Overview

Liquity is a decentralized borrowing protocol that allows users to take out interest-free loans against Ether (ETH) deposits. The protocol is designed to be fully autonomous, with no admin keys or governance. Loans are paid out in the protocol's native stablecoin, LUSD, which is pegged to the US dollar.

LUSD is a stablecoin introduced by the Liquity Protocol, a decentralized borrowing platform that allows users to issue interest-free loans against Ether (ETH) collateral. The stablecoin is designed to maintain a value of approximately $1, with an algorithmic monetary policy mechanism ensuring its stability.

Other notable Liquity features include:

Non-custodial - users retain full control of their assets at all times.
Permissionless - anyone can participate, regardless of their technical expertise.
Decentralized - not controlled by any single entity.

Strengths

Governance free
Fully decentralized collateral + UI
Instant liquidation
Lower liquidation level than competitors like Maker

Important Links

May 2024 Liquity v2 Update

Liquity, a stablecoin lending platform known for its 0% interest LUSD loans, is set to expand its offerings with the introduction of a new stablecoin, $BOLD, as detailed in their v2 whitepaper. Slated for launch in late 2024, $BOLD will coexist with LUSD, providing borrowers with enhanced flexibility by allowing them to set their own borrowing rates using ETH and its staking derivatives as collateral.

Initially, the team explored a reserve model but ultimately reverted to a collateralized debt position (CDP) protocol after learning from the first iteration. V2, expected to launch by year-end, introduces key changes, particularly in interest rate management, which is critical for lending protocols.

Unlike traditional methods where rates are either governance-defined or algorithmic, v2 employs a user-determined interest rate model. Users choose their interest rates, influencing their position in the redemption queue—those opting for lower rates are first in line, while higher rates offer more protection. This model allows for greater agility and adaptability to varying market conditions. The revenue generated primarily flows into the stability pool and incentivized secondary markets, enhancing the overall financial robustness of $BOLD.

Additionally, interest rate delegation will be available, offering users different strategies via various delegates. As the protocol gains adoption, the average interest rate could set a benchmark for other protocols, requiring riskier platforms to offer lower rates to attract borrowers. This innovation, among others, positions Liquity v2 as a significant advancement in decentralized finance.

Key advantages of this model:

Aligning borrower incentives with protocol health
Higher borrowing rates not only increase protocol revenue but also circulate back to benefit $BOLD holders through payouts from the stability and liquidity pools
Creation of a feedback loop that enhances the stability and attractiveness of $BOLD as an investment.

Please note that the rest of this report (below) outlines Liquity v1.

Use Case

Liquity is a decentralized borrowing protocol that offers interest-free loans against Ether used as collateral. Designed to tackle the centralization issue in the stablecoin market, Liquity aims to make borrowing more capital-efficient and user-friendly, while maintaining a fully decentralized and governance-free system.

Stable-value assets are vital for Ethereum applications and have grown to represent tens of billions of dollars in value. However, most of this value is centralized in fiat-collateralized stablecoins like Tether and USDC. Decentralized stablecoins, such as DAI and sUSD, make up a smaller portion of the total supply. Liquity addresses this imbalance by creating a more efficient and decentralized way to borrow stablecoins without governance interference.

Liquity offers several benefits that make it stand out from traditional borrowing platforms:

0% interest rate: Borrowers don't need to worry about accruing debt.
Minimum collateral ratio of 110%: Efficient usage of deposited ETH as collateral.
Governance-free: Fully automated operations and algorithmic protocol parameters set at contract deployment.
Directly redeemable: LUSD can be redeemed for the underlying collateral at face value.
Fully decentralized: No admin keys and accessible via multiple front-end operators, ensuring censorship resistance.

Using Liquity

To access Liquity, users need to choose a web interface (front end) operated by third-party applications or integration services. The core team behind the protocol does not operate a front end, promoting decentralization and avoiding central points of control.

Liquity offers various use cases, including:

Borrowing LUSD against ETH by opening a Trove.
Securing Liquity by providing LUSD to the Stability Pool in exchange for rewards.
Staking LQTY to earn fee revenue paid for borrowing or redeeming LUSD.
Redeeming 1 LUSD for 1 USD worth of ETH when the LUSD peg falls below $1.

