Jiang Zhuoer: If Sun Yuchen's 600,000 ETH is liquidated, will the ETH price really drop below 1,000 USD?

This article is from Chain News, author: Jiang Zhuoer.

In yesterday's market crash, the liquidation volume of DeFi lending platforms reached hundreds of millions of dollars. Tron founder Justin Sun claimed that a liquidation of 600,000 ETH on Liquity was avoided, "saving the crypto world." Some in the community speculated that if these 600,000 ETH were liquidated, the price of ETH might drop below $1,000. In response, LiqiBit Pool CEO Jiang Zhuoer stated that the liquidation on DeFi lending platforms would not be immediately sold on the market, thus having a limited impact on the market.

Below is Jiang Zhuoer's statement.

If Justin Sun's 600,000 ETH were liquidated, would the price of ETH drop below $1,000?

In fact, it's not like that; it's not that scary. Telling a story is one way to explain things, and the more sensational it is, the more listeners it attracts. Explaining the principles is another way.

1. The forced liquidation in DeFi is similar to the liquidation in centralized exchanges, but there are differences. In exchanges, the liquidation orders are posted at a lower price all at once, and because: lower posted orders = downward pressure = latest transaction price drops, it may lead to subsequent orders also getting liquidated, creating a chain reaction.

2. In DeFi, when the collateralization ratio falls below a certain level, the orders will be posted, allowing arbitrageurs to participate in the liquidation. This process is similar to liquidation. For example, if you borrow $100 U and the net value of the collateral ETH is $110, you can liquidate this order, exchanging $100 U for ETH worth $110, and then sell the $110 worth of ETH on the exchange, earning a $10 liquidation profit. (Liquity uses stable pools and other methods for liquidation, the principles are similar, so I won't elaborate further.)

3. However, the latest coin price in DeFi is not generated directly from buy and sell orders like in exchanges, but is input from oracles externally. Therefore, the liquidation orders in exchanges will directly push the transaction price down instantly, while the liquidation orders in DeFi will also lower the transaction price, but this process relies on arbitrageurs to complete, which has a certain delay and is an indirect effect.

4. In extreme cases, if all the arbitrageurs in the market run out of funds, no matter how large the liquidation orders are, they will only exist in the system and will not transmit their impact to other DeFi and centralized exchanges. Justin Sun's 600,000 ETH is such a case.

5. When Liquity's stable pool runs out of LUSD stablecoins (unable to rely on pre-stored stablecoins in the system for liquidation, needing external arbitrageurs), and the overall system's collateralization ratio falls below 150%, it will enter the ultimate mode—Recovery mode. All orders, even those above 110%, will be liquidated from low to high until the overall system's collateralization ratio is restored to 150%, thus forcing borrowers to quickly replenish funds.

6. Recovery mode is what Justin Sun referred to as "the queue for execution has already started, and I am at the end of the queue, with 40,000 ETH already executed in front." Although Justin Sun is currently above 110%, he is also in the queue for execution and can theoretically be executed. However, even if Justin Sun does nothing, after the system executes the orders with lower collateralization ratios in front, it is very likely that the overall system's collateralization ratio will recover to 150%, exiting the queue for execution.

7. Even if the price drops further and the system's collateralization ratio cannot recover to 150%, and Justin Sun's 600,000 ETH is posted for liquidation, if the arbitrageurs' funds are already insufficient, they may not even finish off the liquidation orders (corpses) in front of Justin Sun, and it will not yet be Justin Sun's turn for the 600,000 ETH.

Even if the liquidation orders (corpses) in front of Justin Sun are finished, the 600,000 ETH will still be eaten slowly, and the impact on the exchange price depends on the funds of the arbitrageurs, which are clearly insufficient at this time.

Moreover, when the price rises again, unlike the liquidation orders in exchanges that do not return to normal orders, most DeFi systems will restore the unfinished liquidation orders to normal orders. For example, after the overall system's collateralization ratio of Liquity recovers to 150%, it will exit the queue for execution.

8. So to summarize, what would happen if Justin Sun did not replenish his position in time? The most likely scenario is that nothing will happen because:

• The lowest price only lasts for a few minutes, and after a few minutes when the price rises, the arbitrageurs may not even finish off the corpses in front of Justin Sun.
• Even if they finish off the corpses in front of Justin Sun, the selling pressure on the exchange only depends on the funds of the arbitrageurs, which are clearly insufficient at this time, and due to ETH congestion, the arbitrage efficiency is very low.
• After liquidating the low collateralization orders in front of Justin Sun, the Liquity system's collateralization ratio may rise back to 150%, exiting the queue for execution.

Therefore, it is highly likely that nothing will happen, and it will not lead to "ETH dropping to $1,000." Only a few conditions need to be met: the price remains low for a long time (but not too low, making liquidation unprofitable) + sufficient funds for arbitrageurs + no congestion in ETH, could lead to arbitrageurs continuously moving these 600,000 ETH to the exchange, affecting the exchange price.

9. Justin Sun's biggest risk is: if a certain whale targets him, and Liquity enters the queue for execution, with the overall collateralization ratio severely below 150%, directly using a large amount of U to liquidate all orders in Liquity (including Justin Sun at the end of the queue), then Justin Sun would be bought out at a low price for 600,000 ETH.

However, if a whale buys up 600,000 ETH at once, it is most likely a pure buy, because if they take it to the exchange for arbitrage and push the price down, a 10%-20% price difference is not enough to cause a loss, so it would not lead to "ETH dropping to $1,000."

PS: It is unclear whether these 600,000 ETH belong to Justin Sun or users under him. Remember: No your key, No your ETH.