Bad Debt Risk
Fira markets, both fixed-maturity (“fixed-rate”) and floating-rate, are exposed to bad debt risk. Bad debt can result in partial or total losses for lenders and may materially reduce expected returns. This disclosure is not exhaustive and should be read together with Fira’s broader risk and liquidation mechanics.
1) Description of the Risk
Bad debt occurs when a borrower’s collateral cannot be liquidated for enough value to fully repay the outstanding debt. This may happen when the market value of seized collateral, net of execution costs (price impact, slippage, fees, and other transaction costs), is less than the amount required to close the borrower’s position. The resulting shortfall is bad debt.
Bad debt is typically borne by lenders in the affected market. Losses are generally socialized across liquidity providers (rather than absorbed by a single counterparty), reducing the total assets available to lenders and/or lowering realized yield.
2) How This Risk Can Materialize (Illustrative Scenarios)
Bad debt is more likely during periods of high volatility or liquidity stress, including (non-exhaustively):
Rapid collateral price declines that breach liquidation thresholds faster than liquidators can act.
Deteriorating market depth, where executing sales of seized collateral causes significant slippage and price impact.
Unprofitable liquidations due to increased fees, MEV, adverse price movement during execution, or thin liquidity—leading liquidators to delay or avoid liquidation.
Network congestion or outages, which can prevent timely liquidation transactions or increase gas costs to prohibitive levels.
When liquidations are delayed, incomplete, or uneconomic, bad debt can accumulate and directly impair lender principal and returns.
3) Mitigations (Design Intent) and Important Limitations
Fira’s exposure to bad debt is influenced by liquidation and risk parameters—most notably liquidation loan-to-value thresholds (LLTVs) and asset exposure limits/caps. If these parameters are too aggressive, collateral can become insufficient before liquidation can occur, increasing bad debt likelihood.
Parameter calibration (LLTVs and exposure limits). Fira (or, where applicable, designated curators) may set LLTVs and exposure limits using conservative, data-informed methodologies, including historical analysis of tail price moves and observed execution slippage across liquidity venues. The design intent is to keep liquidations economically viable even under adverse conditions.
However, these mitigations are not guarantees. In stressed conditions, bad debt can still occur due to factors including, without limitation:
extreme or discontinuous price moves (“gaps”) beyond historical assumptions,
sudden liquidity evaporation,
oracle issues or delays,
MEV and adverse execution dynamics,
smart contract or integration failures,
governance/parameter changes that have unintended consequences,
network congestion or chain instability.
Accordingly, even conservatively set LLTVs and caps may not prevent lender losses.
4) User Considerations (Non-Exhaustive)
Lenders bear credit-like risk. Supplying assets can expose you to borrower defaults via bad debt, even in overcollateralized systems.
“Socialized losses” are possible. Bad debt may reduce the value of lender claims or expected yield in the affected market.
Collateral quality and liquidity matter. Thin or volatile collateral increases liquidation execution risk and can raise bad debt probability.
Stress events are when losses happen. Risk is highest when market moves are fast and liquidity is poor—precisely when exits are hardest.
Reminder: This disclosure is provided for informational purposes only, does not constitute advice, and does not eliminate the possibility of loss. Using Fira is speculative and high-risk, and you may lose all or part of your funds.
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