While Liquid Loans is a fantastic tool for making use of PLS tokens to generate passive income, if you do not set your vaults collateral ratio to a safe level, you may find yourself losing your beloved PLS tokens. Today we are going to look at how much you need to place in a vault to not get absolutely REKT and lose your PLS.
As a quick recap, Liquid Loans is a fully decentralized lending protocol that issues a stable coin called USDL as a loan when users place their PLS as collateral in a vault. While Liquid Loans currently exists on only the Pulsechain testnet as we await the launch of Pulsechain Mainnet, the protocol allows users to take advantage of one of two pools in the system to earn passive income on their USDL. For a technical overview, please click ***here*** to dive into the meat and potatoes of Liquid Loans. The protocol requires a minimum collateral ratio of 110% in PLS tokes to take out a minimum of $2000 in USDL tokens, but by taking a loan at this collateral ratio you are at risk of being liquidated if the price of PLS moves down at all. A few questions need to be asked to figure out what collateral ratio is best for you.
- What are the average price drops that we see in a bull market vs a bear market?
- How long do these price drops take to full occur?
- How much of a price drop can a given collateral ratio take before it gets liquidated?
Now, let's dissect the data that we have at our disposal and answer the questions we outlined above.
Average Price Drops
By looking at the history of Ethereum, Bitcoin, Hex, and other successful tokens, we can get a rough idea of how long certain percentages of price drops can happen for PLS. We need to understand that PLS will have its own price chart and whatever averages we find in the data need to be taken as guidelines and not as the basis for our strategies. Let’s now look at a few price movements on the Ethereum price chart.
As you can see in the image above, Ethereum suffered a 95% price drop from January 11, 2018 through December 17, 2018. It took a total of 340 days for this price drop to fully play out before starting to climb back upwards. From February 14, 2020 to March 13, 2020, the ETH price drop just shy of 70%. This massive price drop took a mere 28 days to occur. Other price drops include a 37% drop in just 4 days from September 1-5th, 2020, a 61% drop in 11 days from May 12-23rd, 2021, and an
approximate 82% drop in 223 days from November 7, 2021 to June 18, 2022.
As you can see, there are a few patterns beginning to emerge. If we compare other price charts including Hex, these patterns are similar. 80-95% plus drops are longer drawn out phases that have taken anywhere from 223 days to well over a year to full play out. In less than one month, price drops of up to 70%+ have occurred. And a much more common occurrence is nearly a 40% price drop in just 4 days. What this shows us, is that if you do not set your collateral percentage within your Liquid Loans vault correctly, you can quickly lose all your PLS in a matter of days. Price drops of up to 70% can happen in the bull market (when the market is in an uptrend regarding price performance) and once a market heads into a bear phase (price performance heads downwards), we typically see the more massive reduction in price take anywhere from 200 days to around a year. So, the next question is, how much of a price drop can a given collateral ratio endure before getting liquidated?
Collateral vs Price drop
Looking at the chart below, we can see exactly how much collateral we need to survive a 27-95.6% drop in price in terms of percentage. To survive at least a 90% drop in price before getting liquidated, you would need to provide 1100% collateral in PLS. That means if you want $2000 in USDL and to survive a 90% price drop, you will need to provide $22,000 in PLS. If you want to survive an 80% price drop, you would need to provide 550% collateral, which equates to $11,000 in PLS to get the minimum $2000 in USDL as a loan. Surviving a 70% drop will require 375% collateral, a 60% drop will require 275% collateral, and a 50% drop will require 220% collateral.
While understanding that probability of a significant price drop can reduce your odds of being liquidated, it is highly important to keep an eye on the price of PLS and even top up your collateral levels to always be at least 150% at an extreme minimum. If Liquid Loans goes into recovery mode and you are caught with a collateral percentage less than 150%, the protocol will use your funds in one of three ways based on how far below the 150% collateral ratio your vault sits. For more information on this topic, go to my blog here for an in-depth breakdown on the technical aspects of recovery mode near the end of the blog.
This protocol can be a very useful tool in the Pulsechain ecosystem, however understanding just how quickly something can go wrong and how to combat it is a must before participating. Please do further research before participating for yourself if you choose to, and understand the risks, fully. The Liquid Loans team continues to be an educational force in this space while we await the launch of Pulsechain, and I applaud the teams constant efforts to be in the forefront of our developing ecosystem and community.
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