How are liquidations exploited?
Back-running strategies also apply to liquidations whereby a transaction sender wishes to be the first to liquidate a loan right after a price oracle update (which will allow liquidation to be triggered).
- Fixed spread liquidation used by Compound, Aave, and dYdX allows a liquidator to purchase collateral at a fixed discount when repaying debt.
A detects a liquidation opportunity at block B (i.e., after the execution of B). A then 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 transaction fees for his liquidation transaction T.
A observes a transaction T, which will create a liquidation opportunity (e.g., an oracle price update transaction which will render a collateralized debt liquidatable). A then back-runs T with a liquidation transaction TA to avoid the transaction fee bidding competition.
- The auction liquidation allows a liquidator to start an auction that lasts for a pre-configured period (e.g., 6 hours). Competing liquidators can engage and bid on the collateral price.