LUSD and LQTY Tokens

LUSD is a USD-pegged stablecoin used to pay out loans on the Liquity protocol. It can be redeemed against the underlying collateral at face value. LQTY is the secondary token issued by Liquity, with a capped supply of 100,000,000 tokens. It captures fee revenue generated by the system and incentivizes early adopters and frontends.

To borrow LUSD, users need a wallet (e.g., MetaMask) and sufficient Ether to open a Trove and pay gas fees. To become a Stability Pool depositor or LQTY staker, users need LUSD and/or LQTY tokens, which can be obtained by opening a Trove, participating in the Stability Pool, or purchasing them on a decentralized exchange.

Liquity charges a one-off borrowing fee on loans as a percentage of the drawn amount (in LUSD) and a redemption fee on the amount paid to users (in ETH) when exchanging LUSD for ETH. These fees depend on redemption volumes, increasing upon every redemption and decaying over time as long as no redemptions occur. The borrowing fee is capped at 5%, while the minimum fee is 0.5%, which prevents misuse by arbitrageurs front-running the price feed.

Key Features of LUSD:

Interest-free loans: One of the primary use cases of LUSD is to enable users to take out interest-free loans. Borrowers can deposit ETH as collateral and mint LUSD, which they can then use within the DeFi ecosystem or convert to other stablecoins or cryptocurrencies.
Stability mechanisms: To maintain LUSD's peg to the US dollar, the Liquity Protocol employs a set of mechanisms that adjust the system's parameters. These adjustments incentivize users to either mint or redeem LUSD depending on the stablecoin's current price. For instance, if LUSD is trading above $1, users are encouraged to mint new tokens, increasing the supply and pushing the price down. Conversely, if LUSD is trading below $1, users can redeem their tokens for collateral, reducing the supply and pushing the price up.
Decentralized governance: LUSD operates under a decentralized governance model, with token holders having the power to influence protocol decisions. This approach promotes transparency and community involvement, ensuring that the protocol evolves in line with the preferences of its users.
Integration with DeFi platforms: LUSD is designed to be compatible with various DeFi platforms, allowing users to access a wide range of financial services such as lending, borrowing, trading, and staking.

How LUSD differs from other stablecoins:

Not all stablecoins are created equal! There are several different approaches projects have taken to keep their stablecoin "stable.” By far, the easiest approach (and therefore most popular) is backing a crypto stablecoin 1:1 with fiat dollars/dollar equivalents in a bank. This is the approach market leaders USDT and USDC have taken. For every USDC in circulation, there's $1 (or dollar equivalent) in reserves with the Circle Consortium. There are also stablecoins like PAXG backed by the equivalent amount in gold. While these are the current market leaders, fiat-backed stablecoins inherit all of the issues that come with fiat plus require trust in a centralized custodian. This isn't exactly the revolution crypto promised!

Because of this, over-collateralized stablecoins, such as DAI and others were created. These stablecoins are over-collateralized with another cryptoasset (usually at a ~1.5:1 ratio), ensuring you can always redeem one unit of their stablecoin from the collateral’s value. If the collateral’s value drops below the liquidation level (varies depending on the protocol), the collateral is sold to ensure no losses are sustained. While these stablecoin solutions generally hold their peg, they can suffer in times of high volatility due to cascading liquidations. Liquity and LUSD fall into this category.

stablecoin matrix — Source: Chain Debrief

Finally, algorithmic stablecoins—which have been around for years, but only really began gaining adoption after 2020—use algorithms to control the stablecoin peg and the underlying tokenomics. Generally speaking, algorithmic stablecoins are run by pre-programmed intelligent contracts that execute specific actions to maintain the peg. They usually exhibit some or all of the following properties:

No outside collateral backing the token
Partially/fully-collateralized by a native token
Floating peg (e.g. RAI)

While there are several stablecoins in the DeFi ecosystem, LUSD stands out due to its unique characteristics:

Interest-free loans: Unlike other stablecoins, LUSD enables users to take out loans without incurring interest. This feature sets it apart from platforms like MakerDAO, which charge a stability fee on DAI loans.
Algorithmic monetary policy: LUSD's stability mechanisms rely on an algorithmic monetary policy, making it less dependent on centralized entities for price stabilization. In contrast, stablecoins like USDC and USDT are backed by collateral held in centralized reserves.
Community-driven governance: LUSD's decentralized governance model encourages community participation, whereas other stablecoins may be governed by a centralized entity or a select group of stakeholders.

rai dai lusd venn diagram — Source: Chain Debrief

Competitive Advantages

The recent destabilization of USDC and the ongoing legal tussle between Paxos, the issuer of BUSD, and the Securities and Exchange Commission (SEC), have underscored the growing significance of stablecoins backed by fully on-chain collateral. This trend is evidenced by the consistent surge in demand for LUSD since March 11, a phenomenon reflected in the overall LUSD supply which swelled by over 50% in the first quarter. Notably, LUSD was one of the select stablecoins to register growth during this period.

