The main goal of this forum post is to introduce and explain the issue at hand with small vaults not being able to get liquidated and provide some suggestions for actionable next steps that the Maker Community can consider.
On November 8, the B.Protocol team observed that small, undercollateralized Vaults are not being liquidated as they should in the Maker Protocol. Further, the cost of splitting a vault into small vaults is small compared to the liquidation penalty at current gas prices. Vault holders may start using this tactic to avoid having their position liquidated. The preliminary evidence suggests that Keepers are choosing not to liquidate these Vaults (as opposed to not detecting them), since larger Vaults have been consistently liquidated in recent months.
It’s important to note that this has been a known possibility that has been discussed several times in the past:
dustparameter already exists as a mitigation for this issue: [Signal Request] Increasing the 'dust' amount
- The broader question of Keeper incentives has been extensively discussed, and LIQ2.0 includes explicit Liquidation Incentives for Keepers: https://github.com/makerdao/dss/pull/153
Considerations & Concerns
Based on recent observations, it has become apparent that small (debt close to the dust limit), undercollateralized Vaults are not being liquidated by Keepers. Further indications suggest that this is due to Keepers not seeing these liquidation opportunities as profitable:
- The existing Keeper infrastructure can detect split Vaults as well as normally created ones.
- The lack of liquidation was observed for at least one Vault created normally (not via splitting).
The operation to split one’s Vault into small, un-liquidatable Vaults is currently economically sensible (about 1% of a Vault’s debt, much less than the liquidation penalty).
- Vault holders may start taking advantage of this to avoid liquidation—with governance needing at a minimum three days to raise the dust limit, there is plenty of time for a Vault holder to wait for the price to increase before un-splitting their Vault.
- Someone could release a tool that allows all Vault holders to take advantage of this operation.
- Liquidations 2.0 includes an incentive that governance can adjust to directly reward liquidators; currently, the dust parameter is the only accessible tool to address this issue, at least at the protocol level.
Technical explanation of the dust parameter and its impact on the system
dust: the debt floor for a specific collateral type.
- A new Vault cannot be created with less debt than the
dustspecified for its collateral type.
- A Vault that has non-zero debt lower than its
dustlimit cannot be modified except in a way that either raises its debt above
dustor reduces its debt to zero.
- The situation described in the previous bullet point will arise when the
dustvalue is increased for a collateral type with Vaults already opened for less debt than the new
Technical explanation of the LIQ2.0 Keeper Liquidation Incentives system
- Liquidations 2.0 includes incentives for Keepers that liquidate Vaults in the form of DAI rewards paid directly from the Protocol to the liquidator.
- The technical summary of Liquidations 2.0 explains in detail how these rewards are calculated.
- This feature was added after feedback from the community highlighted the lack of incentives for liquidation as a major concern in the existing system.
- The list of preliminary liquidation parameters for control of liquidation rewards can be found in the following forum post: https://forum.makerdao.com/t/liquidations-2-0-preliminary-risk-parameters/4850
In the short-term, the MakerDAO community may consider increasing the dust parameter to combat this issue. Further, there has been some activity pushing forward this short-term solution. Last week, @Primoz (Risk Domain Team) proposed a Signal Request to increase the
dust value. The Signal Request has since closed with no clear winner. Based on the Signal Request results, three options had almost equal votes (500 DAI, 250 DAI, 100 DAI (no change to current dust value)). Primoz stated that the next steps to determine whether the Maker DAO community wants to increase the dust parameter is a ranked-choice on-chain Governance Poll with the same options listed in the Signal Request. The Governance Poll will be published on Monday, November 16.
As for the longer-term plans (Liquidations 2.0), a solution for Keeper Liquidation Incentives has already been included as an explicit reward to incentivize liquidations.