Liquity USD (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.^[1]

Overview

Rick Pardoe, core developer of the project and Robert Lauko, the CEO, co-founded Liquity USD in April 2021. It is an ERC-20 token designed to power the underlying Liquity decentralized borrowing protocol.

Liquity USD is designed to provide loans in liquidity agreements through its stablecoin backing. To access the loans offered by the platform, users need to have a collection with a minimum deposit of ETH before accessing the LUSD network, thus opening up a '110% collateral' rate to users.

According to Liquity, the protocol is a decentralized lending system allowing users to obtain loans at 0% interest rates while collateralizing ETH. As a result of its deployment on the Ethereum Mainnet, Liquity USD is validated using a Proof-of-Stake (PoS) consensus mechanism, due to the Ethereum Merge.

Users can deposit LUSD tokens into a stable pool to receive rewards from ETH and LQTY, the protocol's secondary token. Over time, the balance of LUSD in the stabilization pool decreases as settlement transactions are executed on the network. In exchange, the protocol rewards users with a percentage of settled ETH and LQTY. While it provides several key use cases for its users, LQTY token holders can also pledge their tokens for a portion of the loan and redemption fees charged by the platform. These fees are primarily allocated to the pledge contract and accrue to ETH and LUSD.

As LUSD is pegged to the US dollar, which means that its value is very close to the normal value of the dollar. Because of this value, token holders can exchange their LUSD tokens directly into fiat currency or other token pairs, such as USDT. In contrast to few DAO's like MakerDAO, Liquity loans carry a 0% interest rate but charge a fee for loan creation. The minimum loan size on Liquity is 2,000 LUSD.^[5]

Liquity USD has a total supply of 261 million LUSD, and an equal amount of LUSD in circulation with a market capitalization of $264 million.
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Redemption Mechanism

LUSD is a fully redeemable stablecoin. At any time, the system allows holders to redeem their LUSD for the underlying Ether collateral at face value. For example, A holder redeeming 100 LUSD would receive $100 worth of Ether collateral from the riskiest Trove(s), minus the current redemption fee. The redemption mechanism will create a price floor for LUSD, pushing its price back to parity whenever it drops below $1. Holders have an incentive to redeem LUSD if they can buy it for less than $1 and then convert it into Ether at a price of exactly $1. Every redemption leads to a contraction of the total LUSD supply and to an adjustment of the base rate. ^[6]

LUSD Supply Shrinkage

Liquity troves are collateralized debt positions (CDPs) that enable users to borrow LUSD against their ETH deposits. Redemptions occur when the price of LUSD drops below $1. Liquity's peg stability mechanism allows users to redeem 1 LUSD for $1 worth of ETH to maintain price stability. However, this ETH comes from troves with the lowest collateralization ratios.

On October 24th, 2023, over 4.13M LUSD tokens were redeemed for ETH. In September, 2023 alone, the total supply of LUSD has dropped by almost 40 million tokens. The rise in trove redemptions has prompted users to close their troves and seek alternative lending protocols. Some users have expressed deep concerns with Liquity's redemption mechanism, saying that it is not capital-efficient for borrowers and causing the biggest users to leave. The recommended safe collateral level for troves is changed to 240%, which means that one can safely borrow only around $42 in LUSD against $100 worth of ETH.

In September 2023, the average collateral ratio of redeemed troves stood at 181%. Arbitrage bots have been taking advantage of the ongoing arbitrage opportunity arising from MakerDAO’s DAI Savings Rate, exerting downward pressure on the price of LUSD and shrinking its supply. As users pay off their debt and close their troves, the supply of LUSD decreases. However, this reduction in supply boosts the yield for LUSD stakers in the stability pool. Currently, the LUSD stability pool offers stakers an annual yield of 4.53% APR.^[7]

