Exploring Liquity - A Decentralized Borrowing Protocol with Interest-Free Loans
Updated: Jul 24
Liquity is a decentralized borrowing protocol that allows users to draw interest-free loans against Ether (ETH) used as collateral. The loans are paid out in LUSD, a USD-pegged stablecoin, and need to maintain a minimum collateral ratio of 110%. The protocol is non-custodial, immutable, and governance-free. This article will discuss the motivation behind Liquity, its key benefits, and how it can be used in various applications.
Motivation behind Liquity
Stable-value assets are essential for Ethereum applications and have grown to represent tens of billions of dollars in value. However, the majority of this value is in centralized fiat-collateralized stablecoins like Tether and USDC. Decentralized stablecoins like DAI and sUSD make up only a small portion of the total supply. Liquity addresses this by creating a more capital-efficient and user-friendly way to borrow stablecoins while remaining decentralized and governance-free.
Key Benefits of Liquity
Liquity offers several key benefits to users:
Interest-free loans: Borrowers do not need to worry about accruing debt over time.
Minimum collateral ratio of 110%: This enables more efficient usage of deposited ETH.
Governance-free: All operations are algorithmic, fully automated, and set at the time of contract deployment.
Direct redemption: LUSD can be redeemed at face value for the underlying collateral at any time.
Fully decentralized: Liquity contracts have no admin keys and are accessible via multiple interfaces hosted by different providers, making it censorship-resistant.
To use Liquity, users must first choose a web interface (frontend) to access the system. The core team building the protocol does not operate a frontend. Instead, Liquity is accessed by third-party frontend applications and integration services. Users can find a list of frontends on Liquity's website.
Main Use Cases of Liquity
Users can interact with Liquity in several ways:
Borrow LUSD against ETH by opening a Trove.
Secure Liquity by providing LUSD to the Stability Pool in exchange for rewards.
Stake LQTY tokens to earn fee revenue from borrowing or redeeming LUSD.
Redeem 1 LUSD for 1 USD worth of ETH when the LUSD peg falls below $1.
LUSD and LQTY
LUSD is the USD-pegged stablecoin used to pay out loans on the Liquity protocol. It can be redeemed against the underlying collateral at face value. LQTY is the secondary token issued by Liquity, capturing fee revenue generated by the system and incentivizing early adopters and frontends. The total LQTY supply is capped at 100,000,000 tokens.
Fees and Earnings
Liquity charges a one-off fee whenever LUSD is borrowed or redeemed. Borrowers pay a borrowing fee on loans as a percentage of the drawn amount (in LUSD). Redeemers pay a redemption fee on the amount paid to users by the system (in ETH) when exchanging LUSD for ETH.
Users can generate revenue using Liquity by depositing LUSD into the Stability Pool to earn liquidation gains (in ETH) and LQTY rewards, or staking LQTY to earn LUSD and ETH revenue from borrowing and redemption fees.
Risks and Considerations
While Liquity is a non-custodial system and diligently audited, users may still lose a part of their funds in certain scenarios, such as the borrower's collateral being liquidated or the Stability Pool depositor's LUSD being used to repay debt from liquidated borrowers. Additionally, a hack or a system failure could also result in a loss of funds. Therefore, users should be aware of the following risks and considerations before using Liquity:
Smart Contract Risk: Although Liquity's smart contracts have been audited, there is always the possibility of undiscovered vulnerabilities or bugs. These could lead to the loss of funds or disruption of the platform.
Liquidation Risk: If the value of a borrower's collateral falls below the minimum collateralization ratio, their position may be liquidated. This may result in the borrower losing a portion or all of their collateral.
Market Volatility: The value of ETH, LUSD, and LQTY are subject to market fluctuations. These fluctuations can impact the platform's stability and the value of users' assets.
Oracle Risk: Liquity relies on oracles to provide accurate and up-to-date price information for collateral assets. If the oracle fails or provides incorrect data, this could lead to the liquidation of positions at incorrect values or other unintended consequences.
Regulatory Risk: Governments and regulatory authorities may implement new regulations or restrictions that could impact Liquity's operations or even force the platform to shut down.
Governance Risk: As the LQTY token allows holders to participate in governance, there is a risk of poor decision-making or malicious actions by token holders that could impact the platform negatively.
Network Congestion: High demand on the Ethereum network can lead to increased gas fees and transaction delays, potentially affecting the user experience and the ability to manage positions in a timely manner.
Competition: The DeFi landscape is continuously evolving, with new protocols and platforms emerging regularly. Increased competition could impact Liquity's user base, liquidity, and overall value proposition.
Economic Risk: The overall health of the global economy, as well as the health of the cryptocurrency market, can impact the performance of DeFi platforms like Liquity.
It's crucial for users to understand the risks and considerations involved when using Liquity or any other DeFi platform. Users should perform their due diligence, research, and risk assessment before engaging in any financial activities on these platforms.
The above article is intended for informational purposes only and should not be construed as financial advice. The information contained in this article is not intended to be a comprehensive analysis of the Trident project, nor should it be relied upon as such. This article is not a recommendation to buy, hold, or sell any investment or financial product. The information contained in this article is based on publicly available information and is subject to change without notice.
The author of this article makes no representation or warranty, express or implied, as to the accuracy or completeness of the information contained in this article, and accepts no liability for any loss or damage arising from any reliance on or use of this information.