Bad Debt Risk

The primary risk for both the protocol and lenders is that the value of the borrowers’ collateral decreases to below the debt value or the debt increases too rapidly. In either scenario, the borrower lacks a financial incentive to repay their loan, as it would result in a loss, leading to bad debt.

While Solera's liquidation framework aims to effectively repay vault loans in an effective manner, issues may arise during the liquidation process (high market volatility, slippage, gas costs, illiquidity, etc.) which may prevent the deposited collateral from being sold in a timely manner to make up for the borrowed amount, resulting in the protocol accruing bad debt.

Bad debt may be realized in "black swan" events. And possibly, an inability to repay user loans may arise due to insufficient liquidity in adverse market conditions. If bad debt is accrued in Solera markets, it will be socialized amongst pool lenders unless alternate remediations are determined by the risk and governance committee, external parties, or insurers.