Liquity Exploration: Innovation and Opportunities in Decentralized Lending Protocols

  1.  ;Project Introduction

Liquity is A decentralized lending protocol that allows users to borrow and lend against a stablecoin called LUSD (pegged to the U.S. dollar), with Ethereum as collateral. At the same time, it also introduced LQTY, a fully redeemable stablecoin. The protocol was designed by Robert Lauko to provide a more capital-efficient, lower-risk alternative to existing systems such as MakerDAO.

The protocol differs from traditional systems that require large amounts of over-collateralization to issue stablecoins Uniquely, Liquidity is able to liquidate risky loans instantly and employs a unique redemption mechanism that minimizes administrative needs, thereby lowering collateral requirements.

For borrowers looking for efficient ways to leverage their Ethereum assets, this is making it an attractive option. The protocol allows the use of ETH as collateral to lend LUSD (a stablecoin that is always pegged to USD). Through the 3-fold liquidation mechanism of the stable pool-debt redistribution-recovery model, Liquity only requires a minimum mortgage rate of 110%, thus greatly The capital utilization rate is improved, and the stability of the agreement can also be well maintained.

Liquity’s main use cases are as follows:

• Open trove: use ETH is used as collateral to borrow LUSD, and the minimum mortgage rate is 110%.

• By providing LUSD to the stability pool (SP) in exchange for liquidation proceeds and Liquidity’s native incentive token LQTY.

• Stake LQTY to earn fees paid by other users to borrow or redeem LUSD.

• Use LUSD to redeem ETH.

  2 . Core Mechanism

The Liquity protocol provides an innovative stablecoin solution in the field of decentralized finance (DeFi) through its unique design. Three key mechanisms—the price stabilization mechanism, the liquidation mechanism, and the supply control mechanism—work together to maintain the stability and efficiency of the system.

Price stabilization mechanism

Liquity’s price stabilization mechanism aims to maintain the value of its stablecoin LUSD at a 1:1 ratio to the United States dollar (USD) of anchoring. The core of this mechanism is to allow users to mint LUSD with ETH as collateral at 1 USD at any time, or redeem ETH with LUSD at 1 USD. This mechanism creates a hard price anchor, that is, when the LUSD price is higher than 1 USD, users are incentivized to mint and sell LUSD to make a profit; when the LUSD price is lower than 1 USD, users are motivated to buy LUSD and use their Pay off debt, or redeem to receive ETH. This two-way price adjustment mechanism forms a powerful feedback loop for price stability.

In fact, this stabilization mechanism is very effective. The figure below is the LUSD/USDc price calculated based on Curve’s LUSD/3pool (Curve The LUSD/3pool is currently the exchange with the largest liquidity of LUSD).

LUSD’s price fluctuations have remained between 0.97~1.03, and most of the time between 0.99~1.02, which shows the stability of LUSD .

Liquidation mechanism

Liquity’s liquidation mechanism is designed to protect the system from the threat of excessive debt and ensure debt repayment. When a borrower's collateralization ratio falls below the minimum (110%), their position will be considered over-indebted and liquidation will be triggered. Liquity uses a unique instant liquidation process that eliminates the need for traditional auctions. First, if there are sufficient funds in the stable pool (the pool where users provide LUSD), these funds will be used to pay off the debt, and the related ETH collateral will be distributed proportionally to the participants of the stable pool. If the stabilization pool funds are insufficient to cover the debt, the system will allocate the outstanding debt to other borrowers through the debt redistribution mechanism. This mechanism ensures the robustness of the system while reducing the need for on-chain auctions and reducing the complexity and uncertainty of the liquidation process.

The stability pool is the core factor that ensures Liquidity’s 110% mortgage rate and stability . As the project white paper says: "Since the acquirer agrees in advance, when the collateral position is insufficient, there is no need to find a buyer on the spot to acquire the collateral. This advantage allows the mortgage ratio to be significantly reduced while maintaining high stability."

Supply control mechanism

Liquity’s supply control mechanism is designed to regulate the total supply of LUSD and keep its price stable. This is mainly achieved by adjusting minting fees and redemption fees, both of which are dynamically adjusted based on market conditions and the frequency of redemption activities. When redemption activity increases, redemption fees rise, making redemptions of LUSD less attractive, and vice versa. Minting fees are also adjusted based on redemption activity and are designed to incentivize or inhibit the minting of new LUSD to regulate market supply. In this way, Liquidity attempts to balance the supply and demand of LUSD through fee adjustments without the regular interest mechanism.

