Obsidian - Liquidation fee is incorrectly calculated, leading to unprofitable liquidations

[sherlock-admin4]

Obsidian

High

Liquidation fee is incorrectly calculated, leading to unprofitable liquidations

Summary

Incorrect liquidation fee calculation makes liquidations unprofitable, leading to insolvency.

Root Cause

During PositionManager.liquidate() , two things happen:

1. An amount x of the position’s collateral is paid to the liquidator (link)
2. The liquidator pays off the debt of the position (link)

During step 1, the liquidation fee is effectively calculated as liquidationFee.mulDiv(x, 1e18)

This is incorrect- the correct way would be to take the liquidation fee from the profit of the liquidator, rather than from the entire amount x

Due to this inaccuracy, a large majority of liquidations will be unprofitable:

Example scenario

Consider a situation where liquidation fee is 30% (as stated in the contest README)

Say LTV = 90%, Debt value = $90, Collateral value drops from $100 to $98

Now, since the position LTV (90/98) is greater than the set LTV (90/100), the position is liquidatable

A liquidator aims to pay off the debt and receive the $98 worth of collateral, effectively buying the collateral at a discount of ~8%

However, They will only receive 70% of the $98 (due to the 30% liquidation fee), so they can only receive $68.6

This is extremely unprofitable since they have to pay off $90 worth of debt, and only receive $68.6 as a reward.

The correct approach to calculating fee would be the following:

1. Calculate liquidator profit = Reward - Cost = $98 - $90 = $8
2. Calculate liquidator fee = feePercentage*profit = 30% of $8 = $2.4

This ensures that liquidations are still incentivised

Internal pre-conditions

No response

External pre-conditions

No response

Attack Path

No response

Impact

Liquidations are unprofitable due to liquidation fee being calculated incorrectly.

This leads to bad debt and insolvency since there is no incentive to liquidate.

PoC

No response

Mitigation

Consider calculating the profit of the liquidation first, and take the fee based on that

[0xjuaan]

Hi @cvetanovv I forgot to escalate this (hard to keep track of so many), but I think everyone would agree this is high severity

[sherlock-admin2]

The protocol team fixed this issue in the following PRs/commits:
sentimentxyz/protocol-v2#339