The struggles confronting centralized stablecoin issuers like Paxos and Circle emanate from multiple counterparty risks and stringent regulatory oversight. These challenges underscore the importance of censorship-resistant alternatives such as LUSD, which provide a degree of operational freedom and resilience in the face of an uncertain regulatory environment.

Liquity's growth trajectory has been further bolstered by its recent listing on Binance. Being perceived as a favored substitute for Paxos on the platform, this development has driven the price of LQTY sharply upwards, leading to increased adoption of Liquity's offering. The enhanced exposure and accessibility facilitated by Binance have invariably positioned Liquity for greater growth and user engagement in the cryptocurrency landscape.

Technology and Design

The Liquity Protocol is a decentralized finance (DeFi) platform that offers interest-free loans backed by Ethereum (ETH) collateral in the form of its native stablecoin, LUSD. LUSD is designed to maintain a peg to the US dollar, and the protocol employs a multi-faceted approach to achieve this objective. This article discusses the four primary mechanisms that Liquity uses to maintain the peg: Redemption, Stability Pool, Redistribution, and Recovery Mode.

Redemption:

Liquity employs a Collateralized Debt Position (CDP) model, where each LUSD is backed by at least $1.1 worth of ETH. If LUSD falls below $1, arbitrageurs can re-peg LUSD by purchasing it in the open market and redeeming $1 worth of ETH from the protocol. This process reduces the debt of Troves with the lowest collateral ratios (CR), incentivizing debtors to improve their CR by topping up collateral or repaying loans. To deter excessive redemptions, the protocol charges a fee (base rate + 0.5%), making it unattractive except for arbitrage purposes.

Troves

Troves are similar to vaults in MakerDAO. They are loans based on the deposited collateral and the debt issued. However, with a Trove, only one Ethereum address can be associated with a Trove (one Trove, one address).

number of Liquity troves jan 2024 — Source

Stability Pool:

The Stability Pool serves as a reservoir of LUSD for instant liquidation of Troves with low CR. Users are incentivized to deposit LUSD into the pool due to the potential profit from liquidations, which ranges from 8% to 10%. When a Trove is liquidated, the corresponding LUSD debt is burnt, and the Stability Pool receives the collateral from the liquidated Trove. This mechanism helps maintain the LUSD peg, especially during market turmoil, when demand for LUSD increases as borrowers seek to repay loans or participate in liquidation opportunities.

Redistribution:

When a Trove is liquidated, the debt is repaid by burning LUSD from the Stability Pool's balance, and the Trove's collateral is transferred to the Stability Pool.In the event that the Stability Pool is depleted, Liquity redistributes both the debt and collateral from liquidated Troves to all existing Troves based on each Trove's collateral proportion. This process decreases individual Troves' CR, making them more susceptible to liquidation. However, debtors benefit as they receive more than $1 worth of ETH for each additional LUSD repaid. This redistribution mechanism helps maintain the LUSD peg even when the Stability Pool is empty.

Recovery Mode:

Liquity enters Recovery Mode when the Total Collateral Ratio (TCR) falls below 150%. In this mode, all Troves with a CR below 150% are liquidated, with only 10% of their collateral penalized. Borrowing fees are set to 0% during Recovery Mode, encouraging users to mint and deposit more LUSD to replenish the Stability Pool.

In addition to these four mechanisms, Liquity has introduced a tool called Chicken Bonds to address the persistent premium of LUSD above $1. Chicken Bonds allow the protocol to increase its Protocol-Owned Liquidity (POL) as more users participate, enabling Liquity to create sell pressure on LUSD when it is above $1 and buy it back when it is below $1 using accrued assets from LUSD sales. This open market operation strategy helps maintain the peg while capturing arbitrage profits.

Chicken Bonds

Chicken Bonds represent a pioneering mechanism that enables projects to establish protocol-owned liquidity at zero cost while enhancing yield opportunities for end users.

