# Burrow State & Liquidation

An operational interpretation of the burrow state and operations on it.

## State

• active: whether the burrow is supported by a creation deposit. If not, it’s considered “inactive”.

• address: the address of the contract holding the burrow’s collateral and creation deposit.

• collateral: the amount of tez stored in the burrow. Collateral that has been sent to auctions does not count towards this amount; for all we know, it’s gone forever.

• outstanding_kit: the amount of kit that is outstanding from the burrow. This does not take into account kit we expect to receive (to burn) from pending auctions. However, outstanding_kit does increase over time, since the burrowing fee and the adjustment fee are added to it. So, effectively, before doing anything else with a burrow, we update its state (“touch” it, see below).

• collateral_at_auction: the total amount of tez that has been sent to auctions from this burrow, to be sold for kit.

• last_touched: the last time the burrow was touched.

• adjustment_index: the last observed adjustment index (at time last_touched).

## Touching

First thing to do before considering any of the things below is to update the state of the burrow, by touching it. The effect of this is to

• Update the timestamp in the burrow to reflect the last time it was touched

new_last_touched = now

• To add accrued burrow and adjustment fee to its outstanding kit

new_outstanding = old_outstanding * (new_adjustment_index / old_adjustment_index)


Note that if the current timestamp is identical to that stored in the burrow, we do not perform any of the above.

Each of the following operations implicitly touch the burrow (i.e., perform the above updates) before doing anything else.

## Is a burrow collateralized (i.e. not overburrowed)?

The burrow is considered collateralized if the following holds:

collateral >= outstanding * fminting * current_minting_price      (1)


collateral here refers to the amount of tez stored in the burrow (collateral that has been sent to auctions does not count towards this amount; for all we know, it’s gone forever).

outstanding_kit here refers to the accrued amount of kit that is outstanding from the burrow (kit we expect to receive from pending auctions is not considered burned here, but still outstanding).

## Is a burrow a candidate for liquidation?

The burrow cannot be marked for liquidation if the following holds:

collateral >= optimistic_outstanding * fliquidation * liquidation_price      (2)


collateral here refers to the amount of tez stored in the burrow (collateral that has been sent to auctions does not count towards this amount; for all we know, it’s gone forever).

outstanding_kit here refers to the accrued amount of kit that is outstanding from the burrow. In this case we optimistically do take into account kit we expect to receive from pending auctions at the current_minting_price, but pessimistically assume that these pending auctions are warranted (so we lose the liquidation penalty). That is

optimistic_outstanding = outstanding - (1 - liquidation_penalty) * (collateral_at_auction / current_minting_price)


## How much collateral should we liquidate?

In general, in order to calculate how much should we auction off we assume that a) this auction is warranted, b) all pending auctions are also warranted, c) the price we’ll get for everything is current_minting_price. a) and b) effectively mean that we can only expect (1 - liquidation_penalty) returns from all auctions considered. Formally:

• First, from auctioning we expect to get the current minting_price, so, if we send collateral_to_auction and repaid_kit is received, we have

collateral_to_auction = repaid_kit * minting_price                   <=>
repaid_kit = collateral_to_auction / minting_price                   (3)

• Second, we assume that the auction is warranted (so we lose the liquidation penalty), thus

actual_repaid_kit = repaid_kit * (1 - liquidation_penalty)    (4)

• Third, we consider all pending auctions to be successful, using the current minting_price, but also warranted:

optimistic_outstanding = outstanding_kit - (1 - liquidation_penalty) * (collateral_at_auction / minting_price)       (5)

• Fourth, under the above conditions we aim to bring the burrow into a state where it’s not oveburrowed anymore, thus

collateral - collateral_to_auction >= (optimistic_outstanding - actual_repaid_kit) * fminting * minting_price    (6)


Solving (3), (4), (5), and (6) the above gives us (7):

collateral_to_auction >=
( outstanding_kit * fminting * minting_price
- (1 - liquidation_penalty) * fminting * collateral_at_auction
- collateral
)
/
((1 - liquidation_penalty) * fminting - 1)


if ((1 - liquidation_penalty) * fminting - 1) > 0.

Say the burrow has been touched and all its parameters are up to date. Concerning liquidation, we have the following cases:

### Case 1: The burrow is not a candidate for liquidation

If (2) above holds then the burrow should not be liquidated. Send nothing to auctions and leave the burrow as is.

