Liquity (LQTY)

Liquity is an algorithmic governance, low collateralization, and interest-free lending protocol with many similarities to the Maker system. 

Basics

• Based in: Zug, Switzerland
• Started in: early 2020
• Testnet release: is on Kovan testnet (27-12-2020).
• Mainnet release: will launch in April 5th 2021 (did so).

History

• Started out with LQTY being the stablecoin and having GT (growth tokens), this was changed into LUSD being the stablecoin and LQTY becoming the staking asset.

Audits & Exploits

• Bug bounty program can be found here, with up to $250.000 (11-3-2022), it went up from the $50k it was before.
• Scored 97% on DeFi Safety (11-3-2022). With the comment:

"This is the first protocol to actually increase its score since we last reviewed them, which we are pleased to report. Liquity takes the crown as the highest scoring 0.8 protocol we've reviewed yet. This is empirical proof that Liquity is the titan (for today) of process quality.

Liquity's GitHub readme.md provides a strong basis for what perfect documentation may looks like and their careful segregation of high and low level information from their Gitbook and repository shows these developers really care about helping their users understand how their protocol operates. It serves as a model for what documentation should be.

Their fantastic testing documentation alongside really strong security practices would be polished to perfection by formal verification testing. It's truly impressive how well Liquity has handled its development. Be it ensuring the protocol can't be taken down via multiple decentralized frontends or making sure that users understand how contracts operate, Liquity cements its legend as a leviathan of process quality."

• Previously got a score of 84% (16-6-2021): "Trails of Bits did a Liquity Proxy Contracts Report on March 5th 2021. Trails of bits delivered their Liquity Protocol and Stability Pool Final Report on March 25th 2021. Coinspect did a Liquity audit on March 30th 2021..Trails of Bits did a Liquity security assessment on January 13th 2021. Liquity was launched April 5th 2021."

With the comment:

"This team has clearly put good effort into their transparency, with high marks all across the board in every category. Good job guys."

Bugs/ Exploits

• From a commissioned Messari report (2-2023):

"Following the Ethereum Merge in September, the ETHW fork contained a clone state of Ethereum with Liquity. As The Merge approached, the Liquity team made it clear that the only version of the protocol they would support would be on mainnet. Additionally, Chainlink, Liquity’s primary oracle, also declined to support the ETHW forked instance. As a result, when Liquity was cloned on ETHW the protocol’s fallback logic kicked in and Liquity began to use Tellor as its price oracle. Due to an incorrect implementation of this oracle by the Liquity team, someone on ETHW was able to stake TRB, report a fake ETHW price and mint trillions in LUSD.

Fortunately, the exploit did not occur on mainnet as Liquity was never required to fallback on the Tellor price feed. Liquity was extremely fortunate that the ETHW fork brought this issue to light. Since then, Liquity has made the proper fix to correctly implement the Tellor price feed."

Governance

Admin Keys

• From DeFi Safety (16-6-2021):

"Admin controls can be found here. All contracts are described as immutable. All contracts are automated and immutable upon launch, but no evidence of Pause Control or similar function."

• From their docs (9-7-2021):

"Liquity contracts have no admin keys and will be accessible via multiple interfaces hosted by different Frontend Operators, making it censorship resistant. Liquity has no admin key, and nobody can alter the rules of the system in any way. The smart contract code is completely immutable."

DAO

• LQTY is not a governance token, as there is no Liquity governance.

Token

Launch

• From EthHub (30-3-2021):

"Liquity will launch in April 5th 2021 with LQTY rewards available at launch. The app will be fully functional at launch minus redemptions."

Token allocation

• From their blog (25-3-2021):

"100,000,000 LQTY tokens will be minted at genesis and will be allocated as follows:

1. 35.3% to the Liquity Community. 32,000,000 LQTY will be allocated to the LQTY rewards pool. These tokens are earned through Stability Pool deposits and will be rewarded by the protocol to frontends and Stability Providers. 1,333,333 LQTY will be allocated to LPs of the LUSD:ETH Uniswap pool. These tokens are earned by staking LUSD:ETH Uniswap LP tokens and will be distributed by the protocol over the course of 6 weeks. 2,000,000 LQTY will be allocated in the form of a Community Reserve. These tokens are earmarked from the Liquity AG endowment and will be used to fund grants, hackathons, events, and other community-focused efforts.
2. 23.7% to Team and Advisors. 23,664,633 LQTY have been allocated to current (and future) Liquity AG employees and advisors. All LQTY in this category are under a 1 year lockup and are 1/4 vested after 1 year of engagement, then 1/36 every month after.
3. 33.9% to Investors. 33,902,679 LQTY have been allocated to Liquity’s early investors who supported our vision and provided the runway necessary for us to succeed long term. All LQTY in this category are under a 1 year lockup.
4. 6.1% to Liquity AG Endowment. 6,063,988 LQTY have been allocated to Liquity AG for use by the company. These tokens are subject to a 1 year lockup.
5. 1% to Service Providers. 1,035,367 LQTY have been allocated to service providers who helped Liquity in various ways before launch. These tokens are subject to a 1 year lockup."

