LIQUITY PROTOCOL

Uniera
5 min readOct 4, 2023

In the ever-evolving landscape of cryptocurrencies and decentralized finance (DeFi), Liquity emerges as a significant innovation in the realm of loans and stablecoin creation. Launched on the Ethereum network in 2021, Liquity introduces a distinct approach to collateralized loans and stablecoin creation. In this article, we will explore the intricacies of Liquity, investigating its technology, security, tokenomics, development progress, ecosystem development, token performance, and the team behind it.

HOW IT WORKS

The Liquity ecosystem revolves around two native assets: the stablecoin $LUSD and the utility and governance token $LQTY.

$LUSD is a stablecoin designed to maintain a 1:1 ratio with the US dollar. Unlike other over-collateralized stablecoins, Liquity stands out by exclusively supporting Ethereum ($ETH) as collateral. Users deposit $ETH as collateral to borrow $LUSD, with a minimum collateral ratio of 110%. This means that for every $100 borrowed in $LUSD, a user must maintain at least $110 in $ETH as collateral.

An important feature of Liquity is its unique borrowing fee, which does not accumulate over time. This approach offers long-term cost efficiency, making it an attractive option in the DeFi lending space.

On the other hand, $LQTY serves a dual purpose. Initially created without governance rights, it primarily served as a means for users to earn a share of the protocol’s revenue, including borrowing and redemption fees. However, in January 2023, Liquity introduced a community governance program called LiquiFrens, granting $LQTY holders voting rights. This change reflects Liquity’s commitment to decentralization.

RISKS AND SECURITY

Liquity employs a multi-layer risk management mechanism to assess and mitigate risks within the protocol. The total collateral ratio of the platform serves as a key risk indicator. A ratio above 150% is considered low risk, while anything below 150% falls into the high-risk category.

In low-risk scenarios, users need to maintain a collateral ratio above 110% to avoid liquidation. However, during high-risk periods, positions with a collateral ratio below 150% face the risk of liquidation. New positions can only be opened with a collateral ratio above 150% until the protocol returns to a low-risk state.

Liquidation in Liquity consists of two layers. The Stability Pool holds $LUSD as liquidation funds, which are used to pay off loans in case of liquidation. Users can withdraw their funds from the Stability Pool at any time except when there are positions subject to liquidation. When the Stability Pool is depleted, a debt redistribution mechanism comes into play, improving the overall ability of positions to fulfill their obligations.

Security is a primary concern in the DeFi space. Liquity’s contract code has undergone audits by Trail of Bits and Coinspect, helping identify and address potential risks. To date, Liquity has not experienced any security incidents related to its smart contracts, instilling confidence in the platform’s security measures.

TOKENOMICS

$LUSD, being a stablecoin, plays a vital role in the Liquity ecosystem. Users can deposit $LUSD into the Stability Pool to earn liquidation fees and rewards in $LQTY. Additionally, $LUSD features a stability mechanism called “Redemption,” allowing holders to redeem $ETH at a 1:1 rate. This mechanism helps maintain parity with the US dollar but comes with higher borrowing costs and redemption fees as the protocol’s base interest rate increases.

$LQTY, originally created without governance rights, evolved into a governance token through the LiquiFrens program. Its primary function is to provide users with voting power in protocol governance decisions. The initial distribution of $LQTY had a total supply of 100 million tokens, with various lock-up periods for team, advisors, and investor tokens.

DEVELOPMENT PROGRESS

While Liquity does not maintain a specific roadmap, the team releases quarterly progress reports. Recent reports indicate a focus on improving the liquidity of $LUSD on Layer 2 solutions. Additionally, the protocol benefits from community contributions through monthly proposals, ensuring continuous development aligned with user needs. As of September 2023, Liquity has a Total Value Locked (TVL) of approximately $650 million and a total collateral ratio of 259.9%.

ECOSYSTEM DEVELOPMENT

Liquity is actively expanding its ecosystem in various directions. It has integrated with lending protocols like Aave, allowing users to borrow and lend in $LUSD. Furthermore, Liquity strives to increase $LUSD liquidity on Layer 2 networks such as Optimism and Arbitrum.

The Chicken Bond, a yield protocol built on Liquity, offers depositors higher yields than the Stability Pool. While the $LUSD ecosystem is less diversified compared to other stablecoins, Liquity’s efforts to broaden its utility and reach are evident.

TEAM, PARTNERS, AND INVESTORS

Liquity was founded by Robert Lauko and Rick Pardoe and is currently led by CEO Michael Svoboda. The founders and the team have extensive experience in the blockchain industry, instilling confidence in the project’s leadership.

Liquity secured $8.4 million in two funding rounds between 2020 and 2021. Major investors include Polychain Capital, Pantera Capital, Alameda Research, IOSG Ventures, 1kx, and Tomahawk. The team’s ability to attract significant investments highlights the project’s potential.

FINAL CONSIDERATIONS

The Liquity protocol is operated by smart contracts, making it a highly decentralized platform. However, there is room for improvement in terms of user experience, especially in the absence of a standard interface.

The $LUSD ecosystem, while growing, is less diversified compared to other stablecoins. However, liquidity and staking fees for both $LUSD and $LQTY remain high, indicating potential for further growth and development. As the popularity of decentralized stablecoins continues to rise, Liquity appears positioned for more opportunities in the future. Its commitment to decentralization, robust security measures, and active development efforts make it a project to watch in the dynamic world of DeFi.

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Uniera

Uniera operates as crypto exchange and venture capital firm that supports early-stage projects. www.uniera.io