Liquidation Process

Liquidation Mechanism

The BSM liquidation system is a three-contract pipeline — LiquidationManager, AuctionManager, and LinearDecrease (the price calculator) — that continuously safeguards the solvency of the protocol by enforcing minimum collateralisation requirements on every leveraged position.

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Every leveraged position in BSM carries an inherent risk: if the underlying asset price drops far enough, the collateral behind the position may no longer be sufficient to honour the stable token (S) obligations it was created to back. The liquidation system exists to detect this situation and restore the protocol's solvency before any S token holder suffers a loss.

Each position is continuously assigned a risk level based on its current net asset value (NAV). When the price of the underlying asset falls, the NAV of LPGOLD declines. The system tracks this decline in real time and classifies each position on a scale from "safe" down through low, medium, and high risk, until eventually the position crosses the liquidation threshold — the point at which it can no longer be considered adequately collateralised.

Once a position breaches the liquidation threshold, any participant on the network may trigger the liquidation process. The liquidated user's LPGOLD are immediately burned and their position is frozen. If any residual value remains above the liquidation penalty, that amount is returned to the user straight away. The rest of the collateral is set aside to cover the S tokens that need to be recovered.

To recoup that outstanding PGUSD value, the protocol runs a Dutch auction. The collateral is offered for sale starting at a premium price that then decreases linearly over time. Anyone can step in and purchase a portion of the collateral by paying the equivalent amount in PGUSD, which are then destroyed. Because the price starts high and keeps falling, rational buyers are incentivised to act quickly — in practice the auction typically clears well before the price reaches its floor.

If an auction stalls and its price falls too low before all collateral is sold, any participant can reset it. The reset re-anchors the starting price to the current market level and restarts the countdown, ensuring the process never gets permanently stuck. Participants who trigger a liquidation or reset a stalled auction receive a small keeper reward paid in collateral, creating a market incentive for third parties to keep the system healthy.

Once all the required PGUSD have been collected and burned, the auction closes, the position is unfrozen, and the protocol records whether the process resulted in a small surplus or deficit relative to the collateral originally allocated. This cycle — continuous risk monitoring, threshold-triggered liquidation, Dutch-auction recovery — ensures that PGUSD holders are protected even through sharp, sudden price moves in the underlying asset.