• From their docs (4-2021):

"LQTY is earned in three ways:

1. Depositing LUSD into the Stability Pool.
2. Facilitating Stability Pool deposits through a frontend.
3. Providing liquidity to the LUSD:ETH Uniswap pool.

LQTY's community issuance (outside of LP incentives and the Community Reserve) follows a yearly halving schedule."

• From the website (9-7-2021):

"Frontend Operators provide a web interface to the end-user enabling them to interact with the Liquity protocol. For that service, they will be rewarded with a share of the LQTY tokens their users generate.‌ How much each party gets is determined by the kickback rate which is set by the Frontend Operator and can range between 0% and 100%.‌"

Utility

• LUSD is the protocol’s native stablecoin which is pegged to the US Dollar. From the website (9-7-2021):

"There are basically two different ways to generate revenue using Liquity:

1. Deposit LUSD to the Stability Pool and earn liquidation gains and LQTY rewards

2. Stake LQTY and earn the revenue from issuance fees (in LUSD) and redemption fees (in ETH)"

• From 0xWangarian (10-5-2021):

"All $LQTY holders are rewarded with 25% of all the $FLTY tokens over the course of 2 years."

• From the website (9-7-2021):

"The system captures the revenue from the borrowing and redemption fees and pays it out on a pro rata basis to the stakers of the LQTY token. The tokens can be staked and unstaked any time with no minimum lockup period."

These staked tokens are not the same tokens that fund the Stability Fund. This gets funded by depositing LUSD and getting LQTY and kickbacks from frontends.

• From a commissioned Messari report (2-2023):

"Chicken Bond depositors funds are routed through B.Protocol. The strategy here is to sell LQTY and ETH generated for more LUSD. It will be important to monitor the price of LQTY as Chicken Bonds continue to grow to see if there is a strong correlation between the price of LQTY and TVL of Chicken Bonds.

The two main use cases of LUSD continue to be support of the protocol via the stability pool or holding LUSD in a [wallet]."

Token Details

• From the announcement (4-5-2020):

"Like existing stablecoin systems, Liquity allows users to mint tokens in a self-service manner; however, other systems have complex governance mechanisms which are required to maintain the USD-peg by updating fees or interest rates. Liquity replaces the need for interests and human intervention by algorithmically adjusted redemption and loan issuance fees to support its currency. Both fees are initially set to 0% and increase with the redeemed amounts, while tending to return to zero in times of low redemption activity.

A borrower first locks up Ether in a smart contract and creates an individual liquidity position called a “trove”. Each trove is required to have a minimum collateralization ratio of only 110%, which is unparalleled in DeFi space. The borrower can then mint LQTY tokens, which are calculated as a debt against collateral. For Ether that is worth $100, the borrower can obtain up to 90.09 LQTY. When the borrower is ready to retrieve their collateral, they simply return the LQTY to the contract to repay their loan and free up their collateral."

Coin Distribution

• When we look at current (9-7-2021) holder numbers, there are 4839 holders. The token holder supply distribution is not a clear cut case on Etherscan, since the top 30 are framed as contracts (with the top three having 38, 27 and 9.4% respectively). When we look at LUSD, it has fewer holders (you would think otherwise), namely 2491. The founder came out saying (1-7-2021) around 90% of LUSD is in the stability fund, also saying a couple whales were mostly behind this.

Tech

• Whitepaper can be found here.
• Code can be viewed here. From DeFi Safety (11-3-2022):

"At 2830 commits and 52 branches, this protocol has some of the most well-moisturised development history we've ever seen."

• Built on: Ethereum

How it works

• From their website (9-7-2021):

"The core team building the protocol will not operate a frontend. Liquity is instead accessed by third-party frontend applications and integration services."

• From the announcement (4-5-2020):

"The Stability Pool is Liquity’s primary mechanism to instantly absorb troves with insufficient collateral. It is maintained by users who deposit LQTY in exchange for the future collateral of liquidated troves. When a trove falls below the minimum collateral ratio of 110%, the system liquidates its debt by burning an identical amount of LQTY tokens held in a Stability Pool. This stands in contrast to existing platforms which auction off collateral in a lengthy process, facing difficult market situations and further price drops.

