Credit Event

A Credit Event is not a subjective declaration but an objective state change that can be cryptographically verified on the blockchain. This eliminates disputes and reliance on third-party committees, as the triggering condition (e.g., a price oracle reporting collateral value below a threshold) is publicly auditable by all network participants.

Credit Events are triggered automatically by smart contract logic when specific conditions are met. Common triggers include:

• Collateralization Ratio Breach: Collateral value falls below the required minimum (e.g., 150%).
• Payment Default: A scheduled payment is not made by a specific block height or timestamp.
• Protocol Insolvency: A lending protocol is deemed insolvent via a governance vote or oracle feed.

The occurrence of a Credit Event initiates a predefined settlement process. In Credit Default Swaps (CDS), it triggers a payout from the protection seller to the buyer. In lending protocols, it triggers liquidation, where a liquidator repays the debt in exchange for the undercollateralized assets, often at a discount. Settlement is enforced by the smart contract.

Most Credit Events depend on external data to determine if a condition is met. Oracles (like Chainlink or Pyth) provide this off-chain data (e.g., asset prices, loan statuses) to the blockchain in a tamper-resistant way. The integrity of the oracle is paramount, as a manipulated feed can trigger false events or prevent legitimate ones.

Unlike traditional finance where a credit event (like bankruptcy) is determined by legal committees (e.g., ISDA Determination Committees), blockchain credit events are deterministic and automated. This reduces settlement time from weeks or months to minutes or hours, but requires all possible scenarios to be perfectly encoded in the initial smart contract logic.

• MakerDAO Vault Liquidation: Triggered when the ETH/USD price feed shows collateral value dropping below the minimum collateralization ratio.
• Aave Loan Liquidation: Similar mechanism, with health factor dropping below 1.
• Opyn, Hegic, or Uma Options/Swaps: Settlement is triggered if an underlying asset price reaches a certain level by expiry, verified by an oracle.

The most common trigger, occurring when a reference entity fails to make a scheduled payment of principal or interest on its debt obligation. The failure must exceed a pre-defined grace period and a payment threshold (e.g., $1 million). This is a clear, objective indicator of financial distress.

A formal declaration of insolvency by the reference entity under applicable law. This includes filing for protection from creditors, administration, liquidation, or the appointment of a receiver. It is a definitive legal event, not merely financial difficulty.

A material change to the terms of the debt obligation that reduces the financial obligation of the borrower, typically to avoid a Failure to Pay or Bankruptcy. Key qualifying changes include:

• Reduction in principal or interest
• Postponement of payment dates
• Change in currency to a less favorable one This trigger is often the most complex and subject to specific definitions in the contract.

Occurs when a debt obligation becomes due and payable before its scheduled maturity due to a default or other event (e.g., a covenant breach). The acceleration must involve a principal amount above the payment threshold.

Similar to acceleration, but triggered when a debt obligation becomes capable of being declared due and payable early, even if it has not yet been formally accelerated. It captures the point where the legal right to accelerate exists.

Triggered when a reference entity or a governmental authority rejects or challenges the validity of its debt obligations, or declares a suspension of payments (a moratorium). This is more common with sovereign or quasi-sovereign entities.

A credit event is a predefined condition, such as a loan-to-value (LTV) ratio breach or a payment default, that activates a protocol's automated liquidation or insurance payout mechanism. In DeFi lending (e.g., Aave, Compound), it's typically a collateral shortfall. In on-chain credit default swaps (e.g., Opyn, Hegic), it's a verifiable default by a reference entity.

The most common credit event in DeFi lending. It occurs when a borrower's collateral value falls below the required maintenance margin, as reported by a price oracle. Key mechanics include:

• Liquidation Threshold: The LTV ratio that triggers the event.
• Liquidation Penalty: A fee paid to the liquidator.
• Health Factor: A numeric representation of a position's safety; a value ≤1 triggers liquidation.

A credit event triggered by the failure of a DeFi protocol's core smart contracts, such as a hack or an irreversible bug that leads to a loss of user funds. This is the basis for protocol cover in decentralized insurance markets like Nexus Mutual or Unslashed Finance, where a validated claim results in a payout to policyholders.

A smart contract where a protection buyer pays premiums to a protection seller for a payout if a specific credit event occurs for a reference entity (e.g., a DAO, a protocol, or a crypto company). Events are verified via oracle networks (e.g., UMA, Chainlink) checking for on-chain insolvency or governance failure.

Credit events rely on external systems for verification and execution.

• Price Oracles (Chainlink, Pyth): Provide the market data to determine collateral health.
• Oracle Networks for Defaults (UMA): Resolve binary questions about real-world or on-chain events.
• Keepers / Liquidators: Permissionless bots that monitor and execute liquidations for a profit, ensuring system solvency.

The aftermath of a credit event involves:

• Liquidation Cascades: Mass liquidations can depress asset prices, triggering further events.
• Bad Debt: If liquidations are insufficient, protocols may incur unrecoverable debt.
• Insurance Payouts: Capital reserves are drawn down to compensate covered users. These events test a protocol's economic security and risk parameter calibration.