What Is Liquity? And Why is it Gaining Momentum — Ratings & Analysis

TokenInsight
9 min readMar 9, 2023

Since $UST crash, some CeFi giants exit the crypto market due to centralization problems. The view that “the future is decentralized” has gradually deepened into the hearts of investors. Liquity, as one of the most decentralized stablecoins, has gained market attention. In this article, we will use TokenInsight’s rating model to take a look at Liquity and provide an in-depth analysis of its current development status.

What is Liquity?

Liquity is a lending platform, as well as a stablecoin issuance platform. The protocol was launched on Ethereum on April 5th, 2021, and currently operates exclusively on the Ethereum network. Liquity has two native assets: a USD-pegged stablecoin called $LUSD, and a utility & governance token called $LQTY.

On Liquity, users can deposit $ETH as collateral to borrow $LUSD, with a minimum collateral ratio of 110%. It means borrowing $100 worth of $LUSD requires at least $110 worth of $ETH as collateral. Compared to other over-collateralized stablecoins, Liquity has several notable features:

  • It only supports $ETH as collateral and operates exclusively on the Ethereum network.
  • Although Liquity’s borrowing interest rate is floating, its borrowing fee is settled upfront and does not accumulate over time, which is more cost-efficient for long-term borrowers.
  • Liquity is completely supported by smart contracts and operates independently. It is immutable once deployed, and even the development team does not has the management permission.

What Is TokenInsight’s Rating for Liquity

TokenInsight has rated Liquity’s current performance with a BB and a positive outlook. The competitors of Liquity include Maker (A), Frax Share (BBB), etc.

The breakdown of the rating results is scored as follows.

  • Underlying Technology & Security 68.85%
  • Token Economics 60.8%
  • Roadmap & Progress 56.67%
  • Ecosystem Development 51.55%
  • Token Performance 49.73%
  • Team, Partners & Investors 66.73%

Underlying Technology & Security (68.85%)

Liquity has adopted a multi-layered risk management mechanism to manage risks. Firstly, Liquity uses the total collateral ratio of the protocol to measure the overall risk level. If the collateral ratio of the entire protocol is greater than 150%, it is considered low risk, and if it is below 150%, it is considered high risk.

  • When the protocol is in a low-risk state, users only need to maintain a collateral ratio of greater than 110% to avoid liquidation.
  • However, when the protocol is in a high-risk state, there is a risk of liquidation for positions with a collateral ratio below 150%. Meanwhile, users can only open a new position with a collateral ratio of greater than 150% until the protocol returns to a low-risk state.

Secondly, Liquity’s liquidation mechanism consists of two layers.

  • The first layer is the Stability Pool, where users deposit $LUSD as liquidation funds. If liquidation occurs, the protocol uses the $LUSD in the pool to repay the loan, and depositors receive the collateral and liquidation rewards as compensation. Depositors can withdraw their funds at any time, except when there are liquidatable positions in the market.
  • When the Stability Pool is drained, a debt redistribution mechanism is triggered. The protocol sorts the positions by risk from high to low and then allocates the loans and collateral of high-risk positions to low-risk positions one by one. (Check out more in the example below.) Although the overall risk of the protocol remains unchanged, the overall ability of positions to meet their obligations increases. Except for the account that was divided, other users and the protocol itself will be benefit.

Source: Liquity Whitepaper

Furthermore, Liquity is heavily reliant on smart contracts to manage its operations, and the development team has no control over the contracts. With a goal to increase decentralization and minimize human intervention, the protocol doesn’t host its own user interface, instead, relying on third-party platforms. However, the current situation is less than ideal because each platform has different features and designs, leading to a less-than-optimal user experience.

Moreover, since Liquity is managed by smart contracts, the code’s security is of utmost importance. The protocol’s contract code has been audited by two institutions (Trail of Bits and Coinspect) in 2021, covering a wide range of the source code. However, the reports uncovered some risks found that had not been addressed. As of writing, there haven’t been any security incidents involving Liquity’s contracts.

Token Economics (60.8%)

Liquity has two tokens: $LUSD and $LQTY. $LUSD is a stablecoin that is backed by overcollateralized $ETH, and users can deposit it into the Stability Pool to earn liquidation fees and $LQTY rewards. In addition, $LUSD has a stability mechanism called “Redemption.” Redemption allows any holder of $LUSD (regardless of whether they have an open position) to redeem $ETH at a rate of 1 $LUSD for 1 USD worth of $ETH. The riskiest position will be redeemed first. Since $LUSD is inherently equal to $1, its price will eventually converge to $1, and borrowers would not suffer any actual loss. However, the base interest rate of the protocol increases with each redemption, resulting in higher borrowing costs and redemption fees. This helps to avoid large-scale redemptions, meanwhile, reduce the circulation of $LUSD to drop its price. However, $LUSD is more volatile than other stablecoins.

$LQTY was issued when the platform was launched in April 2021. The original vision of Liquity was a governance-free platform completely controlled by smart contracts. $LQTY was created without any governance rights, and its main use was to allow users to earn a share of the protocol’s revenue, which includes borrowing and redemption fees. However, in January 2023, Liquity introduced a new community governance program called LiquiFrens, which gives $LQTY holders voting rights. The program is currently being trialed for three months.