  3. LQTY

LQTY is the Liquidity protocol’s stablecoin that is minted when borrowers deposit collateral , the amount of collateral may be significantly lower than that required by other systems. This efficiency is due to Liquity’s innovative liquidation process and redemption mechanism, which ensures a price floor for LQTY, thereby promoting stability without the need for governance intervention. The system is designed to automatically handle liquidations via a stability pool, where LQTY tokens can be burned to clear debt, and by automatically redistributing undercollateralized loans among borrowers. This process is not only designed to maintain the stability of the system but also sets a lower collateralization threshold compared to competitors.

The following are the main features of LQTY and its impact on users and the entire Liquity system:

Allocation and Rewards

The total supply of LQTY is 100 million, and these tokens are mainly distributed to users participating in the Liquidity protocol through a variety of methods. One of the most notable ways of distribution is through the Stability Pool Rewards. Users deposit LUSD into the stable pool to help the protocol manage the liquidation process, and in return they receive LQTY tokens. In addition, users who provide ETH/LUSD liquidity to Liquidity can also receive LQTY rewards.

Value acquisition mechanism

LQTY’s value comes from its ability to capture a portion of the Liquidity protocol’s revenue. When users open a lending position or perform a redemption operation of LUSD, they need to pay certain fees, and part of these fees will be allocated to LQTY holders. This means that LQTY token holders can directly benefit from the operation of the protocol.

Risk and Return

One ​​of the main risks faced by LQTY holders is fluctuations in market value. The market price of LQTY will be affected by various factors such as protocol usage, ETH price, and the overall trend of the DeFi market. However, users can actively influence the value of LQTY by participating in the protocol’s governance, stability pool, and liquidity provision.

Governance function

Although LQTY itself does not have direct governance rights, it is a key component of the Liquidity protocol ecosystem and represents Recognition of contributions to the protocol. The holding and distribution of LQTY reflects the degree of user contribution to the stability and liquidity of the protocol.

  4. Business

Sports Tao:

Liquity is a stable currency - a decentralized stable currency track.

Stablecoins are the track with the most network effects in the DeFi field, and In the last cycle, it also achieved development that significantly exceeded the average growth rate of the industry.

Due to settlement convenience and being more in line with the habits of the general public, stablecoins have replaced BTC /ETH has become the basic settlement currency for spot transactions. It is the settlement currency for new derivatives such as perpetual contracts that are very popular in the market. It is the settlement currency used by most project parties and venture capital institutions for investment and financing activities. Reflected in the data, the increase in the market value of stablecoins exceeds the average increase in the crypto market, and the correction is also smaller than the market average.

The positioning of stablecoins as the basic settlement currency of cryptocurrencies is in the eyes of all market participants It is already very stable in my mind, and its market size will at least grow in tandem with the overall size of cryptocurrency, and there is still huge room for development.

Business products:

The following are important events since the creation of the Liquidity project, as of March 2023.

Chicken Bonds

Chicken Bonds launched by Liquidity is strictly a set of solutions that can stimulate POL (Protocol Owned Liquidity, protocol-owned liquidity). Its first product module is LUSD Chicken Bonds. The goal of Chicken Bonds is to help the protocol guide liquidity at the lowest possible cost while giving users more robust principal protection.

The mechanism of Chicken Bonds is quite complex and exquisite. To put it simply, it means that the existence of chicken The lusd of bonds is nominally divided into three pools (pending, reserve, parnament), but only the lusd of one of the pools can enjoy all the benefits of the three pools (reserve). $blusd is used to represent the user in this exclusive income pool. share.

Core Concepts

bLUSD (Boosted LUSD): By participating in the Chicken Bonds mechanism, users can obtain an enhanced version of LUSD whose value and earning potential exceed that of ordinary LUSD. bLUSD can represent the user’s share in the Chicken Bonds mechanism and can be redeemed into LUSD at any time.

LUSD Bond NFT: the non-fungibility obtained by users after purchasing bonds through LUSD Tokens (NFT) represent users’ claims in Chicken Bonds. The NFT can be exchanged for bLUSD according to the time-yield curve preset by the system.

