🧀 liquidations
tl, dr
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Lending protocol (e.g. Aave or Maker) liquidations present a well-known MEV opportunity.
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They work by requiring users to deposit some collateral. Users can then borrow different assets and toekns from others depending on what they need, up to a certain amount of their deposited collateral.
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As the value of a borrower's collateral fluctuates, if the value of the borrowed assets exceeds the value of the collateral, the protcol allows anyone to liquidate the collateral (similar to margin calls in traditional finance).
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If liquidated, the borrower usually has to pay a hefty liquidation fee, some of which goes to the liquidator (where the MEV opportunity comes in).
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Searchers compete to parse blockchain data as fast as possible to determine which borrowers can be liquidated and be the first to submit a liquidation transaction and collect the liquidation fee.
strategy 1
- A detects a liquidation opportuniy at block B (after the execution of B). Then, A issues a liquidation transaction T, which is expected to be mined in the next block, B+1.
- A attempts to destructively front-run other competing liquidators by setting high transactions fees for their liquidation transaction T.
strategy 2
- A observes a transaction T, which will create a liquidation opportunity (e.g., an oracle price update transaction which will render a collaterized debit liquidatable). A then back-runs T with a liquidation transaction Ti to avoid the transation fee bidding competition.