Bitcoin Suisse

What is Liquity?

May 31, 2022

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Liquity is a decentralized borrowing protocol that offers users interest-free loans for a one-time fee, with Ether (ETH) staked as collateral in the protocol. Liquity credits  are issued in amounts of freshly minted Liquity stablecoin (LUSD), which is pegged to the US dollar as a means to address the volatility challenges that some other DeFi platforms face. With all governance operations managed algorithmically, Liquity also aims to offer a fully decentralized alternative to fiat-collateralized stablecoins such as Tether and USDC.

Beginnings

Liquity was developed by CEO Robert Lauko, a former DFINITY research associate, and Rick Pardoe, the project’s lead engineer. Following 18 months of development, Lauko and Pardoe launched Liquity on the Ethereum blockchain in April 2021. The platform was backed by around $6 million in Series A funding, including Alameda Research, AngelDAO, and Nima Capital investments. The platform’s LQTY token debuted at $9 before settling at around $92 on its first day of trade.

The appeal of Liquity lies in the decentralized loan services that it offers. When users deposit ETH into the borrowing platform as collateral, the Liquity protocol issues their credit in the LUSD stablecoin which is pegged 1:1 to the USD. By locking ETH in the smart contract, or the ‘Trove’, users enter into a collateralized debt position, at a minimum of 110% collateral (compared to MakerDAO’s 150%) and pay a one-time borrowing fee.

To ensure that LUSD is fully backed and therefore to protect against fluctuations in the value of ETH when the value of a Trove drops below the minimum collateral ratio of the loan, Liquity uses Stability Pools and a secondary liquidation mechanism called redistribution to keep the platform solvent. Each Stability Pool contains LUSD which is staked by Liquity users. When the value of ETH drops, LUSD is liquidated upon a function call in order to maintain the loan's value.

Users are incentivized to stake LUSD in Stability Pools because liquidations tend to result in net gains for token holders, and because they earn passive LQTY rewards proportional to the amount of LUSD that they have staked.

Liquity is also distinguished from other Defi borrowing platforms by its full decentralization. While platforms, such as MakerDAO confer governance rights on stakeholders, and so enable ‘whale’ stakeholders to dominate governance decisions, Liquity is entirely ‘governance free’ with no community votes necessary for its ongoing functionality. The platform’s whitepaper emphasizes its decentralization, stating that ‘all operations are algorithmic and fully automated, and protocol parameters are set at the time of contract deployment. The smart contract code is completely immutable, as Liquity has no admin key and nobody can alter the rules of the system in any way. Moreover, the protocol leverages Chainlink’s ETH:USD price feed and Tellor as backup in case of any issues with Chainlink.

LQTY token: Liquity is a dual token platform. While its loans are issued in LUSD, users may also earn LQTY from loan fees and as a staking reward.

Use cases

Liquity’s applications and advantages are derived from its functionality as a DeFi protocol that offers users interest free loans against ETH. Key features of the Liquity platform include:

Frontends: Liquity’s web interface is operated via multiple third-party frontends which allow users to connect to the platform. Third parties can set up a frontend by downloading the Liquity SDK and implementing the protocol.

Resistance to censorship: Because Liquity’s frontends are operated by third parties, the platform is resistant to censorship. Liquity’s governance-free protocol means that holders of large amounts of LQTY cannot influence or manipulate its functionality.

Interest-free loans: LUSD credits are issued with a 0% interest rate in order to ensure that borrowers know the cost of their loans upfront and are, in theory, better incentivized to use the service.

Borrowing fee: Liquity charges a one-time borrowing fee for LUSD loans. The fee is adjusted automatically based on loan redemption activity but may be as low as 0.5% of the value of the loan.

Stablecoin redemption: Each LUSD stablecoin can be redeemed for $1 in ETH at any time – minus the redemption fee. Whenever the value of the LUSD coin drops below $1, the protocol pushes the price back to parity by incentivizing arbitrage and therefore lowering the supply of LUSD. This mechanism incentivizes borrowers to redeem LUSD if it can be purchased at less than $1 and then converted to ETH at face value at any time.

Efficient liquidations: When a Liquity Trove falls under its collateral ratio of 110%, the collateral that it holds is liquidated quickly and efficiently. Liquidations occur via the following process:

  • LUSD tokens held in the Stability Pool are spent to repay the now-undercollateralized debt and are then burned automatically by the protocol. The liquidated Trove’s collateral is sent to the Stability Pool.
  • If there is not enough LUSD in the Stability Pool to repay the debt, then the remaining debt and the Trove’s liquidated collateral are shared between active Liquity borrowers proportionately depending on their collateral.

The speed with which Liquity liquidations take place is designed to ensure the overall health and stability of the protocol. With its liquidation incentives, Liquity aims for over-collateralization of LUSD at any time.

Future

After one year since its launch, Liquity has marked a series of achievements, including issuing over $4 billion in credit, and generating over $28 million in revenue. After reaching a high in Total Value Locked (TVL) of $4.4bn in May 2021, the protocol has seen a downturn and at the time of writing is holding approximately $660 million.

In April 2022, Liquity announced that Bitcoin Suisse had included Liquity credit as part of its DeFi offering. Liquity stated that the Bitcoin Suisse integration was a ‘showcase of our efforts to drive institutional adoption’.

Bitcoin Suisse