> For the complete documentation index, see [llms.txt](https://docs.vaultedge.fi/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://docs.vaultedge.fi/the-protocol/borrowing/redemptions.md).

# Redemptions

The first line of defense

## Redemptions

Redemptions are a core mechanism that maintains the USDVE peg by allowing anyone to exchange USDVE for underlying collateral at face value, minus a small fee.

{% hint style="info" %}
**For USDVE holders looking to exit:** Redemptions are not the most efficient way to convert your USDVE back to collateral. The redemption fee (0.5%+) and softening mechanism mean you receive less than face value. You should first check the **PSM (Peg Stability Module)** for 1:1 swaps or available **liquidity pools** (e.g., USDVE/USDC) for better rates. Redemptions exist primarily as a peg stability mechanism and should only be used when PSM liquidity is exhausted and pool rates are unfavorable.
{% endhint %}

### Redemptions Are Profitable for Borrowers

Unlike liquidations, redemptions are a **net positive event** for Vault owners. When your Vault is redeemed against, your debt is reduced by the full USDVE amount, but your collateral is only reduced by the softened amount (99.5% of fair value). You keep the 0.5% difference as profit.

In practice, this means someone else is paying down your loan for you, and you earn a small bonus for it.

**Example:** A borrower has a Vault with 10 ETH collateral and 15,000 USDVE debt. A redeemer exchanges 2,000 USDVE against this Vault (1 ETH worth at $2,000/ETH):

|                           | Before Redemption | After Redemption  |
| ------------------------- | ----------------- | ----------------- |
| Collateral                | 10.000 ETH        | 9.005 ETH         |
| Debt                      | 15,000 USDVE      | 13,000 USDVE      |
| Softening profit retained | -                 | 0.005 ETH (\~$10) |

The borrower's debt dropped by 2,000 USDVE but their collateral only dropped by 0.995 ETH. They kept 0.005 ETH (\~$10) as pure profit. Their net position actually improved.

#### Especially Valuable for Stablecoin Collateral

For borrowers using stablecoin collateral (like USDC), redemptions are even more attractive. Typical stablecoin yield in DeFi sits around 3-5% APY. A single redemption event delivers a 0.5% return on the redeemed portion instantly, which annualized far exceeds what most stablecoin strategies offer.

{% hint style="info" %}
If a stablecoin Vault gets redeemed against multiple times over the course of a year, the cumulative softening profits can significantly outperform passive stablecoin lending rates, all while the borrower's net position remains healthy and their debt is being paid down by third parties.
{% endhint %}

This makes holding a stablecoin-backed Vault with a competitive (lower) collateral ratio a deliberately attractive strategy. Rather than avoiding redemptions, some borrowers may welcome them as a yield source.

### How Redemptions Work

When USDVE trades below $1, an arbitrage opportunity is created. Users can buy discounted USDVE on the open market and redeem it for $1 worth of collateral through the protocol. This buying pressure pushes USDVE back toward its peg, while the redeemer keeps the difference as profit.

During a redemption, the protocol burns the redeemed USDVE, reducing the total debt supply. This strengthens the collateral backing per remaining USDVE, reinforcing the peg from both sides.

#### Which Vaults Get Redeemed?

Redemptions target the **lowest collateral ratio Vaults first**, but only those above the **Minimum Collateral Ratio (MCR) of 110%**. Vaults below 110% are handled by the liquidation mechanism instead and cannot be redeemed against.

The system works through Vaults in ascending order of collateral ratio:

| Vault   | ICR  | Redeemable?                                   |
| ------- | ---- | --------------------------------------------- |
| Vault A | 108% | No - below MCR, liquidation candidate         |
| Vault B | 112% | Yes - first redemption target                 |
| Vault C | 150% | Yes - only after Vault B is fully redeemed    |
| Vault D | 250% | Yes - only after Vaults B and C are exhausted |

This ordering means that Vault owners with lower collateral ratios face higher redemption risk. To reduce your exposure to redemptions, maintain a higher collateral ratio relative to other Vaults in the system.

#### What Happens to a Redeemed Vault?

When your Vault is redeemed against, both your collateral and debt are reduced proportionally. You do not lose value in net terms. Your debt decreases by the redeemed USDVE amount, and your collateral decreases by the equivalent value (minus a small buffer you retain from softening).

If a Vault is only partially redeemed, it remains active with a reduced position. If fully redeemed, the Vault status changes to **Redeemed**.

### Collateral Split

When a redemption occurs, the collateral is split three ways between the Vault owner, the protocol, and the redeemer.