Users can deposit their LUSD and in return receive an accruing balance of bLUSD. At any point, bondholders can choose to either reclaim their principal and forfeit the accrued amount (known as "chicken out"), or they can exchange it for the accrued bLUSD (known as "chicken in"). In the latter case, a portion of the system-secured LUSD backs the bLUSD supply, with the specific portion depending on the timing of the chicken in the event.

The protocol maintains a Treasury, comprising three logical components, or "buckets": the Pending Bucket, the Reserve Bucket, and the Permanent Bucket. The Pending Bucket, acting as a protocol-controlled vault, holds LUSD for depositors who are yet to make a chicken in/out decision. These funds are invested in B.Protocol and then promptly deposited into the Liquity Stability Pool.

The Reserve Bucket, another protocol-controlled vault, stores a section of the LUSD obtained from previous bondholders post a "chicken in" event. All yields generated by the funds in each bucket are funneled into this Reserve Bucket, thereby supporting bLUSD's supply. The Reserve Bucket backs the bLUSD supply, creating a progressively increasing hard price floor for bLUSD.

Lastly, the Permanent Bucket, a protocol-owned vault, keeps the remaining portion of the LUSD amassed from former bondholders.

bLUSD and Yield

The yield in the Liquity protocol is generated by investing the funds in two primary sources: B.Protocol and the Yearn LUSD3CRV vault.

B.Protocol: Funds in the Pending bucket are consistently invested through B.Protocol. A portion of the Reserve and the Permanent bucket will also be invested in B.Protocol. The funds invested in B.Protocol are then deposited into the stability pool to facilitate liquidations. The ETH and LQTY generated through these liquidations are sold at a discounted rate for LUSD and redeposited in the stability pool. If liquidations are carried out with a collateral ratio of more than 100%, the LUSD quantity will increase.
Yearn LUSD3CRV Vault: LUSD in the Yearn vault is deposited into LUSD3CRV-f, and the resulting LP tokens are supplied to Convex Finance to earn CRV, CVX, and potentially other tokens. The earned tokens are harvested and sold for more LUSD3CRV-f, which is then redeposited back into the strategy. This transfer of LUSD to the LUSD3CRV Curve pool acts as a peg-reinforcing mechanism, balancing the demand and supply of LUSD in the LUSD3CRV pool.

When a user bonds LUSD, they essentially receive a promise to redeem an accrued amount of bLUSD at the time of the chicken-in event, forfeiting the bonded LUSD. The accrual of bLUSD depends on several variables, such as the time, the bonded amount, chicken-in fees, the accrual parameter (alpha), and the redemption price of bLUSD.

A user's bonded LUSD amount, after accounting for the 3% chicken-in fees, is considered for the calculation of bLUSD accrual. The accrual rate may fluctuate based on the current redemption price, which is determined by the LUSD amount in the Reserve bucket divided by the bLUSD supply.

Furthermore, there is a mechanism that reduces alpha to speed up the bLUSD accrual rate. When the current weighted average bond age exceeds the target age of 15 days, the controller will decrease alpha. This function is primarily triggered when bondholders are reluctant to chicken in or out, indicating that they are not convinced that the accrued bLUSD is profitable enough to chicken in.

Liquidations

Liquity users, or debt holders, are required to maintain their "Trove" – a mechanism analogous to a Collateralized Debt Position (CDP) or vault – at a minimum collateral ratio (CR) of 110% under normal conditions, or 150% during active recovery mode. Trove management is crucial to prevent liquidations. The loans are safeguarded by a Stability Pool filled with LUSD, which oversees liquidation procedures.

The Stability Pool is a strategic source of liquidity used to settle debt from liquidated Troves. When a Trove is liquidated, an amount of LUSD equivalent to the remaining debt is burned from the Stability Pool's balance to cover the Trove's debt. In return, all the collateral from the Trove is transferred to the Stability Pool.

In unfortunate circumstances where the Stability Pool lacks funds to manage liquidations, the debt obligation from a liquidated Trove may be transferred to other LUSD debt holders. This transfer of debt obligation could negatively affect the health factor (collateral ratio) of remaining Troves, rendering them susceptible to liquidation should the ETH price plummet further.

The reallocation of collateral and debt is conducted proportionally to the recipient Trove's collateral amount. Troves with higher collateralization receive more debt and collateral from liquidated positions, a design which ensures that the system does not trigger a cascading liquidation effect.