In return for the LQTY that is burned from the Stability Pool, all the collateral of each liquidated trove is sent to the Stability Pool and distributed proportionally among all depositors. This mechanism is expected to yield a net gain to the depositors: the collateral is almost always worth more (in USD) than the LQTY tokens that are burned to offset the debt. This holds because the liquidation is triggered below a collateral ratio of 110%, but with a very high probability above 100%.

If the amount of LQTY in the Stability Pool goes to zero, the system moves to the second phase of the liquidation process in which it redistributes the remaining defaulted troves to all existing troves, in proportion to their collateral ratio. This means that troves which are heavily collateralized will receive more debt and collateral from liquidated positions than those with low collateralization, ensuring that the system doesn’t create cascading liquidations. By redistributing the riskiest positions to the safest and adjusting the incentive structure in times of low collateralization, Liquity quickly stabilizes itself via direct feedback loops.

As a final backstop, the system provides a Recovery mode. Recovery mode is triggered if total system collateralization falls below the Critical Collateral Ratio, set to 150%. When this happens, the riskiest troves are liquidated (even if they are over 110% collateralized) until the Critical Collateral Ratio threshold is met. The Recovery mode acts a self-negating deterrent: the possibility of it actually guides the system away from ever reaching it. These measures ensure that the system’s overall collateralization ratio stays at a healthy level.

When redeemed, the system uses the received LQTY to repay the riskiest trove(s) with the lowest collateral ratios and transfers the respective amount of ETH to the redeemer. While redemption causes no net loss to the affected borrowers (who lose the same amount of debt as they lose collateral), it has a positive effect on the overall collateralization of the system. This also creates an incentive to make sure that troves are sufficiently collateralized relative to all other troves, improving overall system security."

• From DeFi Lama (4-6-2021):

"Allows lenders to provide Ether as collateral with 0% interest. Under normal circumstances they operate under a 110% collateralization ratio, a very low ratio for the industry, and a ratio which potentially allows up to 11x leverage.

Users who lend Ether to receive LUSD open what they call a trove. All troves require a refundable deposit of $200 LUSD be included to cover gas costs. Users can collateralize as they like, provided their collateral ratio exceeds 110%.

That is, if you open a trove with a deposit for $30,000 worth of ETH, a loan of $10,000 would be 300% collateralized and relatively safer against a price drop. A loan of $27,000 would be closer to the 110% minimum and a relatively small price drop in Ethereum would subject such a trove to liquidation."

Fees

• From the docs (4-2021):

"There is a one-off fee whenever LUSD is borrowed, and when LUSD is redeemed:

1. For borrowers, there is a borrowing fee on loans as a percentage of the drawn amount (in LUSD).
2. For redeemers, there is a redemption fee on the amount paid to users by the system (in ETH) when exchanging LUSD for ETH. Note that redemption is separate from repaying your loan as a borrower, which is free of charge.

Both fees depend on the redemption volumes, i.e. they increase upon every redemption in function of the redeemed amount, and decay over time as long as no redemptions take place. The intent is to throttle large redemptions with higher fees, and to throttle borrowing directly after large redemption volumes. The fee decay over time ensures that the fee for both borrowers and redeemers will “cool down”, while redemptions volumes are low. The fees cannot become smaller than 0.5% (except in Recovery Mode), which protects the redemption facility from being misused by arbitrageurs front-running the price feed. The borrowing fee is capped at 5%, keeping the system (somewhat) attractive for borrowers even in phases where the monetary is contracting due to redemptions."

Upgrades

• Is planning V2, which will involve hedging strategies (28-7-2023).

Staking

• From the website (9-7-2021):

"The system captures the revenue from the borrowing and redemption fees and pays it out on a pro rata basis to the stakers of the LQTY token. The tokens can be staked and unstaked any time with no minimum lockup period."

• From DeFi Rate (11-5-2020):

"The protocol intends to distribute GT to two user groups: front-ends and stability pool depositors. Front-ends are applications/products that interact with the protocol. Front-end applications retain the ability to determine the kickback rate to its users. Therefore,  products that interact with the Liquity are ultimately competing with the kickback rates of other applications."

• From the announcement (4-5-2020):

"High-collateral borrowers and Stability Pool depositors provide stability to the system. They are rewarded for their roles by receiving collateral surplus gains from troves that are liquidated. In addition, the depositors will receive Growth Tokens (GT) as a kickback from front ends. GT can be staked in order to earn a proportion of the protocol revenue stemming from issuance and redemption fees."

