Liquity’s Stablecoin Experiment

Overview 

Liquity launched its stablecoin experiment in 2021, with the mission of bringing to market a credibly-decentralized, censorship-resistant, overcollateralized stablecoin. The protocol allows users to mint and borrow the LUSD stablecoin against solely ether as collateral, extending the stablecoin as an interest-free loan. The monetary policy is managed algorithmically, rather than through governance. The stablecoin is globally-redeemable, whereby any LUSD holder could redeem their tokens for the underlying collateral. 

In short order, the protocol gained deposits in excess of 1M ether (~$4B) with over 1.5B in LUSD minted against that. Additionally, the stablecoin maintained its peg, trading between $0.98 and $1.04, and averaging around $1.00 with minimal variance. At the time, it seemed there was compelling evidence that the experiment had validated the hypothesis; that the market demanded a credibly-decentralized stablecoin, and that the mechanism designs behind the stablecoin were effective in production to implement this vision.  

However, since the recording of these lofty metrics of success in 2021, the protocol has experienced a slow decline, driven by redemptions and depositors withdrawing and taking their ether elsewhere. Today, Liquity holds ~150K in ether deposits with 85M LUSD circulating. The protocol saw no reprieve with the market upswing over the past year, as these key metrics continue to make all time lows. Liquity is non-upgradeable, and has no governance. As such, there are no facilities to remedy this trend. 

Learning from the successes and failures of the v1 experiment, the team behind Liquity announced v2, an entirely new stablecoin protocol to iterate on the lessons from the first. With an expected mainnet launch by November 2024, v2 will expand collateral-types to include certain whitelisted LSTs. Additionally, v2 will let borrowers set their own interest rates, allowing for greater expressivity in market participants' demand for leverage and aversion to redemptions. At large, these design changes will direct the majority of protocol-generated revenues back to the BOLD stablecoin, offering a more compelling native rewards stream. In this report, we’ll review the architecture and evidence behind the successes and shortcomings of Liquity v1’s design and estimate the impact of v2’s novel introductions. 

V1 Architecture