Recovery Mode is triggered when the protocol's Total Collateral Ratio (TCR) drops below 150%. In such cases, Troves with collateralization ratios between the current TCR and 110% are liquidated. These liquidations are executed at 110% CR, allowing the borrower to recover excess collateral. Recovery Mode induces more liquidations with a capped discount. However, if the Stability Pool lacks sufficient funds, liquidations are impeded, which could potentially lead to market stress testing LUSD's peg.

Chicken Bonds were designed as an innovative solution to ensure the Stability Pool has sufficient liquidity to facilitate liquidations and safeguard the LUSD peg even under harsh market conditions.

Maintaining the Peg

The Liquity protocol incorporates a sophisticated mechanism to ensure LUSD peg stability, employing both hard and soft peg stability measures.

Achieving Hard Peg Stability

Every LUSD holder can redeem LUSD for ETH at face value, translating to 1 LUSD for $1 of ETH. In such cases, the system uses the redeemed LUSD to offset debt and extracts collateral from the riskiest Troves. This direct arbitrage mechanism establishes a price floor for LUSD at $1.

Furthermore, the 110% minimum collateral ratio sets an upper LUSD price at $1.10. Should the LUSD price exceed this level, arbitrageurs can deposit ETH worth $110 and sell 100 LUSD (valued at >$110) for a profit.

Implementing Soft Peg Stability

When the price of LUSD exceeds $1, borrowing becomes more appealing as users anticipate repaying at a lower rate or arbitraging on various decentralized exchanges (DEXs).

An increase in redemption volume implies higher Borrowing fees, making new loans less enticing and thereby curtailing LUSD supply.

As LUSD approaches the $1.10 mark, the profitability from Stability Pool liquidations starts to dwindle. This scenario would prompt users to withdraw their LUSD from the Stability Pool, thereby increasing the circulating supply of LUSD.

Dual Oracle Design

Liquity is a decentralized and immutable protocol that relies heavily on the ETH-USD price for several critical operations, including the calculation of Troves' individual collateral ratios (ICR) and the total system collateral ratio (TCR). Given the importance of an accurate and up-to-date ETH price, Liquity employs a dual-oracle design with sophisticated logic for handling temporary oracle failures or freezes without the need for human intervention.

The primary oracle in Liquity's system is Chainlink, which is known for its excellent track record, decentralization, and constant improvements. The secondary oracle is Tellor, a fully decentralized system where miners compete to push accurate data and win the associated "tip." Inaccurate data is disputed, with the threat of stake slashing incentivizing honest price reporting. Both Chainlink and Tellor use a proxy-logic pattern, enabling them to upgrade their logic without changing their endpoints, which is crucial for Liquity's immutable design.

When Liquity requires the ETH price, it calls both oracles and tracks their operational status. The primary oracle is preferred, but the secondary oracle is used if the primary fails or freezes. If both oracles are frozen or broken, the system uses the last good price it has seen. In case of a primary failure or freeze, the system keeps checking both oracles and switches back to the primary when both are live and in-sync again.

Chainlink is considered frozen if it hasn't updated its price for more than four hours. In this case, Liquity switches to Tellor. Tellor operates differently, with the price updated only after receiving a "tip" and miners submitting price data. If both oracles are frozen, the system uses the last good price and awaits Tellor's updated price, switching back to Chainlink when both oracles report current data.

An oracle is deemed broken if it provides no response, has an invalid timestamp, or returns a price of zero. Additionally, Liquity checks the price deviation between two Chainlink price updates. If the difference is greater than 50% and the Tellor price doesn't match, Liquity considers the primary price incorrect and switches to Tellor. If the Tellor price matches, Liquity infers that the major price change is legitimate and continues using Chainlink.

In the unlikely event of a double-oracle failure, Liquity freezes the price used by the system and continues to monitor the oracles for recovery. Switching back to the primary oracle is only possible when both oracles are live and have a price difference of less than 5%, as the likelihood of both oracles serving the same incorrect price data is low. If both oracles meet this criterion, Liquity infers that they are serving the real market price and switches back to the primary oracle.

The dual-oracle design, coupled with fallback and recovery logic, maximizes system resilience in the face of oracle glitches or critical failures. This approach ensures that Liquity remains functional for years to come without human control or intervention, providing an accurate and up-to-date ETH price even during times of oracle issues.

