Fallback Liquidations

Despite our best efforts, positions might not be inherited quickly enough during extreme market conditions. When this happens, the external protocol performs its own liquidation. This is where things get complex and potentially lossy for Credit LPs.

Understanding External Protocol Liquidations

When Euler or another underlying protocol liquidates a Twyne position, it doesn’t distinguish between borrower and CLP collateral. From its perspective, it’s liquidating a single position with combined collateral.

The challenge for Twyne is determining how to split the remaining assets fairly between the borrower and CLPs after an external liquidation.

Post-Liquidation Accounting

After an external liquidation, Twyne must:

1. Assess Remaining Assets: Determine what collateral and debt remain

2. Prioritize CLP Protection: Ensure CLPs recover maximum possible value

3. Maintain Liquidatability: Keep borrower in a liquidatable state

4. Prevent Gaming: Avoid creating exploitable conditions

The mathematical framework for this is covered in detail in Section 6.2.1 of the whitepaper. The key insight is that we reset the borrower’s liquidation LTV to the maximum allowed value and redistribute assets accordingly.

Calculating CLP Losses

Credit LPs face potential losses when external liquidations occur. The loss amount depends on several factors:

• The borrower’s risk level $\rho = \tilde{\lambda}_t / \tilde{\lambda}_{\text{max}_t}$

• The external protocol’s liquidation parameters (incentive and closing factor)

• The safety buffer maintained by Twyne

The whitepaper provides detailed loss analysis showing that CLPs are protected as long as specific conditions are met. For typical parameters (5% liquidation incentive, 50% closing factor), CLPs face no losses unless borrowers choose extremely high liquidation LTVs.