Validator Stats

• From a commissioned Messari report (2-2023):

"Liquity generated $757,000 in revenue in Q4 for an increase of 36.4% QoQ. Both the stability pool and LQTY staking saw a continuation of their declining APRs, with decreases of 3.9% and 0.8% QoQ, respectively."

• From Our Network (18-9-2021):

"Stability Pool pays out LQTY, which can then be staked to earn Liquity's protocol revenue generated from fees. Liquity has distributed $4.3M in protocol revenue to LQTY stakers since May and $14.6M has been distributed since our launch in April of this year."

Oracle Method

• Uses Chainlink as their oracle. From Chris Blec (5-12-2022):

"Chainlink’s price feeds are controlled by a 4-of-9 multisig and are capable of being manipulated. The potential is there for Chainlink to become corrupted and force Liquity to shift to Tellor for more accurate prices. If Tellor was to simultaneously become corrupted, Liquity would behave very unpredictably and funds would be at risk."

• From DeFi Safety (11-3-2022):

"The protocol's oracle source is sufficiently documented at this location. The contracts dependent are identified. There is relevant software function documentation. This protocol documents substantial and impressive front running mitigation techniques at this location. This protocol's readme.md is beautiful and other protocols should view it as an example of great process quality they would do well to emulate. This protocol documents flashloan countermeasures at this location. It incentivises potential exploiters to focus on flashloan attacks in their bug bounty offering."

• From the announcement (4-5-2020):

"The value of LQTY in the system is fixed at $1. This means that at any time, a user can redeem 1 LQTY for its corresponding value in ETH. Whenever 1 LQTY trades below $1, holders and arbitrageurs are incentivized to redeem 1 LQTY for $1 worth of ETH. This helps to stabilize the price of LQTY through direct arbitrage rather than by relying on indirect monetary interventions like variable interest rates set by governance."

Their Other Projects

Chicken Bonds

• A protocol owned liquidity mechanism. Launched on the 4th of October. From The Defiant (2-11-2022):

"A new product from Liquity that offers users an enhanced yield over a period of time in exchange for bonding the LUSD stablecoin.

In Chicken Bonds’ simplest form, users deposit LUSD which accrues a balance of boosted LUSD (bLUSD). bLUSD is a derivative token which accrues an amplified yield beyond what is typically available to holders of vanilla LUSD.

The bonding process happens over time — users can decide to “chicken out” at any time and get their LUSD principal back, or “chicken in” and claim their accrued bLUSD — this choice is part of a complex decision based on multiple factors including how deep into the bonding process a user is and what he or she thinks the future value of bLUSD will be.

So far, of the 203 completed Chicken Bonds, 123 have chickened in, and 80 have chickened out, according to a Dune Analytics dashboard. Additionally, when users Chicken In, Liquity permanently acquires a portion of the bonded LUSD. So far, Liquity has acquired 488,000 LUSD through Chicken Bonds.

DeBank lists Sifu as having 16.4% of the total deposits in Chicken Bonds as of Nov. 1. "

Roadmap

• Can be found [Insert link here].

Usage

• From a commissioned Messari report (2-2023):

"LUSD supply increased for the second consecutive quarter by 4.1% to reach a total supply of $179 million, down from its peak of $867 million a year ago.

Users opening troves (troves are similar in concept to vaults or CDPs from other platforms) on Liquity continued to increase, rising from a low of 479 troves in June to 922 troves at the end of Q4. Despite this, the LUSD supply only increased by $22.2 million in the same period for an increase of 14.1%. QoQ, the number of troves increased 41.4% and the LUSD supply increased 5.9%. Notably, although Chicken Bonds reached over $70 million in deposits since inception, the LUSD supply only increased by $10 million. This may indicate that most of the investment in Chicken Bonds came from users already within the Liquity ecosystem. However, the increasing number of troves argues otherwise.

The stability pool continues to grow from its low of $82 million in Q2 to over $134 million by the end of Q4. The stability pool’s 17% QoQ growth can be attributed to the release of Chicken Bonds and the redirecting of a portion of funds from the Pending, Reserve, and Permanent buckets toward the stability pool.

