Liquity - 0% Interest Loans and Capital Efficiency - Decentralise #14

Liquity looks set to revolutionise the decentralised stablecoin market

The New Kid on the Block


Recently I’ve been delving deep into Liquity, which for me was the standout project from EthOnline last month.

If you didn’t hear about it yet, Liquity is a highly decentralised collateral-based stablecoin protocol. You should definitely check out Robert’s full talk here.

What’s fascinating is that it will use an algorithm-based design, adjusting incentives and taking actions autonomously to ensure the health of the protocol.

The design circumvents many of the flaws existing platforms like Maker face, and provides significant efficiency gains along the way.

My first impression was that this project was highly interesting, and the more I’ve learned, the more excited I’ve become for its future.

Core features

I dived deep into the whitepaper and other resources.

Here are my key take-aways:

  • Interest-free loans for borrowers, using a fluctuating one-time fee that trends towards zero.

  • Low minimum collateralisation ratio (110%)

  • Ether as the only collateral, avoiding centralised tokens e.g. USDC

  • Fully decentralised, immutable, and censorship-resistant

  • Governance free, avoiding plutocracy and low participation issues

  • Initial stablecoin LUSD instantly redeemable for Ether (no auctions)

  • Decentralised front-ends supported from day one

  • Multiple built-in incentives for participators

Aside from the benefits for individual users such as interest-free borrowing, Liquity looks like it will have a tangible effect on the wider Ethereum network, providing greater capital efficiency and Ether liquidity.

Here’s a brief overview of some of the mechanisms that enable these benefits.

Stability Pool

The stability pool is the frontline defense mechanism for the LUSD dollar peg. Users deposit into the stability pool and funds from the pool are burnt every time a CDP (known as troves) is liquidated. Perhaps it’s a bad analogy, but the design reminds me of rebasing mechanisms. Those who deposited funds earn a share of liquidated positions, with liquidations providing a net benefit to the network.

Redemption Mechanism

As mentioned previously, anyone can instantly exchange their LUSD for an equal value of Ether. There’s an adjustable fee here, but if LUSD is trading below the peg it can be a profitable arbitrage opportunity. The redemption mechanism establishes a hard baseline for LUSD’s value.

What’s really interesting is the way this works. The protocol uses redeemers to pay off the system’s riskiest troves, returning the remaining collateral to the trove owner.

In short, borrowers lose the same amount of collateral as they have in outstanding debt.

Conclusion

There’s also of course a trove liquidation mechanism, as well as a recovery mode that ensures the overall health of the protocol, maintaining an average 150% collateralisation ratio.

I could write about these features all day but this blog is getting a little long already for one day.

Liquity to me presents a seismic shift in the decentralised stablecoin industry, and it will be interesting to see how far it can go. The project is planning to give live Q1 2021.

I’m especially interested in the projects’ approach to governance, and how a community is already forming around the protocol without centralisation.

If you’re interested in learning more I recommend the EthOnline talk, whitepaper, and Medium page.

You can also go directly to the project’s website and discord community.