Functionality and Use Cases
Last updated
Last updated
The system overview diagram below provides a clear illustration of Liquity v2’s internal mechanics, and how its components seamlessly integrate and function together:
A user can open a Trove by depositing an eligible collateral asset and borrow BOLD up to an LTV of 90.91% (for ETH ) or 83.33% (for wstETH and rETH), implying a minimum collateral ratio of 110% or 120% respectively .
The system requires an additional deposit of 0.0375 ETH regardless of the chosen collateral, which is set aside to cover the gas costs of a potential liquidation.
Importantly, the user needs to set an initial interest rate within a range of 0.5% and 250%, which increases the borrower’s debt over time.
As an alternative to setting their own interest rates, borrowers may delegate interest rate management to a third party by selecting the delegate’s address instead (see below “Interest rate delegation”).
Upon borrowing, the protocol mints the requested BOLD amount minus a small opening fee (see section below) and transfers it to the borrower’s Ethereum address. The borrower is free to use and spend the BOLD to their liking.
The Troves itself are represented as NFTs and can be freely transferred to other Ethereum addresses. The same address can thus hold multiple Troves.
Borrowers are free to adjust their interest rates whenever they want. However, the borrower has to pay a premature adjustment fee if the adjustment happens within less than 7 days since the last adjustment . The fee is equal to 7 days of average interest on the respective collateral branch . It is charged in BOLD and is added to the Trove's debt. The same fee is charged when a new Trove is opened or when its debt is increased.
This premature adjustment fee aims to impede Trove reopening and redemption evasion strategies where borrowers try to minimise their interest payments in an unfair manner .
Borrowers are required to keep their Troves sufficiently collateralized at all times. A Trove whose LTV exceeds the respective liquidation threshold (maximum LTV) is subject to liquidation .
A liquidated Trove loses its entire outstanding debt and most of its collateral, usually amounting to 105% of the liquidated debt. Any remaining collateral after deduction of this liquidation penalty (5%) can be claimed by the liquidated borrower (except in case of a redistribution as explained below).
Liquidations take place inside the borrow market of the liquidated collateral asset. Each collateral has its own liquidation threshold, Stability Pool and a separate redistribution procedure affecting only borrowers whose debt is backed by the same collateral as the liquidated position.
The liquidation is performed in the following order of priority (e.g. for WETH):
Stability Pool contains BOLD: an amount of BOLD corresponding to the borrower’s debt is burned from the SP (ETH), while 105% of the nominal debt value is taken from the borrower’s collateral (ETH) and given to the SP (ETH). The affected SP depositors receive debt and collateral shares in proportion to their current BOLD deposits.
If the Stability Pool doesn’t cover the full entire debt and gets completely emptied by the liquidation, the system falls back to the following liquidations modes.
Stability Pool is empty: the liquidator can freely choose between two fallback liquidation modes for the debt exceeding the funds in the SP:
(2a) Just-in-time (JIT) liquidation: the liquidator deposits an amount of BOLD corresponding to the (remaining) debt to the Stability Pool and immediately triggers its liquidation in exchange for 105% of its nominal value in ETH .
(2b) Redistribution: the liquidator triggers a redistribution, through which the Trove’s entire debt and collateral (ETH) is redistributed to all fellow borrowers with WETH collateral, in proportion to their own collateral amounts. Thus, the respective borrowers will receive a share of the liquidated collateral and see their debts increase proportionally.
As long as the liquidation is triggered slightly above the maximum LTV (e.g. 110% for ETH) and BOLD isn’t substantially over peg, liquidations will be profitable for all recipients (SP, JIT liquidator, fellow borrowers). Based on historical data from Liquity V1 , liquidations are likely to be net positive even with a 5% penalty in most cases.
The increased liquidation penalty in case of a redistribution ensures that the Total Collateralization Ratio (TCR) of the respective borrow market doesn’t drop as a result of the liquidation.