### Case 2: The burrow is a candidate for liquidation

If (2) above does not hold, then the burrow should be liquidated. Either partially, completely, or even be closed.

First things first, the actor who initiated liquidation should get their reward (burrow creation deposit + percentage of collateral):

liquidation_reward = creation_deposit + (collateral * liquidation_reward_percentage)


That is, before we compute anything else, we leave the burrow with less collateral and without a creation deposit:

active     = false
collateral = collateral - (collateral * liquidation_reward_percentage)


Now, depending on how much collateral remains, we have the following cases:

#### Case 2A: collateral < creation_deposit

We cannot replenish the creation deposit.

• We send all the remaining collateral to be auctioned off for kit.

• The burrow remains deactivated.

collateral            = 0
collateral_at_auction = collateral_at_auction + collateral_to_auction


#### Case 2B: collateral >= creation_deposit

We can replenish the creation deposit, and this is the first thing we do:

collateral = collateral - creation_deposit


Now all that remains is to compute what should we auction off to bring the burrow to a state where “any outstanding kits could have just been minted”. For that, we use the (7):

collateral_to_auction = ceil (
( outstanding_kit * fminting * minting_price
- (1 - liquidation_penalty) * fminting * collateral_at_auction
- collateral
)
/
((1 - liquidation_penalty) * fminting - 1)
)

• If collateral_to_auction < 0 or collateral_to_auction > collateral, then restoration is impossible: liquidate the entire remaining collateral (Note that the resulting burrow can be targeted for liquidation one last time (with the creation deposit being the only reward). Alternatively, we could (rather harshly) liquidate the deposit too and close the burrow.):

active                = true
collateral            = 0
collateral_at_auction = collateral_at_auction + collateral

• Otherwise auction off exactly collateral_to_auction:

active                = true
collateral            = collateral - collateral_to_auction
collateral_at_auction = collateral_at_auction + collateral_to_auction


## Was the liquidation warranted?

We sent 10% extra tez to be auctioned off as a penalty, but in case the actual selling price of the tez would not have triggered a liquidation (retrospectively), we wish to bring that back to the burrow, if possible.

Calculations: In order to see whether liquidation should occur, we used equation (2) above, which we can rewrite as

liquidation_price <= collateral / (optimistic_outstanding * fliquidation)    (3)


So, if (3) was satisfied, we wouldn’t have triggered a liquidation. If we assume that at the end we sent collateral_to_auction to be auctioned off and we received repaid_kit for it, we have:

maximum_non_liquidating_price = collateral / (optimistic_outstanding * fliquidation)
real_price                    = collateral_to_auction / repaid_kit    # derived from the auction outcome


If real_price <= maximum_non_liquidating_price then the liquidation was not warranted (i.e. the liquidation price we used when calculating collateral_to_auction was off) and we wish to return the kit we received from the auction in its entirety to the burrow:

real_price <= maximum_non_liquidating_price
collateral_to_auction / repaid_kit <= collateral / (fliquidation * optimistic_outstanding) <=>
collateral_to_auction * (fliquidation * optimistic_outstanding) <= repaid_kit * collateral <=>
collateral_to_auction * (fliquidation * optimistic_outstanding) / collateral <= repaid_kit <=>
repaid_kit >= collateral_to_auction * (fliquidation * optimistic_outstanding) / collateral


So, if the kit that the auction yields is more than

min_received_kit_for_unwarranted = collateral_to_auction * (fliquidation * optimistic_outstanding) / collateral


then this liquidation was unwarranted.

## What if the liquidation was warranted?

When we send collateral_to_auction to an auction, we also send min_received_kit_for_unwarranted so that—after the auction is over—we can determine whether it was warranted. If it was warranted, then we wish to return the received kit in its entirety to the burrow. Otherwise we burn 10% of the kit earnings.

The auction logic might end up splitting collateral_to_auction into parts (slices) that can be sold for different prices; we perform the above check per slice.

collateral_to_auction = tez_1 + tez_2 + ... + tez_n


If we end up selling slice tez_i for kit_i, this part of the liquidation is considered unwarranted (and thus kit_i is returned to the burrow) only if

kit_i >= min_received_kit_for_unwarranted * (tez_i / collateral_to_auction) <=>
collateral_to_auction * kit_i >= min_received_kit_for_unwarranted * tez_i


## Misc

• fminting > fliquidation

• minting_price >= liquidation_price

• liquidation_penalty = 10%