Liquity Protocol is a decentralized lending protocol, also known as Collateralized Debt Protocol - Collateralized Debt Protocol (CDP). You can mortgage ETH (the only type of collateral accepted by Liquity) to apply for interest-free loans and obtain LUSD stablecoin loans. As a DeFi protocol, Liquity Protocol is immutable, non-custodial, and free of governance, and is a completely decentralized DeFi protocol.
It adopts the model of governance token $LQTY + stable currency $LUSD, which is similar to the $MKR + $DAI model of MakerDAO, the leader in the stablecoin track.
The difference between LUSD and third-party managed stablecoins such as USDC and USDT is that the latter are pegged to the U.S. dollar at a ratio of 1:1. If the assets and liabilities deviate from 1:1, then this type of stablecoin will collapse and will no longer be stable. LUSD is not linked to the physical cash stored in the bank, but to the ETH mortgaged in the vault. Moreover, the protocol is completely operated by immutable code and is resistant to deep differences. No common organization can prohibit the issuance of LUSD. The Liquidity Protocol is not responsible for running the front end. There are so many third-party front ends that it is impossible to go crazy.
The Liquity protocol is not upgradeable and no one can change its smart contract. That is, if there are no loopholes in the protocol at the beginning, there will never be a chance to introduce new loopholes, so it is very safe.
Liquity Protocol's interest-free lending mechanism is that the protocol charges a one-time borrowing and redemption fee. This fee is algorithmically adjusted based on the most recent redemption time. For example: If more redemptions occur in the near future (which means LUSD may be trading below $1), lending rates (fees) will increase, discouraging borrowing and lending.
To lend money on this project, the borrower needs to open a treasury (trove) through an Ethereum address. Each address can only have one treasury. By depositing a certain amount of ETH in the treasury, the corresponding amount of LUSD can be withdrawn. The premise is The mortgage rate cannot be higher than 110%, and the minimum loan amount is 2,000 LUSD. Of course, users can pay off their debts and close the vault at any time. While ETH is also at risk of falling prices, the protocol liquidates LUSD to ETH positions instantly to ensure the protocol’s full 1:1 collateralized lending ratio.
LUSD has several special mechanisms to maintain a stable link to ETH and maintain its own circulating supply.
The hard peg mechanism means that LUSD can be exchanged for ETH at a 1:1 ratio. The system charges a one-time redemption fee, which will increase with each redemption. If no redemption occurs over time, it will gradually decrease to zero. LUSD is destroyed upon redemption.
For example, Peg = $0.98, the arbitrageur buys LUSD for $0.98, redeems it for $1, and gets a profit of $0.02. The buying pressure of LUSD will make its price rise; Peg = $1.15, the arbitrageur buys LUSD at 110% Collateralize Take out the maximum borrow and sell LUSD for a profit of $0.05. LUSD Selling pressure brings prices lower.
The soft peg mechanism refers to that LUSD also benefits from the indirect U.S. dollar parity mechanism. Taking the LUSD U.S. dollar parity as the Schelling point is one of them. Since Liquidity Protocol treats LUSD as equivalent to the U.S. dollar, the parity between the two is The implicit equilibrium state of the agreement.
Since the issuance of LUSD, there has been almost no downward unanchoring, because the protocol provides a mechanism to redeem ETH at US$1, so the value is very guaranteed. The current size of LUSD is far less than that of ETH, and the death spiral of LUNA and UST will not occur.
In addition, the mechanism of LUSD's borrowing and redemption fees being the same also prevents the LUSD supply from getting out of control. Depositing ETH to borrow LUSD, borrowing fees and redemption fees work in the same way (the more people issue LUSD, the fees go up).
Liquity Protocol's stability pool as a liquidity reserve is also the source of liquidity for debt repayment in liquidation positions. If the stability pool is exhausted due to liquidation, debt and collateral will be evenly distributed. This mechanism is also a buffer for Liquity Protocol against risks.
Liquity Protocol also has a special recovery mode designed to cope with large-scale liquidation. It is activated when the total collateralization ratio (TCR) of the system is lower than 150%. Positions with a collateralization rate lower than 150% can be liquidated. The recovery mode is designed to encourage deposits. Deposit ETH and repay debt.
The emergence of Chicken bonds attempts to solve the problem of Liquidity Protocol's lack of application scenarios.
The mechanism of Chicken Bonds is quite complex and sophisticated. To put it simply, the LUSD stored in Chicken Bonds is nominally divided into three pools (pending, reserve, parnament), but only the LUSD in one of the pools can enjoy all the benefits of the three pools (reserve ), $bLUSD is used to represent the user’s share in this exclusive revenue pool.
The idea of this mechanism design is really good, but all the calculations of the mechanism designer have not become a reality in actual applications. From a macro perspective, chicken bonds have hardly brought much positive external effects to Liquity. The TVL of the agreement has not changed much after chicken bonds went online. It can only be said that $LUSD, which was originally placed in the stability pool, has entered chicken bonds. There is still a mutual competition of funds on the market, and the wheels of chicken bonds moving at high speed are gradually increasing. Because of various frictions and losses in reality, it finally stopped slowly.
The price of $bLUSD went down, and no one’s bonds were profitable, so no one rebonded. A large number of users canceled bonds in exchange for $LUSD and no longer participated. There is also no incentive for newcomers to enter because there is no longer a reward for creating bonds.
This also caused the pending pool to plummet like a cliff. The ratio of pending/reserve continued to decline, and the bLUSD revenue multiplier also continued to decline. The bLUSD APR plummeted, the market premium became negative, and the $bLUSD price fell, thus forming chicken bonds. death spiral.
$LUSD faces far more difficulties than this.
As time goes by, Ethereum itself is undergoing profound technological changes. The upcoming shh fork officially announces the formation of LSD (Liquid Staking Derivatives) relative to the cryptocurrency side, which is similar to the risk-free interest rate of US Treasury bonds.
This means that simply holding ETH as before has a huge opportunity cost. If the 100 Ethereums in your hand can earn you an almost risk-free income of 4 Ethereums every year, then if you put it now In various lending platforms, in the long run you may only dare to lend out 1/3 of your position in stablecoins. Not counting the interest rate, you have to get a stable annualized income of 12% to barely break even. This level of safe and sustained stable income is actually not easy to find in defi. If you include rates, position adjustments, and gas fees, at least 15% of the APY must be exceeded to be able to compete with direct participation in Ethereum staking.
The result is that many users will pay off their positions in Liquidity and take out ETH to pledge. In this way, Liquidity is faced with a situation where TVL is constantly shrinking. What’s more terrible is that the project Token $Lqty used for stability pool mining has already been used. There is not much left. This mining pool is equivalent to the risk-free interest rate of $LUSD. Once it drops to 0, it will be doubtful whether these $LUSD will have a new place to go.
Liquity might be able to accept some LSD as collateral, but that would certainly take away from $LUSD’s status as the most deep-drift-resistant, most decentralized stablecoin. But if we don’t do this, $LUSD will only become a stable currency used by a small number of geeks and even hackers, and MakerDao, the leading competitor, will take over the banner of LSD mortgage without hesitation and move towards expansion again.
And this is a very dangerous path for the entire DeFi track and the Ethereum community.
(Reference: darkforest@SevenUp DAO; 0xJeff, Nikyous@twitter)