How an Automatic Liquidation of $600M in Ethereum Was Narrowly Avoided

By Liam J. Kelly

Decrypting DeFi is Decrypt's DeFi email newsletter. (art: Grant Kempster)

While everyone is watching the price action of their favorite top tokens, few are talking about how decentralized stablecoins are performing. And one crypto trader in particular, who took his eyes off his stablecoin prize, nearly caused a $600 million Ethereum liquidation on Friday.

That would have caused the price of ETH to crash even harder. But this crypto crisis was narrowly avoided.

Before we dive into what happened on Friday, here’s some background. Decentralized stablecoins, like Maker’s DAI, are backed by other cryptocurrencies, like Ethereum. You deposit Ethereum and the protocol spits out DAI. 

Now, there’s a key caveat: Ethereum deposits must be overcollateralized, meaning they must be more than 100% of the value of DAI you’re minting. Depending on the asset type, this collateralization ratio could be 130%, 145%, or 170%, according to current vaults on Maker.

So, to mint $1 of DAI, I would need to supply $1.30, $1.45, or $1.70 of Ethereum. 

The reason overcollateralization exists throughout DeFi is because of the crypto market’s notorious volatility. If the price of Ethereum drops in a multi-point move, like it did at the end of last week, then projects still have a bit of a buffer before the stablecoin loses its dollar peg. 

Whenever an Ethereum vault in Maker drops below its collateralization ratio, the system notifies the vault holder that they need to deposit more Ethereum to keep that ratio. If the vault holder fails to do so, the collateral in the vault is liquidated and sold on auction at a discount. 

Naturally, scooping up this discounted Ethereum is good business for those who can afford it. It’s good business for the Maker protocol too because it charges an additional “liquidation penalty” to folks who fail to maintain their vaults. 

Good, so that’s the mechanism. Next, let’s get back to the largest liquidation event to ever happen in DeFi and the “sleepy” trader who stopped it from getting worse.

Research firm Delphi Digital reported that 50% of the record-breaking $200 million in Ethereum liquidations that occurred on Friday all happened on Maker. 

Maker’s liquidations nearly hit $600 million in the middle of the crash after one vault holder almost failed to top up his vault and get back into the collateral. 

This vault holder, named “7 Siblings,” would’ve essentially played an enormous role in continued sell pressure on Ethereum. Continued selling could’ve led to further liquidations, and on and on. (This is what people mean by “cascading liquidations,” by the way.)

Maker co-founder Rune Christensen summed it up surreally: “Maker is about to market dump $600 million worth of ETH unless someone can phone up this 7 Siblings guy and tell him to top up his vaults in the next 30 mins.”

After just $65 million in liquidations, it looks like someone eventually got him on the phone (or woke him up, who knows). There’s even been a song written about the event. Check it out here.

And along the way, the Maker protocol scooped up quite a bit of revenue from liquidation penalties. 

Thanks to Friday’s bearish action, Maker has officially earned the most money the protocol has ever earned in its existence.

As for DAI’s peg, CoinGecko shows that the stablecoin briefly fell as low as $0.96 during the liquidation event. It recovered quickly though, which is a testament to the protocol’s resiliency. 

Anyway, it's all a little reminder that a lot happens in crypto besides just “number go up” or down. All of these fun DeFi experiments get run through the wringer (for better or worse). Those that pass enough stress tests move one step closer to becoming the future of finance. 

Decrypting DeFi is our DeFi newsletter, led by this essay. Subscribers to our emails get to read the essay first, the day before it goes on our site. Subscribe here.

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