Liquidation is a permissionless function that can also be called on a batch of multiple liquidatable Troves at once. The liquidator receives compensation for the effective gas costs plus a margin.
The protocol offers two different ways of delegating interest rate management: individual and batch delegation. In both cases, the elected delegate can only change the interest rate, but not the borrower’s debt or collateral.
Batch management improves gas efficiency, allowing third parties to offer professional interest rate management services to borrowers.
A borrower may choose to give interest rate update permissions to an individual delegate address (e.g. a friend or a hot wallet), setting a maximum and a minimum interest rate. This address then has only the ability to update the borrower’s interest rate within the given range.
Individual delegation can be useful for users that go on vacation or institutions that want to keep their Trove in cold storage but manage rates on a regular basis with a hot wallet.
The borrower can revoke the delegation or update the range any time.
Batch delegates set and update a common interest rate for every Trove in the given batch at the same time. In contrast to individual delegation, a batch has a range (maximum and minimum interest rate) and a minimum waiting time between updates preset by the delegate that can’t be changed afterwards. Upon registration, a batch delegate can also set a management fee (e.g. 0.05%) that will be charged over time on the debt under management.
Separately from the interest rate delegation, the borrower may give permission to a third party address (which doesn't need to be an interest rate delegate) for other interactions with their Trove.
The delegate gets full permission to manage the debt and collateral of the Trove by adding or removing collateral or by borrowing or repaying BOLD. This allows delegates to offer services such as automated leveraging or deleveraging without requiring the borrower to use a proxy contract.
The Trove owner can specify a receiver address for the minted BOLD and collateral withdrawals, which may be different from the manager and the owner, according to their trust assumptions.
With this more restricted delegation, the third party address only gets the permission to repay the borrower’s debt or add more collateral. This ‘benevolent’ option is available by default to any Trove owner, and the owner can choose to restrict access to a single specified address or to the owner’s address itself.
Being trustless due to its beneficial nature, this type of delegation could facilitate novel use cases like interest rate swaps. For example, the Trove owner ("owner") and third party ("setter") could enter into an external agreement whereby the owner pays a fixed interest rate to the setter, and in turn the setter sets the rate and pays the prevailing rate of interest to avoid redemption.
Stability Pools act as the first line of defence to absorb liquidations of Troves whose LTV exceeds the liquidation threshold (see above “Liquidation”). Compared with Liquity V1, each borrow market (ETH, wstETH and rETH) has its own SP, giving depositors the choice which collateral they would like exposure to in exchange for yield.
The BOLD contained in the respective SP is used to pay back the liquidated borrower’s debt in return for collateral, resulting in net liquidation gains up to 5% for the depositors
Stability depositors (aka “Earners”) in a given borrow market thus receive
75% of the interest paid by borrowers in BOLD
Liquidation gains denominated in the respective collateral asset
The following diagram illustrates the working of a single Stability Pool (e.g. for ETH borrow market), demonstrating the liquidation of a Trove whose LTV exceeds the liquidation threshold:
Users may deposit BOLD to an SP at any time and will start receiving the interest payments from the respective borrow market, while earning a proportional share of the liquidated collateral in return for the BOLD burned upon liquidations. Deposits can always be withdrawn unless there is undercollateralized debt in the respective borrow market, in which case the debt has to be liquidated first
To compound or realize their yield, depositors can always claim their accumulated interest and collateral gains.
The redemption mechanism ensures that BOLD cannot drop below $1 for sustained periods by allowing any holder to exchange 1 BOLD for $1 worth of collateral.
When BOLD is worth less than $1 minus the current redemption fee, arbitrageurs will have an incentive to buy and redeem BOLD for profit, pushing its price back to parity and creating a price floor around $1. As the redeemed BOLD is burned, redemptions reduce the stablecoin supply in lockstep with market demand.
While the redemption mechanism fulfils the same purpose as in Liquity V1, it also has a number of differences with regard to the procedure, the effect on borrowers, the ordering, the fee, and the collateral split received by the redeemer.
