Collateral conversion
The Collateral conversion mode can be triggered for any loan when the price of the collateral in that particular loan has dropped into its conversion price range. When this happens the collateral becomes locked until either the price of the collateral increases so the mode exits by itself, or through manually closing the loan yourself.
If the price of the collateral drops fully through the conversion price range and your loan health is negative, then all of the collateral has been converted to repay the loan and the loan closes automatically, which is called a liquidation.
You will notice that the regular ADJUST LOAN
interface is different when your loan has entered the collateral conversion mode, where depositing/withdrawing collateral, and borrowing more $MONEY, is temporarily unavailable, and your only options are to repay, close loan, or wait.
What is the Collateral conversion mode?
In the Collateral conversion mode, your collateral has begun actively trading against $MONEY to ensure that the loan is still backed by enough value.
Your collateral for the loan is now a combination of a portion of your originally deposited collateral (e.g. ETH), and some amount of $MONEY. How much depends on how many bands have been triggered at that time.
Example
:
If you have 10 $ETH, that has been split evenly into 10 price bands, and the first band has been converted at an average rate of 3000 $MONEY per $ETH, your total collateral for the loan would now be 9 $ETH + 3000 $MONEY. If the price falls even more and the next price band is hit and gets converted, with that band trading at an average rate of 2900 $MONEY per $ETH, then your new collateral would now be 8 $ETH + 5900 $MONEY, and so on.
Collateral can be converted to $MONEY, but can also be converted from $MONEY back to the original collateral asset if the price of the collateral recovers. It goes both ways.
There are trading fees involved during conversion. If your loan entered conversion, and then exited because the price of the collateral recovered, you would have slightly less collateral left in the loan due to these fees.
A loan can stay in the collateral conversion mode for a long time trading back and forth if the price of the collateral moves within the conversion price range you have set, and the loan can enter and exit the mode unlimited times as well (unless it liquidated). While the Collateral conversion mode is part of what makes the Automated Loan Protection what it is, it is generally advisable for users to try to avoid entering this mode or stay in it for too long, because while in this mode, the selling and buying back of bands of collateral incur trading fees that the user pays for indirectly. Being in this mode also means you could potentially be liquidated, which you as a user generally want to avoid.
What can you do whilst in the mode?
While in this mode, you will notice that you are not able to add or withdraw any collateral. You are only able to repay or close the loan directly with $MONEY. To add more collateral you have to close the loan fully first and open a new loan to set new unlocked price bands.
You can also wait and hope the price of the collateral increases such that the loan exits the mode by itself. On the other hand if the price of the collateral drops fully through the conversion price range, you get liquidated.
Closing the loan whilst in Collateral conversion mode
When you close a loan whilst in Collateral conversion mode, the portion of your collateral that has been converted into $MONEY is used to pay back the loan. The benefit of this is that you have less you need to repay. On the other hand you don't receive the full amount of collateral back, but you can buy that back manually from the $MONEY that you borrowed.
In the future this can be automated with a custom zap so you don't have to manually buy back the collateral back.
Closing the loan whilst in collateral conversion mode is slightly different from closing the mode while not in the collateral conversion mode, because your collateral is now a combination of some of you original deposit and some partially converted into $MONEY. Because of this, if you wish to close the loan, the $MONEY portion in your collateral will be used to pay back the loan, making it so that you do not need to pay the full original loan back, because some of your collateral has already been converted so will be used to pay of the loan.
On the other hand, when you close out the loan while in the collateral conversion mode, you will then not receive all of your original deposit back, because part of it was converted and then used when repaying the loan. If you rather prefer to see if the price of the collateral goes back up again so your deposit gets converted fully back into the collateral asset before closing the loan, you can choose to do so, but that is at your own risk.
Partially repaying whilst in Collateral conversion mode
Partially repaying the loan whilst in collateral conversion mode will not take you out of the collateral conversion mode, as the price bands are "locked in" in during the conversion mode to ensure the best rates for the user. Repaying will improve the loan health though as the liquidation price moves further down, and you lower your interest fees. You can also fully repay the loan without closing the loan, in the hopes of the price of your collateral going back up so the $MONEY portion of your collateral gets converted back into the original collateral by the protocol automatically.
How do you prevent entering the mode?
It is of course impossible to predict how the price of a collateral asset will change over time and if a price change will happen that leads to your loan entering the collateral conversion mode, but as a user there are still ways for you to avoid entering it through risk-management and being proactive anytime the price of your collateral drops significantly towards the conversion range. At any time if you think the collateral's price is too close to your loan's conversion range, you can always add more collateral or partially repay the loan to increase your loan health and lower the risk that the loan will enter the conversion mode. Doing so will minimize potential losses and trading fees that you can accrue if entering the collateral conversion mode.
Edge cases
Still in Collateral conversion despite price recovery
While unlikely, it is possible that your loan remains in Collateral conversion mode despite the price of your collateral going above the conversion range for your loan. This would happen if no bot active in the protocol converted your loan fully back to the original collateral yet.
The reason for this in most cases would be because your loan is too small in value (less than or just a few dollars worth), making it difficult for a bot to convert your collateral and not lose money from gas and trade fees.
If you are creating test loans with very small amounts of collateral (few dollars worth), be aware that Collateral conversion might not behave as expected due to it not being profitable for bots to convert your loans due to gas fees.
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