Recovery Mode

Recovery Mode is a protocol-enforced state in decentralized finance (DeFi) lending platforms, such as MakerDAO, that activates when the total collateralization ratio of the system or an individual position falls below a predefined Global Recovery Ratio (GRR). Its primary function is to prevent systemic insolvency by incentivizing users to restore the health of their undercollateralized vaults, often referred to as Troves. This mechanism acts as a circuit breaker, shifting the protocol's priority from normal operation to safeguarding the backing of its stablecoin, like DAI, by its collateral assets.

When Recovery Mode is triggered, the protocol imposes stricter economic penalties and restrictions. Typically, users with Troves below the GRR cannot withdraw collateral and may face higher liquidation penalties. Furthermore, the system often increases the liquidation reward paid to liquidators, accelerating the process of closing risky positions. The goal is to create urgent economic pressure for vault owners to either add more collateral or repay debt, thereby pushing the system's overall collateral ratio back above the GRR threshold to exit Recovery Mode.

The activation criteria are usually based on the value of the protocol's Total Collateral Ratio (TCR). For example, if the TCR drops below 150%, Recovery Mode may engage. This is distinct from individual liquidations, which occur at a lower Liquidation Ratio. Recovery Mode is therefore a last line of defense for the entire system, ensuring that even in extreme market volatility, the stablecoin remains sufficiently backed and the protocol avoids a scenario where bad debt exceeds the value of the liquidation penalties.

Exiting Recovery Mode requires collective action from vault owners. The protocol remains in this protective state until the TCR is restored above the GRR. This design emphasizes the decentralized and user-responsible nature of DeFi protocols; the system's stability relies on participants actively managing their positions. Recovery Mode is a critical risk-management feature that highlights the trade-off between capital efficiency and security in algorithmic finance.

Recovery Mode is an emergency state in a decentralized lending protocol, such as MakerDAO, that is automatically triggered when the total collateralization ratio of the system falls below a predefined threshold, typically 150%. Its primary function is to protect the protocol's solvency by prioritizing the repayment of the system's stablecoin debt (DAI) over the preservation of individual user positions. When active, it alters liquidation mechanics and borrowing rules to incentivize the rapid recapitalization of the system.

The core mechanism involves modifying the liquidation process. In Recovery Mode, the protocol allows for the full liquidation of a vault (also called a Collateralized Debt Position or CDP) even if its individual collateral ratio is above the normal liquidation threshold, provided it is the most undercollateralized vault in the system. This "best-first" liquidation strategy targets the riskiest positions first to most efficiently improve the global health of the protocol. Furthermore, borrowing new debt is typically disabled to prevent further systemic risk.

For users, entering Recovery Mode introduces significant risks. A vault owner cannot withdraw collateral or generate new debt. More critically, their position becomes eligible for liquidation at a 0% liquidation penalty, meaning liquidators can purchase the vault's collateral solely for the amount of debt it covers, with no bonus. This creates a powerful economic incentive for liquidators to act swiftly, as they acquire collateral at a discount equal to the full stability fee accrued on the debt.

Exiting Recovery Mode occurs when the system's overall collateral ratio is restored above the trigger threshold, usually through a combination of liquidations, users voluntarily repaying debt, and increases in collateral value. This mechanism acts as a circuit breaker, ensuring that during periods of extreme market volatility or collateral price crashes, the protocol can aggressively defend its peg and solvency, even at the expense of individual positions that would otherwise be considered safe.

Recovery Mode is an automated, protocol-enforced state designed to protect a lending system's solvency by incentivizing the recapitalization of undercollateralized positions. When a borrower's vault enters this state—typically because its Health Factor falls below a protocol-defined threshold like 1.0—the system activates special rules. The primary goal shifts from normal operation to safeguarding the protocol's total collateral backing, often by offering liquidation bonuses and restricting certain user actions to encourage rapid resolution.

The process begins with a liquidation trigger, where any user (a liquidator) can repay part or all of the vault's outstanding debt in exchange for its collateral at a discounted rate. This discount, known as a liquidation bonus, makes the action profitable for the liquidator while reducing the system's bad debt. In some protocols like Liquity, Recovery Mode also temporarily increases the Liquidation Reserve and may adjust the Redemption mechanics, allowing stablecoin holders to directly claim collateral from the riskiest vaults at face value, further pressuring the system back to health.

Visualizing the flow: 1) Oracle reports a price drop, reducing collateral value. 2) The vault's Health Factor crosses below the Recovery Mode threshold. 3) The protocol state changes, broadcasting the new rules. 4) Liquidators and redeemers are incentivized to act. 5) Their actions repay debt and remove the weakest collateral, increasing the Total Collateral Ratio (TCR) for the entire system. The process continues until the system-wide TCR is restored above the safety threshold, at which point Recovery Mode deactivates and normal operations resume.