Mechanism workflow

Investment and income: After users use LUSD to purchase bonds, these funds first enter the "Pending Bucket" ), deposit into the Stability Pool through B.Protocol to obtain LQTY rewards and ETH liquidation earnings, which are automatically converted into LUSD to achieve the compound interest effect.

Option: Users who hold LUSD Bond NFT can choose to receive bLUSD (Chicken in) or cancel the bond (Chicken Out). The amount of bLUSD collected will increase over time, but the rate of increase will gradually slow down. Users can receive bLUSD in advance by paying a certain percentage of handling fees, but this will cause part of the LUSD to enter the "Permanent Bucket" and be owned by the protocol.

Liquidity and income distribution: bLUSD’s value and income mainly come from three sources The income generated by all LUSD in the pool (pending pool, reserve pool, permanent pool) will be distributed to bLUSD holders in the reserve pool. Therefore, the return rate of bLUSD is higher than that of simply depositing LUSD into the stable pool.

Competitive Strengths and Weaknesses< /p>

Advantages: Chicken Bonds provides an effective mechanism to motivate POL, while providing users with more than ordinary The earning potential of LUSD increases the appeal of the Liquidity protocol.

Disadvantages: Since Chicken Bonds’ revenue mainly depends on the participation of new users, there are To a certain extent, the persistence and stability of "Ponzi structure" characteristics may be challenged. In addition, most participants are at a loss after participating in Chicken Bonds, which may affect their long-term willingness to participate and the healthy development of the protocol.

In general, Chicken Bonds are used by the Liquidity protocol to incentivize the liquidity owned by the protocol. An innovative mechanism designed to improve performance and user engagement. By providing earning potential that exceeds traditional LUSD, attracting users to participate and lock funds, it increases the stability and attractiveness of the Liquidity protocol. However, its sustainability and impact on early adopters needs to be observed and evaluated over time.

  5. Team/Collaboration/Financing

Team

Robert Lauko, founder and CEO, graduated from the University of Zurich with a doctorate in law. He has many years of legal and lawyer experience. Before founding Liquidity, he was an assistant researcher at Dfinity.

Rick Pardoe, Co-Founder and Core Developer, BA Physics and Economics Master's degree, I started to develop in the blockchain field in 2017 and created the website ethdevs.com.

Kolten Bergeron, Head of Growth, former Stellar Development Foundation Ecosystem and Community Development Manager. According to LinkedIn, there are currently 10 team members, most of whom are developers.

Consultant

Ashleigh Schap, who is also currently the head of growth at Uniswap and previously worked at MakerDAO.

Yulin Liu, Ph.D. in Economics from the University of Zurich, previously an economics professor at Dfinity He is currently an associate professor of economics at Huazhong University of Science and Technology. Dr. Liu has co-published numerous academic papers on cryptocurrency. Conducted the initial macroeconomic model simulation for Liquidity, providing a basis for LUSD to maintain stability under ETH fluctuations.

Cedric Waldburger, he is Liquidity’s original investor.

Investors

The pre-seed round was invested by Tomahawk.VC, where Cedric Waldburger is located, and the specific financing amount and financing time were not disclosed.

In September 2020, it completed a US$2.4 million investment led by Polychain Capital. Seed round financing, with participation from a.capital, Lemniscap, 1kx, Dfinity Ecosystem Fund, Robot Ventures, Robert Leshner (founder of Compound), and Alex Pack.

In March 2021, it completed a US$6 million investment led by Pantera Capital Participating investors include Nima Capital, Alameda Research, Greenfield One, IOSG Ventures, AngelDAO, as well as angel investors Bo Shen, Meltem Demirors, David Hoffman, Calvin Liu and George Lambeth. Previous investors including Tomahawk.VC, 1kx and Lemniscap also invested additional money.

  6. Project advantages/disadvantages

Liquity is currently the leader in fully decentralized stablecoins, but in fact LUSD's competitors are not just fully decentralized stablecoins, but also "partially decentralized" stablecoins such as DAI and FRAX, as well as centralized stablecoins USDT, USDC, etc. Of course, the one that directly competes with LUSD is the decentralized stablecoin.