**Example: Redeeming 1 ETH worth of USDVE at a 0.81% fee rate**

| Recipient           | Amount                  | Description                                 |
| ------------------- | ----------------------- | ------------------------------------------- |
| Vault owner retains | \~0.005 ETH (\~0.5%)    | Protective buffer from redemption softening |
| Protocol treasury   | \~0.00806 ETH (\~0.81%) | Dynamic redemption fee                      |
| Redeemer receives   | \~0.98694 ETH (\~98.7%) | Net collateral received                     |

The Vault owner's retained portion comes from **redemption softening** (set at 99.5%), which means only 99.5% of the fair-value collateral is made available for redemption. The remaining 0.5% stays in the Vault automatically. This is not a fee. It is a protective buffer for borrowers.

The **protocol fee** is separate from softening and is calculated on the softened amount (0.995 ETH in this example), not the full fair value. This fee is sent to the protocol treasury.

### Redemption Fee

The redemption fee is dynamic and adjusts based on system activity. It consists of two components:

**Redemption Fee = Fee Floor + Base Rate**

* **Fee Floor**: A minimum fee per collateral type, default 0.5%
* **Base Rate**: Starts at 0% and increases with each redemption, then decays back over time

#### How the Base Rate Changes

Each redemption increases the base rate by a small amount:

**Delta = (Value redeemed / Total system debt) / 2**

For example, redeeming 1 ETH ($2,000) against a system with $10M total debt:

* Delta = ($2,000 / $10,000,000) / 2 = 0.01%
* If the base rate was 0.30%, it becomes 0.31%
* Total fee = 0.5% floor + 0.31% base = **0.81%**

When multiple redemptions happen in quick succession, the base rate compounds:

| Redemption | Base Rate Before | Base Rate After | Total Fee |
| ---------- | ---------------- | --------------- | --------- |
| #1         | 0.30%            | 0.31%           | 0.81%     |
| #2         | 0.31%            | 0.32%           | 0.82%     |
| #3         | 0.32%            | 0.33%           | 0.83%     |

This progressive increase discourages mass redemptions that could destabilize the protocol.

#### Time Decay

The base rate decays with a **12-hour half-life**. After a spike in redemption activity:

| Time Elapsed | Base Rate (starting at 2.0%) | Total Fee (with 0.5% floor) |
| ------------ | ---------------------------- | --------------------------- |
| 6 hours      | \~1.40%                      | \~1.90%                     |
| 12 hours     | \~0.98%                      | \~1.48%                     |
| 24 hours     | \~0.48%                      | \~0.98%                     |
| 48 hours     | \~0.12%                      | \~0.62%                     |

The fee never drops below the floor (default 0.5%).

#### Per-Collateral Fees

Each collateral type maintains its own independent base rate and fee floor. Redeeming against one collateral does not affect the fees of another.

| Collateral | Fee Floor | Current Base Rate (example) | Total Fee |
| ---------- | --------- | --------------------------- | --------- |
| WETH       | 0.5%      | 0.3%                        | 0.8%      |
| WBTC       | 0.5%      | 0.1%                        | 0.6%      |
| USDC       | 0.5%      | 0.0%                        | 0.5%      |

If one collateral type has experienced heavy redemption activity, users may find it cheaper to redeem against a different, less active collateral market.

#### Where Do Fees Go?

Redemption fees are sent to the **protocol treasury**. In the future, governance may redirect fees to a staking pool.

### Managing Redemption Exposure

Vaults with the lowest collateral ratios above 110% are redeemed first. Depending on your strategy:

* **To attract redemptions** (and earn softening profits): Maintain a lower collateral ratio, closer to but safely above 110%. This positions your Vault earlier in the redemption queue.
* **To avoid redemptions**: Maintain a higher collateral ratio relative to other Vaults. The further above 110% you are, the less likely your Vault is targeted.
* **Monitor the system**. If many Vaults have low collateral ratios, redemption activity increases across the board.

Either way, redemptions do not cause a net loss. Your debt is reduced alongside your collateral, and you retain the softening buffer as profit.

### Relationship to Other Mechanisms

**Liquidations** handle Vaults that fall below the Minimum Collateral Ratio (110%). Redemptions only target healthy Vaults above this threshold. The two mechanisms are complementary: liquidations address undercollateralization, while redemptions maintain peg stability.

**The Stability Pool** is the primary mechanism for liquidations, where depositors absorb bad debt in exchange for discounted collateral. Redemptions operate independently from the Stability Pool.