Cross-chain Opportunities

As the Ethereum mainnet's high gas costs limit smaller wallets from interacting with protocols such as Liquity, exploring cross-chain expansion becomes essential. Layer 2 solutions, like Optimism and Arbitrum, offer low-cost transactions, allowing smaller wallets to use LUSD without worrying about transaction costs. However, Liquity can only exist on the mainnet due to its immutable code. Although bridging LUSD and LQTY to other chains can cater to smaller wallets, it's essential to understand the limitations and opportunities.

Expanding LUSD utility and use cases on new chains involves three steps: 1) growing liquidity, 2) diversifying use cases, and 3) obtaining a ChainLink price feed for advanced integrations. Growing liquidity is the first step, followed by establishing partnerships with other DeFi projects to enable non-price-sensitive use cases. Once liquidity and volume are sustained, obtaining a ChainLink price feed allows more advanced integrations like using LUSD as collateral.

Expanding Liquity and LUSD across chains can introduce additional risks. To minimize these risks and grow the ecosystem sustainably, the teams working on integrations must consider the following:

Select chains wisely to reduce the overall risk scope.
Maintain a balanced or capped scale of LUSD's L2 presence.
Hedge risks posed by LUSD's presence on L2, ideally.

Staking

To begin staking in Liquity, users simply need to deposit their LQTY tokens into the Liquity staking contract. Once deposited, users start earning a pro rata share of the borrowing and redemption fees in LUSD and ETH, proportional to their share of the total LQTY staked at the time the fee occurred.

The amount earned from staking LQTY depends on the user's share of the total LQTY staked. As fees are generated from borrowing and redemption activities, users with a larger share of the staked tokens will earn a higher proportion of the fees.

Unlike some other staking platforms, Liquity does not enforce a lock-up period for staking LQTY tokens. Users can withdraw their staked funds at any time, offering flexibility and easy access to their assets.

In Liquity, only LQTY tokens can be staked. However, users can deposit LUSD into the Stability Pool to secure the system and receive rewards.

Staked LQTY tokens in Liquity serve a different purpose than those in some other platforms, such as Maker. They are not used to backstop the Liquity system or for governance purposes, as Liquity is a governance-free protocol. Instead, staking LQTY tokens allows users to earn a share of the generated fee revenue, incentivizing participation and contributing to the growth of the platform.

Economics

LQTY

Liquity offers a unique approach to lending, featuring interest-free loans that are backed by Ether and paid out in LUSD, a stablecoin. These loans necessitate maintaining a fixed minimum collateral ratio of 110%. The Liquity protocol is distinguished by its governance-free and immutable nature. LQTY, the protocol token, entitles its holders to a share of the fees earned by the protocol.

Loan applications are subject to Borrowing and Redemption fees, which are both a function of the redemption rate. The Borrowing fee, ranging between 0.5% and 5%, is remitted in LUSD, while the Redemption fee is settled in ETH and can vary from 0.5% to an undefined upper limit.

When the volume of LUSD redemptions rises — indicating LUSD is trading below its peg — the Borrowing fees are automatically escalated to deter further borrowing. The Redemption fee, on the other hand, acts as a regulatory measure for the redemption velocity, increasing when redemptions occur and gradually decreasing since the last fee event.

Furthermore, an additional 200 LUSD is levied as a Liquidation Reserve during the borrowing process, which is refunded when the debt is repaid. It's important to note that Liquity imposes a minimum debt requirement of 2,000 LUSD. This balance of carefully curated features and checks ensures a sustainable, stable, and user-friendly lending platform.

Standard protocols allow third parties to seize collateral during liquidation when a user's borrow balance surpasses a protocol-defined threshold, posing an insolvency risk. This process is not automated; instead, it is delegated to sophisticated DeFi users who design smart contracts and operations to profitably liquidate users.

In contrast to the traditional model, Liquity maintains a Stability Pool filled with LUSD. In cases of loan liquidation, LUSD from the Stability Pool is utilized to repay the loan. Following repayment, the LUSD is burned, and the Ether collateral is distributed to users who contribute LUSD to the pool.

Due to the 110% minimum collateral ratio, most liquidations end up being profitable for Stability Pool participants, as they receive more value in ETH from the collateral than they lose from the LUSD burn. For a more detailed understanding of Liquity's liquidation logic, refer to their official documentation.

