Liquity is a decentralized borrowing protocol that allows you to draw interest-free loans against Ether used as collateral. Loans are paid out in LUSD (a USD pegged stablecoin) and need to maintain a minimum collateral ratio of 110%.
In addition to the collateral, the loans are secured by a Stability Pool containing LUSD and by fellow borrowers collectively acting as guarantors of last resort. Learn more about these mechanisms under Liquidation.
Liquity as a protocol is non-custodial, immutable, and governance-free.
Motivation Behind Liquity
Stable-value assets are an essential building block for Ethereum applications and have grown to represent tens of billions of dollars in value.
However, the vast majority of this value is in the form of fiat-collateralized stablecoins like Tether and USDC. Decentralized Stablecoin like DAI and sUSD make up only a small portion of the total stablecoin supply, meaning the vast majority of stablecoins are centralized.
Liquity addresses this by creating a more capital efficient and user-friendly way to borrow stablecoins. Furthermore, Liquity is governance-free, ensuring that the protocol remains decentralized.
Key Benefits of Liquity
Liquity’s key benefits include:
- 0% interest rate - as a borrower, there’s no need to worry about constantly accruing debt
- Minimum collateral ratio of 110% — more efficient usage of deposited ETH
- Governance free - all operations are algorithmic and fully automated, and protocol parameters are set at time of contract deployment
- Directly redeemable - LUSD can be redeemed at face value for the underlying collateral at any time
- Fully decentralized - Liquity contracts have no admin keys and will be accessible via multiple interfaces hosted by different Frontend Operators, making it censorship resistant
Main Use Cases of Liquity
- Borrow LUSD against ETH by opening a Trove
- Secure Liquity by providing LUSD to the Stability Pool in exchange for rewards
- Stake LQTY to earn the fee revenue paid for borrowing or redeeming LUSD
- Redeem 1 LUSD for 1 USD worth of ETH when the LUSD peg falls below $1
LUSD and LQTY
LUSD is the USD-pegged stablecoin used to pay out loans on the Liquity protocol. At any time it can be redeemed against the underlying collateral at face value. Learn more about the stability mechanism.
LQTY is the secondary token issued by Liquity. It captures the fee revenue that is generated by the system and incentivizes early adopters and frontends. The total LQTY supply is capped at 100,000,000 tokens.
There is a one-off fee whenever LUSD is borrowed, and when LUSD is redeemed:
For borrowers, there is a borrowing fee on loans as a percentage of the drawn amount (in LUSD).
For redeemers, there is a redemption fee on the amount paid to users by the system (in ETH) when exchanging LUSD for ETH. Note that redemption is separate from repaying your loan as a borrower, which is free of charge.
Both fees depend on the redemption volumes, i.e. they increase upon every redemption in function of the redeemed amount, and decay over time as long as no redemptions take place. The intent is to throttle large redemptions with higher fees, and to throttle borrowing directly after large redemption volumes. The fee decay over time ensures that the fee for both borrowers and redeemers will “cool down”, while redemptions volumes are low.
The fees cannot become smaller than 0.5% (except in Recovery Mode), which protects the redemption facility from being misused by arbitrageurs front-running the price feed. The borrowing fee is capped at 5%, keeping the system (somewhat) attractive for borrowers even in phases where the monetary is contracting due to redemptions.
Liquity protocol offers interest-free loans and is more capital efficient than other borrowing systems (i.e. less collateral is needed for the same loan). Instead of selling Ether to have liquid funds, you can use the protocol to lock up your Ether, borrow against the collateral to withdraw LUSD, and then repay your loan at a future date.
For example: Borrowers speculating on future Ether price increases can use the protocol to leverage their Ether positions up to 11 times, increasing their exposure to price changes. This is possible because LUSD can be borrowed against Ether, sold on the open market to purchase more Ether — rinse and repeat.*
*Note: This is not a recommendation for how to use Liquity. Leverage can be risky and should be used only by those with experience.
Stability Pool and Liquidations
The Stability Pool is the first line of defense in maintaining system solvency. It achieves that by acting as the source of liquidity to repay debt from liquidated Troves—ensuring that the total LUSD supply always remains backed.
When any Trove is liquidated, an amount of LUSD corresponding to the remaining debt of the Trove is burned from the Stability Pool’s balance to repay its debt. In exchange, the entire collateral from the Trove is transferred to the Stability Pool.
The Stability Pool is funded by users transferring LUSD into it (called Stability Providers). Over time Stability Providers lose a pro-rata share of their LUSD deposits, while gaining a pro-rata share of the liquidated collateral. However, because Troves are likely to be liquidated at just below 110% collateral ratios, it is expected that Stability Providers will receive a greater dollar-value of collateral relative to the debt they pay off.
To ensure that the entire stablecoin supply remains fully backed by collateral, Troves that fall under the minimum collateral ratio of 110% will be closed (liquidated).
The debt of the Trove is canceled and absorbed by the Stability Pool and its collateral distributed among Stability Providers.
The owner of the Trove still keeps the full amount of LUSD borrowed but loses ~10% value overall hence it is critical to always keep the ratio above 110%, ideally above 150%.
LUSD Price Stability
The ability to redeem LUSD for ETH at face value (i.e. 1 LUSD for $1 of ETH) and the minimum collateral ratio of 110% create a price floor and price ceiling (respectively) through arbitrage opportunities. We call these "hard peg mechanisms" since they are based on direct processes.
LUSD also benefits from less direct mechanisms for USD parity — called "soft peg mechanisms". One of these mechanisms is parity as a Schelling point. Since Liquity treats LUSD as being equal to USD, parity between the two is an implied equilibrium state of the protocol. Another of these mechanisms is the borrowing fee on new debts. As redemptions increase (implying LUSD is below $1), so too does the baseRate — making borrowing less attractive which keeps new LUSD from hitting the market and driving the price below $1.
LQTY is the secondary token issued by the Liquity protocol. It captures the fee revenue that is generated by the system and incentivizes early adopters and Frontend Operators. LQTY has a max supply of 100,000,000 tokens.
LQTY rewards will only accrue to Stability Providers — i.e. users who deposit LUSD to the Stability Pool, frontends who facilitate those deposits, and liquidity providers of the LUSD:ETH Uniswap pool.
As technical rewards, they are based on a preprogrammed functionality of the protocol and not on a claim towards Liquity AG or any third party.
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