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For years, one of the biggest issues with crypto loans has been the high borrowing and issuance fees charged by platforms. Many of these services charge predatory interest rates and are designed to benefit the development team at the expense of users. However, a new system called Liquity has arrived on the scene, and it has the potential to revolutionize the entire crypto-lending market.
Key Takeaways:
LUSD is a USD-pegged stablecoin that serves as the primary network token for the Liquity protocol. When users place their Ethereum into their account or Trove, as it’s known, they receive a loan in the form of LUSD. The token can also be redeemed in exchange for Ethereum, as explained in the Redemptions section below.
LQTY is the secondary network token of the Liquity borrowing system, and is given out as a reward to stability providers. These include the frontends who complete the transactions, contributors to the stability pool, and liquidity providers. These are the only ways to earn LQTY.
It’s important to note that LQTY is not a governance token, as the system is entirely self-governing, algorithm-based and self-sustaining.
Liquity was founded in late 2019 by Robert Lauko, who currently serves as head of research, and Rick Pardoe, the project's lead engineer. Its development team also includes CEO Michael Svoboda, who has previously served as CEO of multiple blockchain companies. Liquity officially went live in 2021.
The inspiration for the project was the desire to create a borrowing platform that’s more efficient in terms of capital, and also easier to use. Other borrowing platforms tend to use stablecoins like USDC, which are centralized. The project's founders wanted to offer a decentralized, USD-pegged stablecoin to borrowers, which led to the creation of LUSD.
Liquity's main goals include providing interest-free, low-cost smart contracts in the form of loans to crypto users while supplying LQTY incentives to those who make the system work. The protocol also aims to provide a future-proof system by eliminating governance and allowing the system to continue working as intended.
Crypto users in need of a loan use one of several third-party frontends to access the system. After linking a wallet, they deposit ETH into a Trove, against which they can then borrow. There’s a minimum debt of 2,000 LUSD, which is designed to prevent spammers from creating a large number of small Troves and causing gas prices to rise to unsustainable levels.
Additionally, from the initial deposit, 200 LUSD is reserved by the protocol to cover gas prices in the event that the account is closed before the debt is repaid. Accordingly, borrowers aren’t required to pay back those 200 tokens as part of the loan. The only real requirement is that the minimum collateral ratio is observed, and that the ratio stays between 110% and 150%, which we'll explain in more detail below.
Users can borrow by opening a Trove, which is the term used for a borrowing pool. After posting ETH as the underlying collateral, loan recipients receive an interest-free loan of LUSD, the protocol's native stablecoin. No interest is charged, and users only pay one-time issuance fees that are set by the Liquity algorithm at the base rate plus 0.5%. The current base rate is also 0.5%, although that’s subject to change. However, the total borrowing fee will never exceed 5%.
For example, if a borrower opens a Trove on Liquity and deposits 5 ETH as the underlying collateral, they would then receive 5,000 LUSD as a loan. However, they would also be responsible for the one-time borrowing fee, which we'll assume is at the current 1%. That would come out to 50 LUSD. Finally, the 200 LUSD liquidation reserve would be added on, giving a total debt of 5,250 LUSD. However, as the 200 LUSD is simply a reserve, the borrower would only need to repay 5,050 LUSD.
The Stability Pool, as the name suggests, ensures that the protocol remains stable and can operate at peak efficiency. Its primary use is to cover the debts incurred by liquidated accounts, which is the network term for the closure of a Trove. The necessary amount of LUSD is removed from the pool to cancel out the debt, and then the locked Ethereum is distributed proportionally to the pool's stakers. These are known as "liquidation gains.”
Liquidations only take place under two circumstances: when a Trove falls below the minimum collateral ratio of 110%, or if the system is in Recovery Mode, as explained below. The owner of a liquidated Trove is allowed to keep the LUSD they were loaned, but will still lose money since they won't receive their collateral back (which will always be higher than the price of the loan).
The loan is repaid from funds in the Stability Pool, which eliminates the debt, and the liquidation gains are split among the stability providers. Then, the tokens used to cover the debt from the Stability Pool are burned. Finally, the stability providers receive the liquidation gains to cover the cost of their burned tokens.
One of the more unique features of Liquity is that LUSD token holders can redeem their LUSD stablecoins for Ethereum at face value — i.e., $10 LUSD for $10 worth of ETH. Redemptions can take place at any time and are significantly more common, as you might expect, during times when there’s a beneficial exchange rate. The system does charge redemption fees that vary, but are generally around 1%.
