Bad Debt Management

Handle and prevent bad debt accumulation in your Flux vault.

Overview

Bad debt occurs when liquidated positions cannot cover outstanding debt. This directly reduces vault asset value and LP returns.

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Understanding Bad Debt

How It Happens

1. Manager's position becomes unhealthy

2. Price crashes before liquidation

3. Liquidation executed

4. Assets sold for less than debt

5. Difference becomes bad debt

Impact

Example:
Manager debt: 100,000 USDC
Position value: 95,000 USDC
Liquidation payment: 95,000 USDC
Bad debt: 5,000 USDC

LPs share this 5,000 USDC loss proportionally

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Prevention

1. Adequate Bond Ratios

Higher bond ratios = more buffer:

Bond Ratio 10%: Liquidates at 110% health
Bond Ratio 20%: Liquidates at 120% health
Bond Ratio 30%: Liquidates at 130% health

More room for price crashes

2. Liquidation Buffers

Additional safety margin:

Liquidation Threshold = 1 + minBondRatio - liquidationBuffer

Example:
minBondRatio: 20%
liquidationBuffer: 10%
Threshold: 110%

Position liquidates if health < 110%

3. Reliable Liquidation

Ensure liquidations execute quickly:

• Run your own liquidation bot

• Incentivize liquidators

• Monitor liquidation performance

• Test liquidation speed

4. Conservative Asset Selection

Choose liquid assets:

• Deep DEX liquidity

• Low volatility

• Reliable oracles

• Proven track record

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Monitoring

Track Bad Debt

function getBadDebtMetrics(address vault)
    public
    view
    returns (
        uint256 totalBadDebt,
        uint256 badDebtRatio,
        uint256 badDebtGrowth,
        bool concerning
    )
{
    IFluxVault v = IFluxVault(vault);

    totalBadDebt = v.getBadDebt();
    uint256 totalAssets = v.totalAssets();

    badDebtRatio = totalBadDebt * 100 / totalAssets;

    // Compare to last week
    badDebtGrowth = totalBadDebt - lastWeekBadDebt;

    // Concerning if >3% or growing quickly
    concerning = badDebtRatio > 3 || badDebtGrowth > totalAssets / 100;

    return (totalBadDebt, badDebtRatio, badDebtGrowth, concerning);
}

Alert Thresholds

Good: <1% bad debt
Acceptable: 1-3%
Concerning: 3-5%
Critical: >5%
Emergency: >10%

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Response to Bad Debt

If Bad Debt Occurs

1. Assess: How much? Why did it happen?

2. Communicate: Inform LPs immediately

3. Analyze: What went wrong?

4. Prevent: Implement improvements

5. Monitor: Watch for recurrence

Parameter Adjustments

If using mutable strategy:

// Increase safety margins
strategy.setMinBondRatio(higherRatio);
strategy.setLiquidationBuffer(largerBuffer);

// Restrict risky assets
strategy.removeAllowedAsset(volatileAsset);

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Recovery

Socialized Losses

Bad debt is shared among all LPs:

Share value before: 1.05 USDC
Bad debt: 2% of vault
Share value after: 1.029 USDC

Each LP absorbs 2% loss

Recovery Options

1. Accept loss: Most common, LPs share loss

2. Insurance payout: If insured

3. Backstop: Use reserve fund if available

4. Raise capital: Emergency fundraise (rare)

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Best Practices

Conservative Parameters

Start safe:

Bond Ratio: 25-30%
Liquidation Buffer: 12-15%
Assets: Top 10 only
Max position: 5% of vault

Active Management

• Monitor positions daily

• Run liquidation bot

• Test liquidations regularly

• Audit oracle reliability

• Review parameters monthly

Transparency

Communicate with LPs:

• Current bad debt ratio

• How it occurred

• Prevention measures

• Expected recovery

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Related Documentation

• Vault Risks

• Oracle Integration

• Liquidation

• Emergency Procedures