To encourage more user participation in the Stability Pool, Liquity provides additional incentives in the form of LQTY token rewards. This strategic move reinforces Liquity's commitment to ensuring stability while simultaneously offering rewarding opportunities for its user base.

Staking

Team and Backing

Liquity is backed by reputable investors and partners such as Polychain Capital, Pantera Capital, 1kx, Tomahawk VC, Robot Ventures and more.

Vulnerabilities and Security

Audits

Risks to LPs of bLUSD-LUSD3CRV

Just like any other form of investing or financial strategy, providing liquidity to the bLUSD-LUSD3CRV pool also comes with its own set of risks. These include:

Impermanent Loss

Impermanent loss is the potential loss a liquidity provider might face if the price of one of the assets in the pool changes compared to when it was deposited. The bLUSD Curve pool is a V2 pool, which mitigates the effects of impermanent loss by only updating price scale when it has offset losses by trading fees earned.

Price Risk

Low liquidity on bLUSD-LUSD3CRV might cause a higher price impact, leading to a potential drop in the price of bLUSD when selling. This risk increases when there's a larger gap between bLUSD's market price and its ever-increasing floor price.

The stability of LUSD’s peg to the US Dollar may be influenced by market sentiment, especially during an ETH flash crash. Although LUSD has historically traded at or above its peg, the possibility of it getting depegged shouldn't be ignored.

The Risk Associated with Yield-Generating Protocols

bLUSD is exposed to the inherent risks of B.Protocol and Yearn, which are used for yield generation. Loss of funds from these protocols/vaults for any reason can severely impact the bLUSD floor price.

B.Protocol: Despite B.Protocol's audit and bounty programs, there still exists a potential risk in extreme market conditions. If the ETH price crashes heavily, causing liquidations to happen below a 100% collateral ratio, there might be losses.

Yearn LUSD vault: While Yearn has been active and patched from a past attack, the potential for undiscovered smart contract bugs exists, which can lead to losses.

Opportunity Cost

There is a risk that the system might reach a state where bonding will not be profitable, which could result in stagnating trades between bLUSD and LUSD and a decrease in vAPY. This would effectively mean that liquidity providers may be better off investing their funds elsewhere, representing an opportunity cost.

It is important to note that while these risks do exist, measures are put in place to mitigate them to the best extent possible. However, as is true with any investment, the potential for loss does exist, and it is crucial for individuals to understand these risks fully before deciding to provide liquidity.

Roadmap

Liquity is set to revolutionize the Collateralized Debt Position (CDP) market in 2024 with the introduction of a user-determined interest rate mechanism, marking a pivotal advancement in decentralized finance (DeFi). This innovation provides users with unprecedented autonomy over their borrowing costs, representing a significant evolution in the approach to stablecoin lending and borrowing dynamics.

User-determined interest rates diverge from traditional CDPs and money markets, where rates are typically algorithmically determined or set through governance. By allowing users to select their interest rates, we empower them to manage their borrowing experience in alignment with their risk tolerance, offering full control over their financial positions.

This model significantly mitigates redemption concerns, as borrowing rates now determine the order of redemptions, enabling users to influence their likelihood of being redeemed by opting for higher interest rates. This shift towards a borrower-rate determined model also aims to enhance the stability of the stablecoin's peg to the dollar by introducing dynamic borrowing rates and a responsive monetary policy.

Moreover, the protocol's adaptability to economic conditions is further augmented through the possibility for users to adjust their interest rates at any stage of their loan's lifecycle, or to delegate this capability to third-party managers or smart contracts. This flexibility ensures that the system remains responsive and dynamic, catering to the evolving needs of the DeFi ecosystem.

The new stablecoin will support borrowing against various LSTs and ETH, enhancing the Ethereum-native characteristic of the offering without reliance on fiat or traditional financial assets. Inclusion of built-in liquidity incentives and the provision of sustainable real yield from borrowing fees and liquidation gains address the challenges of maintaining liquidity and ensuring the sustainability of stablecoin demand.

The introduction of this innovative DeFi primitive is not merely an evolution of the CDP model but a significant leap forward. By solving the critical balance between borrowing and stablecoin demand through user-set interest rates, the protocol empowers borrowers to adapt to market changes proactively. This autonomy enhances the system's overall stability and efficiency, benefiting both borrowers and the broader DeFi ecosystem.

Loading...