What is Liquity?
Liquity is a decentralized borrowing protocol that allows users to draw interest-free loans against ETH as collateral (akin to MakerDAO). Loans are paid out in LUSD (USD-pegged stablecoin) and need to maintain a minimum collateral ratio of 110%. Loans are secured by the Stability Pool, where users can deposit LUSD that may be used to instantly repay uncollateralized debt. In return, they receive ETH collateral when liquidations occur and continuous LQTY rewards (Liquity’s secondary token capturing the protocol’s fee revenue).
Liquity recently launched on April 5th, 2021 and has attracted ~$2.5B TVL since then, ranking among the top 10 projects listed on DeFi Pulse. In addition, LUSD is also ranked among the top 10 stablecoins on DeFi Pulse and is the 2nd largest collateral-backed stablecoin behind DAI. Source.
Decentralization
- The Liquity contracts have no admin keys and are accessible via multiple interfaces hosted by third-party frontend operators, making it censorship resistant.
- The protocol is immutable and governance-free, as all operations are algorithmic and fully automated, and protocol parameters to maintain system health were set at time of contract deployment.
- LUSD is only backed by ETH and no other collateral types may be added.
As concerns and regulations continue to arise around the stablecoin landscape, it’s clear that the DeFi ecosystem needs decentralized alternatives. With LUSD being fully decentralized, censorship-resistant, and already detached from governance by design, it seems like an obvious choice as a hedge against regulatory risk for Compound and its users.
LUSD Peg Maintenance
- Redemptions: An arbitrage mechanism that allows users to redeem LUSD for ETH at face value (i.e. 1 LUSD for $1 of ETH minus fees) against the riskiest Troves (loans). In other words, when LUSD is below $1 on the open market, users can redeem (exchange) their LUSD for the underlying ETH collateral 1:1 within the protocol. The purpose of this mechanism is to pull excess LUSD out of circulation (i.e. deleveraging users), resulting in LUSD’s price going back up to $1.
- Minimum Collateral Ratio (MCR): Thanks to Liquity’s instant liquidation mechanism, Troves are allowed to maintain a CR as low as 110%. This means that if LUSD ever exceeds $1.1, users can open Trove at the minimum CR and sell it for an instant arbitrage profit.
Besides these two hard-peg mechanisms, LUSD also maintains its peg through less direct mechanisms covered here.
LUSD Stability
While the protocol is still relatively young, LUSD has been trading within a narrow range of 0.991 - 1.002 against DAI on Curve (14d stats) — where LUSD is most liquid.
Source (Snapshot taken on 11/17)
Protocol Stability
As a borrowing protocol, minted debt (LUSD) and system health is heavily dependent on liquidation efficiency. In contrast to collateral auctions, Liquity liquidates under-collateralized Troves instantaneously — substantially reducing the possibility of protocol loss and the risk of LUSD becoming partially unbacked.
Around one month after launch, the protocol faced its first stress test (flash crash on 5/19) and liquidated $93.5M against the Stability Pool with 0 protocol loss. Liquity has completely innovated this necessary function of borrowing protocols by creating a liquidation mechanism that’s fast, effective, and works under extreme conditions. More info here.
It’s also worth highlighting that almost half of all positions got liquidated, going from ~1130 Troves to ~496 Troves within a 9 day span. Since then, Liquity has seen consistent growth and is now at a new all-time-high of >1200 Troves.
Source
LUSD Utilization
Although there is currently ~$550M LUSD sitting idly in the Stability Pool, it doesn’t need to be as large as it is considering it could have managed liquidations just fine if it were 5x smaller based on the liquidation volumes of 5/19. We also expect it to decrease in size as meaningful integrations appear such as an LUSD market on Compound. At time of writing, the Stability Pool dominance is hovering around the all-time-low of ~64% and is on a downtrend as new integrations are becoming available.
Source (Snapshot taken on 11/17)
Liquidity and Volume on DEXes
Motivation
Although Liquity has favorable borrowing parameters such as the MCR at 110% and being interest-free, some users would prefer borrowing LUSD on Compound for three main reasons:
- Borrowing LUSD against other collateral assets besides ETH
- Protection from redemptions
- Protection from Recovery Mode in Liquity, which allows any Trove below 150% collateral ratio to be liquidated.
Asset Parameters
We’d like the Compound community to decide on what the following parameters should be for LUSD:
- Collateral Factor:
- Reserve Factor:
- Borrow Cap:
- Interest Rate Curve:
Audits
Trail of Bits Security Assessment - January 2021
Coinspect - March 2021
Trail of Bits Liquity Protocol and Stability Pool Final Report - March 2021
Trail of Bits Liquity Proxy Contracts Report - March 2021
Contracts:
LUSD Token Address: 0x5f98805a4e8be255a32880fdec7f6728c6568ba0
Chainlink LUSD Price Feed: 0x3D7aE7E594f2f2091Ad8798313450130d0Aba3a0
