return profiles via smart contracts on the blockchain.

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