The LQTY token is an emerging cryptocurrency designed to maintain system stability and solvency through a stability pool and liquidation mechanism. This article will delve into key aspects such as how the LQTY token works, the functionality of the Stability Pool, the liquidation process, and early adopter rewards.
What is a stable pool?
The stability pool is the first line of defense in maintaining system solvency. By providing liquidity, the Stability Pool is used to pay off the debt of liquidated vaults, ensuring that the total supply of LUSD is always supported. When a vault is liquidated, the LUSD corresponding to the vault's remaining debt is burned from the balance of the stability pool to repay the vault's debt. In exchange, all collateral from the vault is transferred to the stability pool.
The stability pool is funded by users depositing LUSD into it (called stability providers). Over time, stability providers lose a proportional share of their LUSD deposits while gaining a proportional share of liquidated collateral. Since the vault will likely be liquidated with a collateral ratio of just under 110%, stability providers will expect to receive a higher dollar value of collateral relative to the debt they repay.
Why should LUSD be deposited into the stable pool?
Stability providers will receive liquidation proceeds and early adopter rewards in the form of LQTY tokens. This makes stability pools an attractive investment option, especially for investors looking for stable returns in the cryptocurrency market.
What is liquidation? To ensure collateral can fully back the supply of all stablecoins, vaults falling below the 110% minimum collateral ratio will be closed (liquidated). The debt of the treasury is canceled and absorbed by the stability pool. The collateral is distributed among stability providers. The owner of the vault still retains the full amount of borrowed LUSD, but will lose approximately 10% of the value overall. Therefore, it is crucial to always keep your mortgage ratio above 110%, and ideally above 150%.
Who can liquidate the vault?
Once a vault's collateralization ratio drops below the minimum collateralization ratio of 110%, anyone can liquidate it. Initiators will receive trading fee compensation (200 LUSD + 0.5% of Trove collateral) as a reward for this service.
How do I get compensated for liquidating my vault? The liquidation of a vault is associated with certain transaction fees that the originator must pay. Users can reduce the cost of liquidating each vault by implementing batch liquidations of up to 95 vaults, but to ensure that liquidations remain profitable even when transaction fees spike, the protocol provides transaction fee compensation given by the following formula:
Transaction fee compensation = 200 LUSD + 0.5% of Trove collateral (ETH)
200 LUSD is funded by liquidation reserves, while a variable portion of 0.5% (in ETH) comes from liquidation collateral. This slightly reduces the liquidation returns of stability providers.
As a stability provider, how do I benefit from liquidation? Since liquidations occur when a vault's collateralization ratio is less than 110%, you will most likely receive a net gain whenever a vault is liquidated. Let's say there are 1,000,000 LUSD in the stable pool and your deposit is 100,000 LUSD. Right now, there is a vault with a debt of 200,000 LUSD and a collateral of 400 ETH that is being liquidated at an Ethereum price of $545. At this time, the mortgage rate is 109% (= 100% * (400 * 545) / 200,000). Since your stable pool share is 10%, your deposit will be reduced by 10% of the liquidated debt (20,000 LUSD), i.e. from 100,000 to 80,000 LUSD. In return, you will receive 10% of the liquidated collateral, which is 40 ETH, currently worth $21,800. So, your net benefit from liquidation is $1,800.
As a stable provider, how do I benefit from early adopter rewards?
First, you need to open a vault, borrow LUSD, and deposit it into the stable pool. After making a deposit, you will begin to continuously accumulate rewards (in LQTY) proportional to the size of your deposit. Rewards are calculated based on the rewards schedule and the rebate rate on the front end you use to deposit. The rewards will be highest for early adopters of the system. You can withdraw pending rewards to your Ethereum address at any time.
Can I withdraw my deposit at any time? Generally speaking, you can withdraw your deposits into the Stable Pool at any time. There is no minimum lock time. However, if there are pending vaults with a collateral ratio below 110% that have not yet been liquidated, withdrawals will be suspended.
What oracle do you use to determine the price of ETH?
The protocol uses Chainlink's ETH:USD price feed, but falls back to the Tellor ETH:USD oracle under the following (extreme) conditions: - Chainlink price has not been updated for over 4 hours - Chainlink response call resume, responds with an invalid price or is invalid timestamp - price change > 50% between two consecutive Chainlink price updates.
Will I lose money if I deposit funds into the Stability Pool? While most of the time liquidations will occur at collateral ratios well above 100%, it is theoretically possible for collateral ratios to fall below 100% during an ETH price flash crash or a vault being liquidated due to an oracle failure. In this case, you may suffer a loss because the return on the collateral will then be less than your reduced deposit. If LUSD trades above $1, liquidation may not be profitable for the stability provider even if the collateralization ratio is above 100%. However, this loss is hypothetical as LUSD is expected to return to its anchor value, so the "loss" will only occur if you withdraw your deposit and sell LUSD at a price higher than $1.
Please note that although the system has been carefully reviewed, we cannot completely rule out hacking attacks or system errors that may cause user losses.
What happens if the stability pool is empty when liquidation occurs?
If the stable pool is empty, the system will use a secondary liquidation mechanism called reallocation. In this case, the system will reallocate debt and collateral from the liquidated vault to all other existing vaults. Debt and collateral are redistributed in proportion to the value of the collateral in the recipient’s vault.
In summary: LQTY token provides users with a stable and potential investment option through its stable pool and liquidation mechanism. Both stable providers and early adopters can reap substantial benefits. As more people understand and participate in it, the future prospects of LQTY token will be brighter.