The initial distribution of $LQTY had a total supply of 100,000,000 tokens, with 56.6% allocated to investors, the team, and advisors. The team and advisors’ tokens are gradually unlocked over 3.25 years, while investor tokens are locked for one year. However, there are no further details provided about the investor tokens’ detailed lockup period.

$LQTY Distribution Plan, Source: Liquity’s details page on TokenInsight

Roadmap & Progress (56.67%)

Liquity doesn’t have a specific roadmap for its development, but the team releases progress reports in a quarterly basis. According to the 2022Q4 report, the team intends to further enhance the liquidity of $LUSD on Arbitrum. Moreover, the monthly proposals of the protocol will also contribute to the project development. Details on these proposals can be found on the Liquity Snapshot page.

Currently, the total $LUSD supply is around 230 million, with a TVL of approximately 600 million, and the platform’s total collateral rate is 259.9% (as of March 3rd, 2023, source: Dune and DefiLlama). Although the overall supply of $LUSD has decreased over the past year, the amount of positions (Troves) has been steadily increasing since June 2022 and is almost back to early 2021 levels. However, most Troves are small positions ranging from 10–100 $ETH, and only 7 have 10k-100k $ETH.

As for $LQTY, the current circulating supply is 91 million, and 53.43 million $LQTY is staked, which accounts for approximately 58.72%. The amount of staked $LQTY has been steadily increasing since April 2022, but there has been a slight decrease of 99,011.84 $LQTY in the staked amount due to a recent price increase as of today compared to the 27th. The annual percentage yield (APR) for $LUSD in the Stabilization Pool is 5.74%, while for $LQTY staking, it is 0.76%.

Source: Dune Analytics@dani

Ecosystem Development (51.55%)

As of March 2023, Liquity has listed 20 frontends on its official website (64 according to Dune), of which Liquity.App has the highest number of active users.

Source: Dune Analytics@dani

As disclosed in Liquity’s report, the project is now mainly focused on expanding the $LUSD ecosystem through Chicken Bond, Layer2, and Lending.

  • Chicken Bond is a yield protocol built on the top of Liquity, which provide $LUSD depositors with higher yield than the Stability Pool. Users’ yield is mainly generated from the auto-compouned revenue and partially from LP revenue of Curve’s $LUSD Pool. Currently, Chicken Bond’s TVL is $20.64m, of which $6.38m comes from $LUSD deposited by users.
  • Layer 2: Liquity is contributed to increase $LUSD’s liquidity on Layer2 networks, including Optimism and Arbitrum.
  • Lending: Liquity has integrated other lending protocols such as Aave and Euler to enable users to lend/borrow $LUSD.

Source: Dune Analytics@dani, Dune Analytics@SebVentures

As shown in the figure above, except for the Stability Pool, most of $LUSD is distributed on Curve, Uniswap, Layer2 and other lending protocols. Generally, the utilization of $LUSD is not diversified as $DAI. According to statistics from DefiLlama, the current total market value of stablecoins on OP is $656.9m, with $USDC accounting for 54.97% and $LUSD accounting for only 0.89%.

Token Performance (49.73%)

The following chart displays the price fluctuations of $LQTY over the last 90 days. The data indicates that the price of $LQTY gains this February in the $BUSD reserve storm and the growing popularity of decentralized stablecoins.. From February 1st to 27th, the price of $LQTY rose from $0.711 to $1.278. On February 28th, the coin was listed on Binance, causing its value to double once again. Currently the price remains around $2.2.

Source: Liquity’s details page on TokenInsight

Team, Partners & Investors (66.73%)

Liquity was founded by Robert Lauko and Rick Pardoe, and is currently led by CEO Michael Svoboda. Both founders have more than 5 years of experience in the blockchain industry.

According to statistics, Liquity completed two rounds of financing totaling $8.4 million between 2020 and 2021. Its major investors include Polychain Capital, Pantera Capital, Alameda Research, IOSG Ventures, 1kx, and Tomahawk.VC.

Closing Thoughts

Liquity’s protocol is operated and supported by contracts, making it a highly decentralized platform. However, there is room for improvement in terms of user experience, as there is no standardized frontend.

In terms of mechanics, Liquity only supports one type of collateral and charges a one-time borrowing fee. This might help it stands out from other overcollateralized stablecoins. However, the price stability of $LUSD is not as optimal as that of other stablecoins, although this may provide greater arbitrage opportunities.

Currently, compared to other stablecoins, the ecosystem of $LUSD is less diversified and the utility of $LQTY is relatively limited. But notably, the stake rates of both $LUSD and $LQTY remains high (more than 50%), which might be a positive indication.

Overall, although Liquity has not suffered nay security issues related to its smart contracts and the platform has been operating stably, the ecosystem is currently weak and token use cases are not yet diverse enough. However, considering the increasing popularity of decentralized stablecoins, Liquity might has more development opportunities in the future.

Read the original article at: https://tokeninsight.com/en/research/analysts-pick/what-is-liquity-and-why-is-it-gaining-momentum-ratings-analysis

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TokenInsight

Leading Data&Tech-driven Blockchain Financial Institution.