1. Fundamental analysis:Project IntroductionLiquity is a decentralized lending protocol. It allows users to withdraw interest-free loans with ETH as collateral, and the loans are paid out in LUSD, a stablecoin pegged to the U.S. dollar, with a minimum collateralization rate of 110%.
On September 25, 2020, Liquidity received US$2.4 million in seed round financing, led by Polychain Capital. On March 29, 2021, Liquidity received US$6 million in Series A financing. The investment was led by crypto-focused venture capital firm Pantera Capital, with participation from Nima Capital, Greenfield.one and IOSG. Angel investors including Meltem Demirors, David Hoffman and Calvin Liu also contributed to the financing.
Liquity was launched on Ethereum on April 5, 2021. Its founder is Robert Lauko, a former DFINITY researcher. Its co-founder is Rick Pardoe, currently the chief engineer. The current CEO of the company is Michael Svoboda, who has served as CEO and COO in many blockchain companies.
2. Token economic model
(1)LUSD
LUSD issued by Liquity is a stablecoin backed by over-collateralization of ETH. Its upper and lower ranges are guaranteed by two mechanisms: the hard hook mechanism and the soft hook mechanism. The hard peg mechanism relies on the ability to exchange 1 LUSD for 1 USD worth of ETH and a 110% minimum collateralization rate guarantee. LUSD also indirectly benefits from the U.S. dollar parity mechanism—called the “soft peg mechanism.” Taking the LUSD dollar parity as the Schelling point (also called the focus point, which can be simply understood as the thinking point that most people tend to think about when the same thing happens) is one of them, because Liquity treats LUSD as equivalent to the U.S. dollar when determining the collateral ratio , so the parity between the two is the implicit equilibrium state of the agreement.
Liquity's borrowers have debt denominated in LUSD, but the current value of ETH held as collateral is expressed in USD, so the collateralization ratio is defined as USD collateral divided by LUSD debt. On the basis of this formula, given the redemption mechanism, hard price floor, and clear brand image of a USD-based stablecoin, users would view the 1:1 USD peg as a Schelling in which the system tends to return after a temporary deviation. point. When an overwhelming majority holds this belief, LUSD above $1 makes borrowing more attractive and LUSD below $1 incentivizes paying down existing debt.
LUSD can be deposited into the stablecoin pool to ensure liquidity while earning the protocol's liquidation income and LQTY rewards. The current APR is approximately 9.00%. It has no governance itself and is automatically completed by the algorithm. All protocol parameters are set when the contract is deployed.
(2)LQTY
LQTY is a platform currency issued by the Liquidity protocol. It captures the fee revenue generated by the system and uses this to incentivize early users and front-end operators. LQTY rewards will only be cumulatively distributed to stable providers, that is, users who deposit LUSD into the stable pool, the front-ends that facilitate these deposits, and the liquidity providers of the LUSD/ETH Uniswap pool. Also available as technical awards, they are based on the pre-programmed functionality of the protocol and are not based on a claim against Liquidity AG or any third party. LQTY holders can earn fees from loan issuance and LUSD redemption by staking. At the same time, LQTY has no lock-up period, and users can withdraw mortgage funds at any time.
The maximum supply of LQTY is 100,000,000, of which 35.3% is allocated to the liquidity community, including front-end operators, stablecoin providers, and community reserve funds (used for community-focused activities); 33.90% is allocated to investors, and 23.66% is allocated to the team and advisors, 6.1% to Liquidity AG for use by the company, and 1% to service providers who helped Liquity in various ways prior to its launch. This distribution mechanism gives a large amount of profits to the community and investors, which is in line with the team's concept of decentralized operations.
Maker, which also mints stablecoins through lending protocols, is usually the comparison target of Liquidity. The platform governance token MKR issued by Maker is quite different from LQTY in terms of issuance. MKR itself is involved in Maker's debt problem. The auxiliary role of this token is to serve as a capital restructuring resource for the Maker protocol. If the system debt exceeds the surplus, a debt auction will be triggered to increase the supply of MKR tokens and recapitalize the system. This risk will encourage MKR holders to unite and manage the Maker ecosystem responsibly to avoid excessive risks. Therefore, there is no fixed amount of MKR supply; LQTY’s issuance and distribution mechanism are fixed and will not participate in the settlement of debt issues. At the time of its issuance, LQTY was not a governance token because the Liquidity system had no governance. However, on January 24, 2023, Liquidity stated that it would give LQTY holders the right to vote for governance for a period of three months.
3. Business model
(1) Decentralized lending
The Liquity protocol provides interest-free loans and is more capital efficient than other lending systems, meaning less collateral is required on Liquity. Currently, Liquidity only supports ETH as collateral. The loan process is as follows:
Before borrowing money from the Liquidity protocol, users must first open a vault (Trove) and deposit a certain amount of collateral (ETH) into it before they can withdraw a certain amount of LUSD. The treasury (Trove) records users’ mortgaged assets (ETH) and debt denominated in LUSD, and is the place where users obtain and maintain loans. Each vault is connected to an Ethereum address, and each address can only have one vault. Users can change the amount of each account by adding collateral or paying off debt.
Whenever a user withdraws LUSD from Trove, the Liquidity protocol deducts a one-time borrowing fee from the amount withdrawn and adds it to the user’s debt. This fee is algorithmically adjusted based on the most recent redemption time. If more redemptions occur in the near future (which means LUSD may trade below $1), borrowing fees will increase. At the same time, when users borrow money, Liquity will also charge a liquidation reserve of 200LUSD. Once the vault is liquidated, this fund will be used to compensate the gas fee of the Ethereum transaction sender; conversely, the funds will be returned in full after the user repays the debt. . In addition, as a borrower, you need to pay a borrowing fee (borrowing fee = amount of liquidity withdrawn * base rate, the base rate fluctuates between 0.5% and 5%), which will be added to Trove’s debt. Loans issued by the Liquity protocol have no repayment schedule, but require a guaranteed collateral ratio of at least 110% to keep the vault running and repay the debt at any time.
Liquity is more suitable for long-term borrowing users. It does not need to bear the risks caused by interest fluctuations in the borrowing market, and interest will not increase as the borrowing period increases, making it more conducive to managing account risks.
4. The difference between the lending models of Liquity and Maker
Market prospects and challenges
In 2022, the crypto industry was in a deep bear. The situation throughout the year was turbulent. Many exchanges experienced frequent thunderstorms, and the entire market was hit hard. At the beginning of 2023, regulation approached stablecoins, and BUSD was forced to stop selling. USDC was affected by the Silicon Valley Bank incident and once detached its anchor to $0.87. Under this severe situation, although the number of users and transaction volume of Liquidity have been affected, it has generally maintained normal development. So far, the operating situation has returned to close to the situation before the Luna thunderstorm in the first half of 2022.
Liquity's decentralized lending model provides higher capital efficiency and interest-free loans, which is attractive to long-term borrowing users. However, market uncertainty and regulatory risks remain major challenges. As the stablecoin market develops, Liquidity needs to continue to innovate and adapt to market changes to remain competitive.
To summarize: As a decentralized lending protocol, Liquidity has demonstrated certain competitive advantages in the cryptocurrency market through its unique token economic model and business model. However, market risks and regulatory challenges remain important issues that need to be faced in its future development.