Key Benefits and Motivations

Liquity v2 offers a plethora of benefits and innovations:

• Multiple LSTs as collateral

• More attractive short-term borrowing

• User-set interest rates with delegation facility

• Sustainable real yield

• Improved peg dynamics

• More capital efficient: minimum collateral ratio of 110 % and no Recovery Mode

• Instant multiply

• Separate borrow markets and collateral risk alignment

• Improved redemption mechanics

• Protocol-Incentivized Liquidity (PIL)

• Minimal governance

• Multiple Troves per address

Multiple LSTs as Collateral

Besides WETH, Liquity V2 will support Lido wrapped staked ETH (wstETH) and Rocket Pool staked ETH (rETH) as collateral. Borrowers can thus get liquidity or multiply collateral while benefiting from auto-compounding staking yields.

In contrast to most other Liquity forks with LST collaterals, V2 will represent each LST as a separate borrow market with its own interest rates and risk parameters. In this setup the risk for each LST will be reflected individually through the ratio between the debt collateralized by the LST and the size of the corresponding Stability Pool (SP). This enables the protocol to manage collateral risks in an autonomous way by directing BOLD redemptions mostly towards LSTs with lower SP backing in order to reduce the exposure to the corresponding LST. As with the user-determined interest rates, V2 is relying on market-driven mechanisms to manage and reduce the risk in the system.

More Attractive Short-Term Borrowing

With its vastly reduced upfront costs, Liquity V2 is inherently more attractive to short-term borrowers and multiplication seekers. Borrowers will be paying an interest rate for the duration of their loans, benefiting from greater flexibility in time.

User-Set Interest Rates with Delegation Facility

Liquity V2’s main innovation lies in its unique market-driven interest rate mechanism: borrowers may choose the rate they are willing to pay for their debts between 0.5% and 1000%. While borrowers can freely set and adapt their individual interest rates, they are expected to manage their rates in line with the market to avoid redemptions.

The redemption mechanism allows any holder to swap BOLD for $1 worth of collateral (such as ETH and LSTs), enabling arbitrage whenever BOLD is trading below peg. The collateral paid to the redeemer is taken from the borrower who is paying the currently lowest interest rate , in return for an equivalent reduction of their debt. Borrowers affected by redemptions lose exposure to their collateral even if they don’t incur a financial loss at that moment. They are thus incentivized to keep their redemption risk low by paying sufficiently high interest rates compared to their peers.

As the interest payments by borrowers determine the yield achievable on BOLD, the interest rates help stabilize the peg and redemption volumes under changing market conditions: when borrowers increase their rates to minimize redemption risk, it becomes more attractive to deposit BOLD to earn a share of the borrowers’ interest payments. Higher interest rates thus result in a higher stablecoin yield, supporting BOLD’s price when below peg and curtailing redemptions. Vice versa, when BOLD is above peg and the redemption risk is low, borrowers may safely reduce their rates, decreasing the stablecoin demand and its price.

Borrowers and Stability Pool depositors (aka ’Earners’) will thus act as the two sides of a dynamic interest rate market, obviating the need for controllers or human governance to manage a global interest rate. Liquity V2 behaves similarly to money markets but with opposite spreads: depending on the utilization and integration of the stablecoin in broader DeFi, the Stability Pool yields may even exceed the average interest rates , something that isn’t possible on money markets where borrowers always pay higher rates than what the lenders receive.

This yield amplification increases with the number of external use cases and utility for BOLD, by reducing the fraction of BOLD in the Stability Pool. An increasing demand for BOLD puts upward pressure on the peg, lowering the probability of redemptions. When redemptions are less likely, borrowers may lower their rates and get more attractive conditions. Liquity V2 should therefore benefit from decreasing interest rates the more it gets established in the broader DeFi ecosystem.

We anticipate that borrowers will need to adjust their interest rates on a regular basis to manage their redemption risk and optimize their borrowing costs. As this may not be suitable for every borrower, the system offers a convenient, safe and gas-efficient way to delegate the management of the interest rate to third parties.

The efficiency gain is due to a batching mechanism which allows the chosen delegate to adjust the interest rates of multiple borrowers at once in the same transaction. We expect that professional batch delegates will offer their services to Liquity V2 borrowers.

Sustainable Real Yield

As opposed to Liquity and most of its forks, Liquity V2 comes with a sustainable real-yield source in the form of continuous interest payments (in BOLD) by borrowers to Stability Pool depositors (Earners) and other recipients such as liquidity providers. This will ensure a base holding-demand for BOLD in the long run.

Improved Peg Dynamics

Liquity V2 employs a market driven monetary policy through user-set interest rates which can dynamically react to situations where BOLD is above or below $1 .

As the interest rate paid by borrowers serves as direct revenue for the BOLD stablecoin within the Stability Pool, it also has an impact on the stablecoin demand. When BOLD trades above $1, borrowers will tend to reduce their rates due to the lower redemption risk. This makes borrowing more and holding BOLD less attractive.

Conversely, when BOLD is below $1, borrowers are exposed to a higher redemption risk and are likely to increase their rates. Borrowing thus becomes less attractive, while demand for BOLD should increase, pushing its price upward.

More Capital Efficient

Liquity V2 increases capital efficiency in high interest environments as the redemption risk can be managed by adjusting the interest rate rather than lowering the LTV of a Trove. While Liquity V1 has experienced very high collateral ratios due to excessive redemption risk in such scenarios, Liquity V2 will enable capital efficient borrowing in all market situations.

