# Bad Debt Risk

## Definition

Bad debt emerges when a borrower's collateral cannot be liquidated for enough value to fully repay the outstanding debt. The shortfall between liquidation proceeds (minus execution costs) and outstanding obligations becomes the bad debt burden.

## Triggers

* Swift collateral value declines exceeding liquidation speed
* Market depth deterioration causing substantial slippage during asset sales
* Liquidations becoming economically unviable due to fees, MEV, or thin liquidity
* Network disruptions preventing timely liquidation or inflating transaction costs

## Loss Distribution

Bad debt typically affects lenders through socialized losses across liquidity providers rather than concentrating on single parties. This reduces total available assets or diminishes realized yields.

## Mitigations

Fira employs liquidation thresholds and exposure caps using conservative, data-informed methodologies based on historical price volatility and execution data.

### Limitations

* Extreme price gaps can bypass protections
* Sudden liquidity disappearance
* Oracle failures
* Smart contract issues

## Key Risk

Lenders face credit-like risk comparable to borrower defaults, with losses most likely during stress periods when market volatility peaks and liquidity contracts simultaneously.