Liquity’s competitive advantages in the stablecoin market can be summarized as the following points:

1. Complete decentralization: Liquidity serves as a fully decentralized stable Token protocol, its decentralized nature is one of its most significant competitive advantages. This makes LUSD immune to single points of failure or regulatory risks, providing greater security and censorship resistance. Especially in the context of increasing regulatory pressure on stablecoins, Liquidity’s completely decentralized features are even more valuable.

2. Excellent mechanism design: Liquity’s stability pool, debt repayment Mechanism designs such as allocation and recovery modes are considered to be very advanced and efficient. These designs not only enable a fast and secure liquidation process, but also provide natural utilization scenarios through stability pools, allowing LUSD to maintain price stability without a centralized guarantor while maintaining high capital efficiency.

3. No governance required, reduced human intervention: Liquity’s no-governance model This means that its protocol parameters and updates are completely controlled by preset algorithms, reducing the risk of human error or manipulation that may occur in the governance process. This design improves the transparency and predictability of the protocol while also ensuring long-term stability and security.

4. Low-cost lending services: Liquity provides interest-free borrowing For services, borrowers only need to pay a one-time minting fee and redemption fee. This low-cost design attracts many users looking for efficient capital utilization, especially when the cryptocurrency market is highly volatile, allowing users to flexibly manage their assets.

5. Proof of being widely forked: Number of times the Liquidity protocol has been forked More than any other stablecoin protocol, which is a testament to the popularity of its mechanism design and the recognition of its innovation within the industry.

6. Experience the market test: Liquity has successfully experienced It has experienced severe fluctuations in the crypto market many times, which proves the resilience and effectiveness of its core mechanism. Especially during market declines, Liquidity’s liquidation mechanism and price stability have been fully verified.

Of course, compared to other stablecoin projects, one of the innovations of Liquity’s own protocol is There are many advantages, and some features are also controversial, which also brings certain competitive disadvantages to the agreement. Liquity’s competitive disadvantages in the stablecoin market mainly include:

1.  No governance mechanism limits use case expansion: Although Liquidity’s no-governance feature provides advantages in terms of security and decentralization, it also limits the protocol’s flexibility and ability to adapt to new changes. The absence of governance means that it is difficult for Liquidity to adjust protocol parameters or introduce new features to respond to market changes through governance, which may limit Liquidity's ability to expand use cases and quickly adapt to market needs.

2. Charging structure: Liquity adopts the method of charging when minting and redeeming A one-time fee model rather than a model based on borrowing interest. This charging model may lead to unstable protocol income, and as the circulation of LUSD increases, it will be unable to continue to profit from the increased scale of stablecoins, resulting in unequal risk and return.

3. Insufficient future incentives: The main incentive of LQTY tokens is for Stability Pool, but over time, the amount of LQTY reserved for Stability Pool incentives will decrease. Going forward, Liquidity faces the challenge of insufficient incentives, which could impact its ability to attract and retain users.

4. Competitors’ governance and product innovation capabilities: compared to Unlike other stablecoin projects, such as MakerDAO and Frax Finance, Liquidity’s governance-free model may be at a disadvantage in terms of governance and product innovation. These competitors use governance models to more flexibly adjust protocol parameters and launch new products in response to market changes and user needs.

5. Adaptability to external changes: Due to the lack of governance model, Liquity may have difficulty adapting quickly to changes in the external environment, such as changes in the staking mechanism of ETH, which may limit its long-term competitiveness and market share growth.

  7. Summary

As a decentralized stablecoin issuance platform, the Liquidity project has demonstrated its unique innovation and market potential. By providing interest-free borrowing services with Ethereum as collateral and introducing a series of innovative mechanisms such as stability pools, debt redistribution and recovery models, Liquity not only optimizes capital efficiency, but also enhances the stability and security of the system.

Despite this, Liquity faces the challenges posed by the governance-free model, specific Issues such as the fee structure and possible insufficient future incentives are important aspects that the project needs to continue to pay attention to and resolve. In order to maintain its competitive advantage and achieve long-term development, Liquidity needs to further optimize its products and mechanisms, strengthen cooperation with both inside and outside the industry, and continuously explore and respond to market changes.

In summary, Liquity, with its decentralized features and innovative mechanism, Establishing a strong competitive position in the stablecoin market. Facing the future, Liquity is expected to continue to expand its business scope and market influence by leveraging its team's professional capabilities, continuous technological innovation and market strategy adjustments, bringing more value and possibilities to the cryptocurrency and decentralized finance fields. .