Hey folks, if you’ve been following me for a long time, you’ll know that I’ve been a pretty big fan of Liquity team, especially for their highly anticipated release of Liquity V2 which is scheduled to go live sometime soon during Q3 of this year.
As I’ll be breaking down in this article, if history repeats itself (which I personally think it will), my guess is that similar to what V1 did last cycle, Liquity will once again be creating another new standard for overcollaterized stablecoin lending.
First what is Liquity V2?
In a nutshell, the premise of Liquity V2 (as was with V1) is that users will be able to mint an overcollateralized stablecoin with one of the hardest assets in crypto, $ETH. Where Liquity V2 differs significantly from V1 is that minters will be able to do so not just with $ETH, but different $ETH liquid-staked derivatives (LSDs) including possibly:
A big deficiency with V1 was not only could you only collateralize vanilla $ETH, but borrowing rates were free and immutable.
Wait, but isn’t free borrowing rates a good thing? This was good in theory, but because of Liquity’s redemption mechanisms, anyone with $LUSD (V1’s overcollateralized stablecoin minted from collateralized $ETH) could redeem the loan or trove with the lowest collateralization rate at any time. When market forces caused $LUSD to depeg under $1 dollar, this meant that people could get a significant discount on $ETH by receiving $1 dollar’s worth of $ETH for less than $1 dollar’s worth of $LUSD. Although technically not a liquidation, trove owners were being forced to redeem their overcollateralized loans, making Liquity V1 a pretty unstable (or at the very least, a pretty unattractive) place to borrow against their $ETH.
Enter User-set rates
Apart from the ability to supply $ETH LSDs instead of just $ETH, perhaps the biggest innovation by the Liquity team was to introduce user-set rates, where if a redemption rate takes place, the trove owner with the lowest set interest rate gets redeemed first.
In other words, users on V2 can still mint stablecoins (called $BOLD in V2) at nearly a 0% interest rate, however if they choose to do so, they risk a higher rate of redemption if $BOLD ever falls below peg. Conversely if trove owners want a lesser chance of getting redeemed, then they can manually set their interest rate higher so that they will be one of the last trove owners to get redeemed.
Given that market conditions could significantly change week-to-week or even day-to-day, having variable interest rates allows V2 to adapt and remain competitive under any bull or bear market. In the case of V1, many were selling their off their V1 $LUSD in order to swap for stablecoins with higher interest rates — namely $DAI or $USDC. In V2, if there’s a greater risk of being redeemed, their will be greater pressure for trove owners to pay more interest, which then in turn goes to the Stability Pool.
What is the Stability Pool? We’ll talk about that next…
Stability Pool = Interest rates = Real Yield = Flywheel effect
The real beauty behind the introduction of interest rates is that Liquity will start generating #realyield revenue, mostly from V2’s Stability Pool. People depositing $BOLD into V2’s stability pool will help ensure that trove liquidations occur efficiently while at the same time receiving the majority of interest generated from the troves:
In other words, the greater the rates on Liquity’s troves, the greater returns that the Stability Pool will make. Although I personally don’t suspect the Stability Pool’s interest rates to go astronomically high, what this does is create a flywheel effect that helps ensure maintenance of $BOLD’s peg:
- The higher the Stability Pool’s interest rates become, the more desirable it is for people to get more $BOLD and deposit into the Stability Pool.
- The more desirable it is to have $BOLD, the greater $BOLD’s peg becomes.
- The greater $BOLD’s peg becomes, the less attractive it becomes to redeem a trove.
- The less attractive redemptions become, the more attractive it is for new troves to be opened up with new collateral.
- The more troves that open up, the more interest that is accrued that goes to the Stability Pool.
— wash, rinse, repeat —
BUSL vs. FOSS
Another significant difference between V1 and V2 was that V1’s code was free and open-sourced (FOSS), while with V2, Liquity will have its code set as a business source license (BUSL), much like Uniswap and Aave have done with their V3s.
In theory, a BUSL will significantly decrease the amount of dilution that might occur with unauthorized forks, or in other word copy cats/iterations of V2’s code. Uniswap for instance, first introduced a BUSL after suffering from significant vampire attacks from forks such as Sushiswap. Liquity V1 itself has been forked more than 35 times, seeing a dilution effect of more than $1 billion dollar’s worth of TVL:
With the introduction of a BUSL, the idea is that most competitors will be deterred or at least delayed from “vampire mining” away funds from Liquity’s V2, thus capturing greater overall revenue potential from anyone wanting to mint stablecoins against their $ETH.
Other things to consider
$LQTY: If you’ve been following the Liquity team on twitter or Discord, most of the frequently asked questions have to do with $LQTY — Liquity’s altcoin from V1. There hasn’t been any confirmations (or denials) of what $LQTY’s involvement may or may not be in V2, but at the very least, I see the token as the only store of value that can encompass the network effects of the Liquity protocol itself, and I imagine that the price will most likely move in coincidence with how successful V2 is as a whole.
No one can predict the future: Liquity V1 was created to solve a problem during it’s time — allowing people to essentially take interest free loans against their $ETH, dictated by immutable code. With V2, it’s clear that there’s been a pivot to make it more resilient against more market conditions, but will it be invincible? There’s no guarantee.
The “ethos” of crypto: With the announcement of their BUSL, there’s already been some critics to come out of the woodwork accusing Liquity of going against the FOSS-ethos of crypto, but in my opinion, there’s already too much dilution in Crypto as a whole. With so many DEXes, so many Perpetual trading platforms, and so many lending/borrowing platforms, the only way that new platforms can compete is usually by creating massive incentives with new tokens that are being artificially printed out of thin air. As we’ve seen over the last few months with meme coins, continually printing tokens en masse can hurt and dilute the value of the entire industry — not something I want for my bags.
LRTs: With the advent of the whole re-staking that we’ve seen come into full effect this year, a possible blind spot that Liquity V2 may have is its lack of exposure to Ethereum’s liquid-restaked derivatives. LRTs introduce more risk and aren’t nearly as battle-tested as LSDs, but in the coming years if they continue to prove their meddle, I imagine that Liquity might lose out on a significant amount of future marketshare if most people would rather to continue to hold their $ETH via LRTs as opposed to LSDs.
Conclusion; TLDR
In true Liquity-fashion, it’s clear that there’s been a significant deal of planning about to how to make V2’s $BOLD the most profitable and resilient collateralized stablecoin out there. The biggest key indicators I’m most excited about are:
- User-set rates that can adapt to any market condition
- Stability Pools that will offer real yield generation
- A BUSL that will help ensure marketshare and profitability
Will Liquity V2 be more successful than V1? I certainly think so, but the true test will be to see how adept their new model will be at adapting to various market conditions, and for that we truly won’t know until it’s faced with pivotal pressures in real time.
If you’ve read through this and want to learn about V2 and it’s mechanics, you can check out my last article I wrote about V2 here.
If you’d like to read more about V1and $LUSD, I recommend you read my last breakdown here.
And as always thanks for taking the time to read this and be sure to follow me on twitter (https://twitter.com/CryptosWith) to get all my latest updates. Also, looking for a gift for your Crypto-loving/hating friend? Give them a REKT journal to cheer them up!
Disclaimer: This is not financial advice and this is for educational and entertainment purposes only. Please as always, do your own research and find what investments are best for you. Cheers everyone!