To cover the ETH needed, the Liquity protocol uses the redeemer's LUSD tokens to repay Troves with the lowest collateral ratios, which would be the riskiest accounts. The account holder receives their remaining collateral back, as their debt has been paid, and therefore doesn’t take a net loss on the process.
LUSD is soft-pegged between $1 and $1.10. If it goes above this amount, LUSD token holders can redeem those coins for ETH and thereby lower the price back toward $1. If it dips below, users can again trade LUSD for Ethereum and then sell the redeemed Ether at a profit. This system ensures that the price will always trend toward $1 without having to resort to hard pegging.
Unlike most other blockchain-based systems, there is no official frontend for Liquity. Instead, third parties provide the interfaces that allow users to borrow. This policy is specifically to ensure decentralization, and to allow all potential loan recipients the opportunity to receive loans. One of the core tenets of the system is the elimination of censorship, which can become a problem with other protocols or services.
LQTY rewards are distributed in several ways, the primary recipients being stability and liquidity providers. The more LUSD that they have in the pool, the greater the amount of LQTY they’ll receive. They can then take those LQTY rewards and put them back into the system as a stake, which will provide them a share of the protocol's fees.
In exchange for staking LQTY tokens, users can receive a share of the loan issuance and redemption fees charged by the system. There is no minimum period required and stakers can withdraw their LQTY tokens at any time. Only LQTY can be staked in this way. However, LUSD can be added to the Stability Pool, as mentioned above.
The process is simple, as users only need to add their coins to the Liquity staking contract. They will then receive a share of the fees mentioned above, proportional to their share of the total amount of LQTY staked.
In order to make sure the Liquity protocol works as directed, the system's supply of Ethereum collateral should be above 150% of the total network debt. If it drops below this amount, the system enters Recovery Mode. At this point, all Troves with below 150% collateral can be liquidated or removed from the system. Although the system is designed never to have to be used, its implementation can easily be avoided by users ensuring their collateral ratio is above 150%, since they would be unaffected even in Recovery Mode.
Liquity's major accomplishments to date include revolutionizing the crypto borrowing space by creating an ideal protocol that can never be changed, and which is infinitely self-sustaining.
In the future, Liquity hopes to continue providing low-cost loans to crypto traders. Unlike other protocols, there is no admin key and no governance, meaning the system will never change. The only real goal Liquity has is increased usage, in addition to being able to provide more rewards to its stakers and stability pool providers. Its fully automated smart contract delivery system makes changes or progress both impossible and undesirable.
LQTY serves as the secondary token for the Liquity protocol. It has a maximum supply of 100 million coins and a current circulation of approximately 91.4 million. It reached its all-time high of $146.94 on Apr 5, 2021, shortly after launch, and its all-time low was $0.543990 per coin on Nov 14, 2022.
At launch, 33.9% of available coins were distributed to investors, 33.3% to the community, 23.7% to the team and its advisors, 6.1% to the Liquity AG Endowment, 2% to the Community Reserve and 1% to service providers. Except for those coins distributed to the community, all LQTY tokens issued were subject to a 1-year lockup.
Despite the all-time low reached only four months ago, LQTY quickly recovered and experienced a surge in price, rising nearly 500% in value from $0.54 to its current price of $2.22 as of Mar 22, 2023.
Experts at DigitalCoinPrice predict that LQTY will close 2023 at $5.31 and reach $8.82 by the end of 2025. They also believe that it will attain a value of $25.40 by the end of 2030.
PricePrediction is slightly more bearish in the short term and bullish in the long term, predicting a final 2023 price of $2.91, a 2025 price of $6.04 and a 2030 price of $38.03.
Although there are inherent risks in all investments, LQTY is considered an excellent long-term choice. First, the price increase expected over the next few years would provide an excellent return on investment. Second, the beauty of the Liquity borrowing platform is that it’s ungoverned. A group of users can't change the system to benefit themselves at the expense of others — a rare occurrence in the crypto sector, but always a possibility.
However, the most important factor in LQTY’s price remains whether or not the Liquity platform itself can continue to grow in the coming years. As more users enter the system, the coin will become more valuable and desirable. Based on its current growth rate continuing to expand monthly, it’s safe to assume that this trend will continue, since there can be no major systemic changes that would drive off the existing user base. As always, it’s important to do your own research before jumping on the bandwagon or investing in any cryptocurrency, including LQTY.
In short, the Liquity protocol is designed to ensure borrowers can easily receive crypto loans without having to pay excessive fees. Liquity is ungoverned and immutable, meaning its system will never change. It’s widely considered to be the best fully automated, decentralized borrowing protocol available, as it’s fully decentralized and has an ever-expanding user base that will keep the system running for many years to come.
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