In contrast to LUSD, BOLD is backed by a multitude of collaterals. Instead of letting the redeemer freely choose the collateral to redeem, Liquity V2 optimizes the process for economic safety. Redemptions are thus serviced through a collateral mix in a way that enhances the overall backing of BOLD.
Upon confirmation, the protocol first splits the redeemed amount between all borrow markets, i.e. across the eligible collateral assets.
The split is determined proportional to the "outside" portion of the respective debt, which is defined as the total debt borrowed against a certain collateral minus the size of the SP of the respective borrowing market. Given outside debt amounts of 100 BOLD, 50 BOLD and 100 BOLD respectively as an example, a redemption will result in a 40% (ETH) - 20% (wstETH) - 40% (rETH) split:
Based on the determined collateral split, the redemption is then performed against the borrowers in all markets concurrently in ascending order of interest rates, starting with the Trove with the lowest rate. If the redeemed amount exceeds the debt of the currently lowest rate borrower, the protocol switches to the next higher rate borrower to redeem the remainder, and so on.
The redeemed BOLD is used to repay the debt of Troves in exchange for an equivalent amount of collateral. The actual amount c of collateral that is taken out from the affected Trove(s) and given to the redeemer is calculated as follows:
where β is a constant decay factor determined to result in a half-life of 6 hours.
where α is a constant spike parameter set to 1.
The protocol aims to protect each borrow market from ever becoming undercollateralized in case of a collapsing collateral asset. It does so by throttling debt creation and collateral withdrawal in unhealthy markets and by shutting down the entire market as an ultima ratio.
To that end, the protocol incorporates two safety thresholds for the system’s Total Collateralization Ratio (TCR), using different thresholds for ETH and the LSTs:
Critical Threshold (CT)
Shutdown Threshold (ST)
If the TCR of a borrow market falls below the respective CT (150% for ETH and 160% for wstETH and rETH), creation of new debt in the affected market is prohibited. Collateral withdrawal is allowed as long as it goes along with a debt repayment greater than or equal to the collateral withdrawn (i.e., as long as it’s overall improving both individual CR and TCR). In the meantime, borrowers can still repay debt or top up their collateral. Unlike in Liquity V1’s Recovery Mode, the liquidation threshold (maximum LTV) for individual Troves remains unchanged though, avoiding unnecessary liquidation of innocent borrowers .
If the TCR drops below the ST (110% for ETH and 120% for wstETH and rETH) or in case of an oracle failure oracle failure , the protocol triggers the shutdown of the respective borrow market and permanently disables all borrowing operations except for closing Troves. Upon triggering a collateral shutdown, the protocol enables and encourages single-collateral redemptions , aimed at repaying the entire debt of the affected market as soon as possible. For that matter, users are allowed to redeem BOLD against the respective collateral at a more favorable exchange rate than the current oracle price of the LST, replacing the usual redemption fee by a positive discount of 2%. As long as BOLD isn’t trading significantly above peg, arbitrageurs are thus incentivized to redeem all BOLD from the unhealthy borrow market [ until its debt collapses to 0.
Despite these extra incentives there’s no guarantee that the system will be able to successfully clear the entire debt backed by the respective collateral if its value has dropped extremely or keeps dropping too fast. In the worst case scenario, the system may end up with a portion of its BOLD supply becoming unbacked by debt.
where m is the redeemed amount for the respective collateral and Trove, the oracle price of the collateral in USD at current time t, and f(t) the current redemption fee. With that, the redemption fee is deducted from the withdrawn collateral and remains with the Trove owner.
Liquity v2 applies the same formula for determining the redemption fee as Liquity v1, but with different parameters (larger spike and faster decay). The fee rate f(t) is the sum of a minimum fee (= 0.5%) and an exponentially decaying base rate b(t) calculated for each time step as follows:
When a redemption transaction is executed at time , the base rate spikes depending on the redeemed amount m relative to the current BOLD supply n according to the following formula:
The resulting fee is already applied to the redemption causing the spike.