Furthermore, Liquity V2 does away with the Recovery Mode known from Liquity V1, simplifying the liquidation logic and offering an effective minimum collateral ratio of 110% or an LTV of 90.91% for ETH and 83.33% for wstETH and rETH. Borrowers don’t have to worry about being liquidated at higher ratios if the system’s total collateralization drops too low.

Multiply

Liquity V2 allows users to enter a multiplied collateral position in one transaction by using external flash loans and swapping the borrowed BOLD back using the incentivized liquidity pools. Users can thus achieve the desired multiplication in a predictable and cost-effective way without having to manually loop and swap the borrowed amounts, reducing gas costs and unforeseen losses due to slippage.

Separate Borrow Markets and Collateral Risk Alignment

Each supported collateral asset constitutes an individual borrow market with its own group of borrowers and a separate Stability Pool (SP) backing their debts in return for a share of their interest payments. For example, stability depositors to the SP (ETH) only benefit from the interest paid by users borrowing against ETH, and receive liquidation gains in ETH accordingly.

The borrow markets are separated in the following aspects:

• Separate list of borrowers ordered by interest rates (relevant for redemption order)

• Individual Stability Pool (relevant for liquidation)

• Redistribution limited to the list of borrowers (no mixing of collateral among positions)

This separation impacts the user groups in different ways:

• Borrowers: collateral risk is limited to the collateral asset held by the borrower. Given that collateral assets are never redistributed across different borrow markets, a borrower isn’t negatively affected by a failure of another collateral asset.

• BOLD holders: as a multi-collateral stablecoin, BOLD is reliant on effective liquidations of undercollateralized loans in every borrow market to remain overcollateralized. Holders are thus subject to the risks of all supported collateral assets, facing a potential depegging of BOLD due to failed liquidations and bad debt in worst case scenarios .

• Earners: in case of a liquidation, SP depositors (Earners) only get exposure to the asset they have opted for. However, as BOLD holders they are similarly affected from a potential depegging.

To manage the risks across multiple collateral assets, Liquity V2 incorporates an adaptive redemption logic, keeping “weaker” collateral assets in check compared to collaterals with larger SP backing. If only little BOLD is held in a certain SP compared to the outstanding debt amount for the respective collateral, it signals a lower confidence of the market in this LST.

Thus, proportionally more redemptions will be executed against Troves collateralized with the respective LST (to shrink the exposure of the protocol to this collateral). Along with emergency measures and a collateral shutdown mechanism, this increases BOLD’s overall resiliency.

The segregated borrow markets and the redemption mechanic not only aim to align the risks across the LSTs with their different risk profiles and qualities (e.g. available liquidity), but allow each borrow market to establish its own range of interest rates . Borrow markets may thus achieve competitive rates for every collateral asset with regard to the broader DeFi market.

Improved Redemption Mechanics

The market-driven interest rate mechanism and its positive effect on stablecoin demand aims to reduce redemption volumes overall compared to Liquity V1 where redemptions are based on the borrowers’ collateral ratios.

To mitigate potential losses for borrowers hit by redemptions, the redemption fee charged to the redeemer remains inside the affected Troves rather than being diverted as in Liquity V1. In other words, affected borrowers essentially benefit from a better BOLD:USD exchange due to the applicable fee.

Protocol-Incentivized Liquidity (PIL)

Having sufficient liquidity on DEXes is important especially for new stablecoins. Liquity V2 diverts on the protocol level 25% of the interest revenue from all borrow markets to various liquidity initiatives, based on a split determined through weekly gauge voting. With its sustainable Protocol Liquidity Incentives, we expect 10% of the BOLD supply to be available as liquidity across multiple AMMs like Curve or Uniswap.

Peripheral governance with time-base voting power

Liquity V2 is subject to minimal governance which is solely tasked with distributing the available liquidity incentives between the available DEX pairs through gauge voting.

Governance has no other functions or powers as Liquity V2’s smart contracts are immutable and not upgradeable. This ensures V2 users will benefit from the same predictability as in V1. Terms and conditions are set in stone, and are thus not subject to governance and potential take-overs.

The BOLD stablecoin is an ERC-20 token exclusively minted through borrowing and burned when repaid or redeemed or in case of liquidation. Like LUSD, BOLD is unstoppable, market driven and managed autonomously by a non-upgradeable protocol.

Being immutable yet adaptable, Liquity V2 has a peripheral governance mechanism in charge of managing 25% of interest revenue from borrowing. Despite its limited scope, the mechanism comes with a number of innovations to align incentives, while making voting attractive and efficient.

Liquidity incentives accrue in BOLD and are then distributed on a weekly cadence across any number of eligible initiatives, or target addresses. Their distribution is a function of gauge weighting: users with voting power can propose, weigh and veto initiatives as they see fit.

Users accumulate voting power for protocol liquidity incentives by staking the LQTY token, without any locking mechanism. The voting power is proportional to the amount staked and the time passed since staking:

Voting Power = LQTY Staked × (Average ) Staking Age

The above chart shows the individual voting power of four users A, B, C and D that have staked the same amount at different times. By dividing their individual voting power by the total voting power, the protocol derives the relative voting power distribution:

The longer a user stakes, the more voting power they risk losing if they decide to unstake. Over time, defection becomes increasingly costly, effectively binding stakers to the protocol and aligning their incentives without imposing the opportunity costs associated with traditional locking or vote escrow mechanisms.

As V2 stakers also keep earning the LUSD and ETH rewards from V1, staking in V2 presents a unique dual-reward opportunity at no extra cost.