LUSD & LQTY Bridging

To cater to smaller holders LUSD has also arrived on Optimism. The process works as: an LUSD-IOU on the target chain can be burned to recover the base LUSD on mainnet, although the process takes a week, a delay is required for the Challenge Period serving to help secure the assets stored on an Optimistic network. Due to the bridges, LUSD can exist on layer 2, enabling smaller holders to easily acquire it on their local DEX venue too. The process is exactly the same for LQTY. Bridging LUSD to layer 2 is to democratize access to it.
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Partnerships

LUSD x Maverick

The first three liquidity pools involving LUSD that were launched on Maverick:

• LUSD / wstETH pool
• LUSD / ETH pool
• LUSD/ USDC pool

Maverick’s highly customizable liquidity structure for LUSD/ETH pools, enables much higher liquidity efficiency than UniswapV2-type distributions, with a similar availability, depending on the chosen range. The LUSD/wETH pool, a LUSD/wstETH is also available, as part of a joint effort with the Lido Finance team.
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LUSD x GearBox

GearBox, the composable leverage protocol, was live on October 31, 2022. GearBox V2 is used to leverage LUSD/3CRV Curve/Convex yields. The user can be a supplier of tokens used by leveragers, to earn a native yield and GEAR tokens. Users can earn and provide liquidity to facilitate LUSD/3CRV leveraging, and supply DAI or USDC on GearBox. ^[10]

LUSD x Synthetix

In November 2021, Synthetix integrated LUSD into their ecosystem. It was to help aid sUSD’s peg on Layer 2. ^[11]

LUSD x OHM

The co-incentivized LUSD / OHM Sushiswap pool was live on October 6, 2021 and was eligible for liquidity mining rewards. There is $400,000 in combined rewards allocated to the pool. ^[12]

Benefits

Decentralization

Liquity operates in a decentralized manner, eliminating the need for central authorities and intermediaries. This makes it censorship-resistant and trustless.

Transparency

All transactions on the Liquity platform are recorded on the Ethereum blockchain, ensuring transparency and auditability.

Stability

The Stability Pool mechanism allows LUSD to maintain its peg to $1, even in times of market volatility.

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.^[4]

Liquidity

Liquity USD is tradeable and can be used in various DeFi applications, giving users flexibility in how they manage their assets.

Incentives

Users can earn rewards by participating in the Liquity ecosystem, either by depositing collateral, minting LUSD, or contributing to the Stability Pool.
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Challenges and Risks

Price volatility

Price volatility in the collateral asset (ETH) can pose a risk to users if the value of their collateral falls significantly. Users should always be aware of the potential risks associated with participating in DeFi platforms. Monitoring and adjusting this ratio can help ensure the stability of the stablecoin.

Smart Contract Security

Verify the security of the smart contracts governing the Liquity protocol. Security vulnerabilities can pose risks to the liquidity and stability of the protocol. Stay informed about any security audits and updates.

Governance and Upgrades

Keep an eye on the governance mechanisms and community involvement in the Liquity protocol. Transparent governance and a responsive development team are crucial for addressing concerns and implementing necessary upgrades to enhance liquidity.

Integration with DeFi Ecosystem

Assess how integrated Liquity is within the broader decentralized finance (DeFi) ecosystem. Strong integration with other protocols and platforms can contribute to liquidity and stability.

Community Communication

Regular and transparent communication with the community is essential. Updates on protocol changes, security measures, and any potential risks should be communicated effectively to maintain trust and confidence.

Monitoring Oracle Systems

Verify the reliability and security of the oracle systems providing price feeds to the Liquity protocol. Accurate price feeds are crucial for maintaining the stability of the stablecoin.

Liquidity Pools

Assess the liquidity available in decentralized exchanges or liquidity pools where LUSD is traded. Adequate liquidity on these platforms is essential for users looking to buy or sell LUSD without significant slippage.

Regulatory Compliance

Stay informed about regulatory developments that may impact the operation of Liquity. Ensuring compliance with relevant regulations is crucial for the long-term viability of any stablecoin project.
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