Mero protects registered user's loans from liquidation by executing automated collateral top-ups. A collateral top-up is the act of depositing additional collateral into a collateralized debt position. When a top-up occurs, it increase the health factor of the loan which in turn prevents or deceases liquidation risk.
Top-ups are personalized to the user. Meaning, users select specific parameters that best match their risk profile. Top-ups will continue to occur until (if triggered) one of the following criteria is met:
- Maximum allocation value < top up increment value
- User unregisters their position
Liquidity that is registered for top-ups reacts to a user's positions. When a user's loan is safe from liquidation, liquidity is deployed to generate yield. If the loan becomes at risk of liquidation, liquidity is deployed to execute a collateral top-up (prevent liquidation).
In this example a user is borrowing $37,500 of DAI against $50,000 of ETH as collateral on Aave. This is a risky, or highly leveraged, loan with a health factor of 1.066. In order to mitigate liquidation risk, the user makes the following top up registration:
Health factor: 1.05 Increments: $2,500 Max allocation: $10,000.
At some point in time ETH drops in value which causes the Aave loan to become less collateralized. This negatively impacts the LTV or collateralization ratio of the loan and decreases the health factor (health factor < 1 = eligible for liquidation).
When the user's loan hits a health factor of 1.05 a Mero keeper immediately reports this to the Mero smart contract which then executes a collateral top up. $2,500 is taken from the Mero user's liquidity (which has been earning yield) and deposited into the user's collateral. This increases the health factor of to 1.103 which prevents possible liquidation and greatly increases the safety level of the loan.
Once registered, collateral top ups are entirely automated for users and will continue to occur (if triggered) until the user unregisters their Mero liquidity or lacks sufficient funds.
This example demonstrates how the Mero protocol can be used to increase leverage. Increasing leverage comes at the cost of higher liquidation risk. The user was able to mitigate liquidation risk and maintain a lower risk health factor by registering their loan on Mero. Additionally, the user was able to decrease the cost of borrowing thanks to Mero's reactive liquidity.