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Recently, the supply of stablecoins has experienced explosive growth, and the centralized legal currency stablecoins have occupied half of the market. (such as USDT, USDC). The decentralized stablecoin MakerDAO is regarded as the most reliable product, sitting on a TVL (total locked position) worth 5.7 billion U.S. dollars, and as of March 1, it has generated DAI worth 2.4 billion U.S. dollars. In addition to MakerDAO, other alternatives (such as algorithm-based elastic stablecoins) have also emerged in decentralized stablecoins. The reason is mainly because MakerDAO uses fiat currency-backed stablecoins as collateral to mint DAI, which is not completely anti-censorship, which has been criticized by users. However, these resilient stablecoins have not been very stable. Their mechanisms cannot resist violent price fluctuations, but are more volatile and speculative than over-collateralized stablecoins such as MakerDAO and fiat-backed stablecoins.
Room for Improvement of MakerDAO Mechanism
Capital inefficiencies such as overcollateralization
Governance is inactive
soft anchor only
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Liquity is an elastic stablecoin with encrypted assets as collateral (which can solve the problems mentioned above), aiming to issue a fully decentralized and censorship-resistant stablecoin LUSD. In short, the main value of Liquity is reflected in:
Stablecoin LUSD Collateralized by Crypto Assets
Low mortgage rate threshold - 110%
Algorithmic monetary policy
Non-governance, reducing risk of human error
Price floor: LUSD can be exchanged for ETH at the current value at any time
Decentralized front end
The table below shows the comparison of Maker and Liquity mechanism, and also explains why we believe Liquity has enough potential to challenge Maker's status.
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Comparison of Maker and Liquity Mechanisms
One of the reasons why Liquity is better than Maker is that it has a lower collateralization ratio. Macroscopically speaking, Liquity can release more ETH liquidity than Maker. Microscopically speaking, users can obtain higher leverage and less liquidation risk. But how do you achieve this low collateralization ratio?
First, the reason why Maker requires ETH to provide 130/150% collateral is because of its liquidation mechanism. Assuming the auction process is fairly lengthy, that leaves more time for price fluctuations to eat away at the value of the collateral. In this sense, additional collateral acts as a buffer against the risk of price fluctuations. Liquity, on the other hand, provides almost instant liquidation, so it does not need to take as high a risk as Maker, i.e., it has the ability to lower the collateralization rate. The innovative liquidation mechanism incorporates three layers of defense:
1. Stability Pools - Liquity avoids the lengthy liquidation process that is typical of MakerDAO and other lending protocols. The system supports automated liquidation with a stability pool designed to absorb and eliminate defaulted debt, and once collateral is at 110%, up to 40 positions can be liquidated at a time.
So what if the stable pool doesn't have enough liquidity to support the system?
2. Redistribution mechanism - If there is not enough liquidity in the stable pool, the second phase starts, which is the redistribution mechanism. The reallocation mechanism can reallocate the remaining debt from the liquidated positions to all existing positions. In this case, the high-collateralization position will take on more debt and receive more collateral from the liquidated assets than the low-collateralization position. To provide this additional layer of security to the system, these higher collateral positions are rewarded as liquidators, essentially getting liquidated base collateral.3. Recovery Model - The third layer of protection focuses on systemic risk. Liquity introduces a recovery mode. This mode will be triggered if the overall collateralization ratio of the protocol drops below 15%. This way, the system will attempt to offset positions with the lowest collateralization ratio (even if it is higher than 110%) with the stable pool. LUSD and USD are hard anchored
DAI has no redemption mechanism, so it is not hard-pegged to the US dollar, but it relies on governance to implement a sound monetary policy that pushes the value of DAI towards $1. On the other hand, LUSD is pegged to the U.S. dollar is implicitly designed into the agreement.
LUSD tokens can be returned to the protocol for ETH at any time based on price, ETH:USD ratio, and redemption fees
This redemption is very important, because when the LUSD price is lower than the USD price, arbitrageurs will buy LUSD, convert it into ETH, sell ETH to obtain USD, and lock in the arbitrage profit to make a profit
Additionally, this process improves the health of the system because whenever a redemption occurs, the current supply of LUSD is reduced by low-collateralized borrowers, i.e. the system uses the redeemed LUSD to pay off the riskiest assets
On the other hand, the minimum collateralization rate is 110%, putting the natural price cap at $1.10
When the LUSD:USD ratio exceeds 1.10, the borrower can borrow the maximum amount of collateral and sell LUSD for a profit above 1.10 USDhttps://docs.liquity.org/documentation/resources.
The game theory behind this concept provides a soft anchor mechanism for LUSD price movements. To learn more, you can read related technical documents:
Every aspect of Liquity's design is inseparable from the principle of decentralization. Therefore, the Liquity team will not be doing the front-end operations themselves. In other words, front-end operators are incentivized by kickback rates. That is, the distribution of LQTY between the frontend and users is based on the rebate rate, which can be freely set by the frontend operator (between 0% and 100%). Thus, Liquity creates a marketplace for front-end developers. Front-end developers who provide the best interface and special features can win the most rewards, and strong incentives for developers also create a secondary market solution for Liquity.
Summarize
Summarize
The degree of decentralization, hard-anchored USD, algorithm-driven and non-governance agreements, interest-free debt, and high capital efficiency are unique combinations in the DeFi field, making Liquity the most anticipated project in 2021. As such, it is one of the first protocols to offer a highly viable alternative to the MakerDAO mechanism.
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