Efforts to integrate LUSD have undoubtedly been made with the integration of AAVE and deployment on L2s such as Optimism and Arbitrum. Currently, LUSD is available on six different decentralized exchanges (DEXs) and accepted as collateral on six different protocols. Protocols such as Solidlyeth and Silo Finance both integrated LUSD in November, improving the utility of LUSD within the DeFi ecosystem. In December, Liquity announced an integration with Camelot DEX to bring LUSD to Arbitrum, the fourth largest blockchain by TVL. In the future, Liquity plans to integrate with Aztec Network, a privacy friendly and gas efficient zk-rollup. "

• From Our Network (12-2-2022):

"Numerous projects have adopted LUSD due to its decentralization, but the most notable are OlympusDAO, Fei Protocol, and Synthetix. Whether it's for the treasury, as a form of collateral, or as a source of yield, these projects have accumulated and utilized a combined 230m LUSD."

• Around 90% of the total LUSD supply is held in the Stability Pool. However, the stats are heavily skewed by some big whales that have deposited most or all of their borrowed LUSD to the Stability Pool (9-7-2021).
• Reached a TVL of $2.7B by 9-7-2021.
• From Our Network (22-5-2021):

"Liquity does not charge interest on loans, but instead charges a one-time borrow fee up front ranging from 0.5% to 5% (most often ~0.5%). The borrow fees combined with redemption fees are distributed directly to LQTY stakers and have generated >$10.3M in protocol revenue since launch."

• From Dose of DeFi (20-4-2021):

"Liquity reaches $1bn TVL in 10 days."

Pros and Cons

Pros

• Instant liquidation
• No interest tax.

Cons

• Had investment from Alameda Research/FTX. This could mean fall-out risk. Turned out (8-12-2022) to have sold $250k worth of tokens to Alameda.
• Uses Chainlink as their oracle. From Chris Blec (5-12-2022):

"Chainlink’s price feeds are controlled by a 4-of-9 multisig and are capable of being manipulated. The potential is there for Chainlink to become corrupted and force Liquity to shift to Tellor for more accurate prices. If Tellor was to simultaneously become corrupted, Liquity would behave very unpredictably and funds would be at risk."

Competition

• Fluity is a similar friendly fork of Liquity on BSC. Liquity currently has 'no oversight' over Fluity (10-5-2021).
• MakerDAO. From DeFi Rate (11-5-2020):

"There are a few major differences with Liquity. For one, there’s no stability fee or interest rate that accrues over time. Instead, depositors incur a one-time issuance fee when LQTY is minted and a one-time redemption fee when LQTY is redeemed for the underlying collateral – in this case Ether. In addition, Liquity features a significantly lower collateralization ratio of 110%  compared to Maker’s 150%, effectively allowing depositors to draw more liquidity from the protocol with the same amount of ETH.

Second, one of the biggest drawbacks with the Maker system is the reliance on Keeper’s to liquidate under-collateralized vaults. Running a Maker Keeper bot requires some in-depth technical knowledge, creating some barriers to entry for participating in a critical piece of the system. This is ultimately what led to a significant amount of Vault owners being liquidated for 100% of their collateral during Black Thursday as millions in ETH was liquidated for 0 DAI.

To combat this, Liquity instead relies on stability pools to liquidate undercollateralized CDPs. These stability pools comprise of LQTY tokens that any user can deposit. If a CDP falls below 110% collateralization ratio, the position is liquidated and a corresponding amount of LQTY is burned. In return for depositing LQTY into the stability pool, users are given the ETH collateral distributed pro-rata to depositors at a discount (generally between 100 – 110% of the position’s value)."

Team, Funding, Partnerships, etc.

Team

• Full team can be found here (9-7-2021).
• Liquity AG is the developer of the code.
• Robert Lauko; founder & CEO, previously researcher at DFINITY.

Funding

• Turned out (8-12-2022) to have sold $250k worth of tokens to Alameda.
• From Our Network (12-2-2022):

"Liquity has excelled in generating yield. Since launch, LUSD holders in the Stability Pool have earned ~67.5k ETH from liquidations at a ~9% discount, while LQTY stakers have earned ~$27m in revenue from protocol fees — an 86% increase from total revenue in September."

• Matter Labs; according to Matter Labs, the founders and leadership of a bunch of DeFi projects, among which this project, joined in on the $50m raise for zkSync (8-11-2021).

• From Cointelegraph (29-3-2021):

"Liquity Protocol has secured $6 million in Series A funding. The funding round was led by Pantera Capital, a crypto-focused venture capital firm, with additional contributions from Nima Capital, Alameda Research, Greenfield.one and IOSG, the company announced Monday. Angel investors including Meltem Demirors, David Hoffman and Calvin Liu also contributed to the raise."

• From EthHub #133 (28-9-2020):

"Raised $2.4M. The round was led by Polychain Capital, with follow on investments from a_capital, Lemniscap, 1kx, DFINITY Ecosystem Fund, Robot Ventures (Robert Leshner), and Alex Pack."

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