[Company Watch] Liquity, the Challenger of MakerDao

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Coinmonks

6 min readMay 4, 2021

The recent ETH price hike, to a certain extent, is attributable to MakerDao increasing its cap of DAI. It basically means more DAI could be minted via pledging ETH. And, some use the newly minted DAI to purchase ETH. And as we see it now: there’s $380 billion of ETH, but all stablecoins adding together is less than $80 billion.

Therefore, we see more ETH, and BTC of course, as well as other assets, can be collateralised in the defi world. It will ideal that BTC and ETH can be collateralised in the real world for borrowing fiat; but if it’s not happening on a massive scale soon, it will at least be easily collateralised on chain first. When it’s on chain — we wish that there’s a meaningful course for it; but if it’s not happening on a massive scale soon, it will be at least used to buy more ETH or BTC. As it seems, it heralds a volatile market ahead of us.

Taking one step back, MakerDAO’s profits and price have tripled since early this year, and this draws other players. Liquity is one of them.

Liquity’s selling point is interest free, for pledging ETH to borrow LUSD, its version of stablecoin like DAI. MakerDao is charging a fee of 3.5% to 10% now. Liquity also only requires a collateral ratio of 110%, vs MakerDao’s minimum of 130% (corresponds to 10% fee per annum).

How Does Liquity Work?

The basic process of Liquity is similar to MakerDao. If you are a MakerDAO user, this is easy to you. For others, essentially you have to pledge some ETH as collaterals to borrow LUSD; and repay the LUSD to take ETH back as some time later.

There are quite a number of differences between Liquity and MakerDao, and two major ones are:

No Interest by an Up-front Borrowing Fee

Liquity charge a borrowing cost of 0.5% to 5%, depending on the activities in the protocol at the time of borrowing. Take it as that if the protocol is congested with everyone using ETH, borrowing or buying, then the fee will be higher. Otherwise, the fee cools down to a minimum of 0.5%.

No Funds Required from Liquidator, but a Stability Fund

Liquity has a similar liquidation concept compared to MakerDao, when the collateral ratio falls below certain level, liquidation can be triggered by any third party. For individual Trove (which is equivalent of CDP of MakerDao), the collateral ratio is 110%. When the global collateral ratio falls below 150% in recovery mode of Liquity Protocol, liquidation can also be triggered. Callers of the liquidation function do not need to provide capital, but instead a Stability Fund provides the capital for liquidation. Stability Fund is where users deposit LUSD for the liquidation purpose, and shares the liquidation rewards, like KeeperDAO. Most of the liquidation rewards go to the Fund, and callers keep 200 LUSD and 0.5% of the collateral of the liquidated Trove.

Other Innovations of Liquity

Other than the above variations on MakerDAO, Liquity has a Redemption feature, where users holding LUSD, can purchase ETH from other Troves , at the market price. Purchase starts from Troves with the lowest collateral ratio, till that Trove is emptied.

Redemption will cause the trove selling ETH to increase its collateral ratio as a result. So if redemptions happen, the overall collateral ratio of the protocol will increase, improving its stability.

However, there’s a fee similar to borrowing cost for redemption with a minimum of 0.5%, higher than the cost of buying ETH in swaps. Therefore, so far the redemption volume is small, less than 0.1 ETH a day, compared to $70,000 ~ $90,000 borrowing fees a day.

New Risks Pertinent to Liquity

Liquity will have the same set of risks as MakerDAO, e.g. liquidation or price fluctuation, etc. depending on your role in the system.

In addition to those, Liquity does not have a reserve to back up in extreme situations, nor does it have a Global Liquidation mechanism. Instead, it has a mechanism of re-distribution. This happens when there’s no funds in the Stability Fund, then liquidation will trigger a re-allocation of the debt and collateral of a liquidated Trove to other Troves, pro rata to their collaterals.

Whilst this is an innovative design, the potential risk is that it might trigger a chain reaction of Trove liquidations, if ETH price drops abruptly for a huge percent.

Protocol Status Now

Info can be obtain from Dune Analytics Page. There are a total of 1.1m ETH being pledged in Liquity and $1.4b LUSD in circulation, mostly now in the Stability Fund.

The Protocol is having a liquidity mining event to incentivise the adoption of LUSD. Rewards go to Uniswap LUSD-ETH pool, staking LQTY the platform token and the Stability Fund. The yields are over 100%, 45% and 27% now, respectively.

Further, Curve Finance and Wasabi Finance have dedicated LUSD pools, now giving yields at 40% and 100%, respectively.

The Team and Governance

The Liquity team is led by CEO Robert Lauko, previously Researcher at DFINITY. For more info, the media kit of the company is available here.

Interesting, contrary to many DAO of the defi world, Liquity has no governance at all. It basically says: There’s no governance!

However, the team also does not run any of the protocol, they only design it and anyone can run a front end for it — open source and permission less. Try some out here: https://eth.liquity.fi/stake to experience the features of Liquity and a full list is available at the official website.

(Serenity Team, 4 May 2021, Twitter: https://twitter.com/SerenityFund)

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