Decentralised Finance and protocol rulesets can be (and have been) developed to extract as much value as possible in the most convoluted of approaches. But there are some protocols that keep things simple, as they ultimately should be, in order to appeal to a broader audience. In today’s article, we are taking a closer look at Liquity Lending Protocol (LQTY) and how it works.
Liquity is essentially a new borrowing platform in DeFi. According to their whitepaper, “Liquity provides liquidity without charging borrowers interest or recurring fees. ETH holders can obtain liquidity against their collateral for free. However, as an algorithmically controlled monetary instrument, the protocol charges a Borrowing Fee (as a one-time fee) for newly drawn liquidity to support the peg with the USD”
Users are free to utilize their stablecoin, LUSD, to participate in the broader DeFi market consisting of many different products which are designed to generate yield. Many experts believe that Liquity has the potential to revolutionize the entire borrower market in DeFi.
Protocol Tokens:
LQTY: LQTY is the reward token created by the protocol to incentivize users. The stability providers are paid with LQTY for their contribution to the stability pools.
LUSD: LUSD is a USD pegged redeemable stable coin of the protocol.
They allow you to deposit ETH as collateral and borrow their stable coin “LUSD” at zero percent interest rate, which could be used in any DeFi protocols. In addition to having zero interest rate, they also have a low Collateral ratio of 110%. This implies that if we deposit ₹110 worth of ETH, we can borrow ₹100 worth of LUSD. One of the distinctive features is that they do not have their own first party front end. In other words, their entire protocol is out there in the open and any project can build front end for liquidity.
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There are four components that are pertinent for Liquity.
A trove is the debt position that was opened using the collateral. It only has two balances: ETH which is given as collateral and the protocol’s native token “LUSD”, that can be changed by adding more collateral or repaying debt. Users can close the Trove by paying off the debt. This trove can be liquidated automatically when the collateral falls below 110%
Liquity AG does not run its own web interface. Instead, Liquity’s Ethereum-based smart contracts can be accessed via third party apps. Currently there are 19 providers with kick back rates ranging from 95%-100%.
A kickback rate is set by every frontend, ranging from 0% to 100%, and it determines the share of rewards earned by their users' Stability Pool deposits. For example: If the kickback rate is 99%, the frontend will be rewarded with 1% of the LQTY rewards while the users keep the rest.
The Stability Pool plays an active role in maintaining system solvency. It achieves that by acting as the source of liquidity to repay debt from liquidated Troves—ensuring that the total LUSD supply always remains backed. The Stability Pool is funded by users transferring LUSD into it (called Stability Providers).
These are people who provide liquidity to the stability pools through LUSD tokens. In exchange they are rewarded in two ways.
Firstly, they receive liquidation gains from the stability pools consisting of the difference between absorbed debt (in LUSD) and the received collateral (in ETH). In addition, they acquire collateral from liquidated positions at a significant discount.
Secondly, they receive rewards, that are paid out in LQTY tokens based on the deposited LUSD and the kick back rate of the frontend through which their deposits are made
Stability Providers can withdraw their ETH gains and LQTY rewards at any time, while LUSD deposits can be withdrawn as long as the system contains no liquidatable debt.
Liquity recently launched the Chicken Bond program, a bonding system built on game theory principles and utilizing dynamic NFTs that evolve according to decisions made by the holder. The purpose behind the project is to enable protocols to bootstrap liquidity at a low cost, and offer better protection to those providing liquidity with a unique bonding model. Bond utilization is off to a healthy start, with nearly 10 million LUSD accumulated by the treasury.
With multiple protocols that are cluttering the defi lending space, Liquity is slowly catching up to the likes of bigger players such as Maker, Venus and Fluity by offering an SDK technical platform for developers to build their own Liquity Frontend and integrate with its service. LUSD has become one of the top 5 stable coins in the Optimism platform. With a progressive road map of launching “Generalised” Chicken Bonds for protocols/DAOs in Q2 2023, Liquity stands as a tall contender in the zero interest borrower market.
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