Kolten Bergeron & Robert Lauko: Liquity – The Decentralized Borrowing Protocol #384

Transcript

this is epicenter episode 384 with guests robert and colton from liquity protocol so we're on today with robert who is the ceo and founder of liquidity and colton who's the head of growth at liquidity uh here to talk today about their uh very interesting new lending protocol that they're building on ethereum and we're going to be diving deep into a lot of the mechanism design and sort

of the reasons for why they you know there's a lot of lending protocols already today and why they felt the need that like hey this is going to bring something really new to the table uh but before we dive into that this is actually a very special episode as well because uh we have a brand new co-host joining us this time uh zubin koticha he is he's been on the show twice already you know talking about open v1 and then another the more recent episode just last week with openv2 um and you know we just had him on and i've known zuma for a long time and we've had him on and he's just been you know always really interesting and great at a lot of this stuff and so we just you know wanted to bring him on as a

co-host so i want to give zubin a chance a quick second to just intro himself as well to all the listeners hey hey guys i'm zubin thanks so much for that uh for that intro sunny so sunny and i go way back actually went to college together and then right after college we were living together in sf uh and it was just like this crypto house which is it was just like the best time uh ever i always knew sunny as the podcast guy because he would always wake up really early in the morning and be like guys be silent i have a podcast but some of the really cool kind of moments with some of the top minds in the space have come out with that uh out of that that process and it's been so cool to see

um and so i was you know really excited to to join as for me i'm a co-founder and ceo of open which is a decentralized options protocol in ethereum um and we are kind currently allowing people to trade call and put options on ethereum and the goal is to allow for ethereum and all sorts of erc20s in the long run and build the first highly liquid options market in in d5 um but you know i have two epicenter episodes talking about that more in depth uh for now uh happy to turn it back to sunny and and be chatting with uh robert and colton

awesome thanks and so yeah guys uh can you tell us a little bit about what is your guys's background how did you guys get involved the space how did you guys start working together and what led you to liquidy yeah hi everyone and and thanks for having us on the show uh it's a great pleasure to be here so yeah let me like tell you a bit about my background first so i'm robert lauco i'm a swiss resident i used to grew up in i used to grow up in this crypto valley uh which has become famous over time um but then later on i um like moved to zurich that's where i'm based now and i i'm a lawyer by profession actually

but i always had a keen interest on technology and computer science in particular and um while working as a lawyer i just realized that when blockchain became a thing and it was even a thing in my home town that it's really like something i wanted to dive in and i just started doing my own research uh and after a while i was lucky to get in touch with people from dfinity to the small company back then but it led me to my first job basically in in the blockchain space and i became the first employee in switzerland i had a chance to work on their protocol as a researcher but also helped with operations and yeah and while working there i also realized that i

got more and more interested in the d5 space which which was starting to unfold in the ecosystem around ethereum it was mainly a compound and maker back then in 2018 and then early 19 i started to like think about like how i would do things differently and maybe like more efficiently than maker uh when it comes to borrowing um crypto assets and that's how the idea came about and yeah in november 2019 i left dfinity to fully focus on my own project liquidity which is all about borrowing and yeah i mean we set up the company later like maybe colton can tell a bit more about how he joined

uh as a head of growth yeah so my sort of crypto journey is a lot like really long and windy so i'll spare a lot of the details but like long story short i was kind of the weird kid in like 2014 in college talking about bitcoin uh this new magic internet thing that people didn't really understand at the time and then i ended up graduating in 2018 so that wasn't like you know the best time to work in the space but after graduating in 2018 i was like okay crypto is is slowing down quite a bit uh just because of the the chaos that happened in 2017.

uh i'll i'll go work in my other my industry that i'm also passionate about which is esports i spent about a year there mostly as a graphic designer motion graphics designer a video editor content producer um and then after that i wanted to make my way back into crypto um and ended up coming across a position at the seller development foundation where i spent about two years working on community and ecosystem development and then i wanted to make my way back into ethereum and through a mutual connection i was introduced to robert and liquidy we ended up hitting it off we had a lot of good conversations and after a couple months i ended up joining the team which was like three months ago now so it's been full scene ahead

ever since then awesome um and so yeah so robert like what led you to want to build liquidity so you know you mentioned you were you got interested in d5 because you saw a lot of these like existing you know you mentioned compound uh so that you know there are a number of existing lending protocols and such on ethereum you have compound you have ave you have ones that output a stable coin like maker uh what what was the sort of weaknesses that you saw with some of the existing systems that led you to want to design a new one so i was looking mainly at the way those systems

liquidate positions that become under collateralized because those loans they are they all need to be sufficiently collateralized and i just realized that speed it's all about speed the faster you are able to like sell off or or somehow make sure that your position gets bailed out in case of uh an under collectorization the lower you can set your collateralization ratio or the the less extra margin you need for the same like system security and and then like i started like thinking how how to make this just more efficient and quicker like than an auction for example or

on the other hand i mean you can also just sell off collateral at the discount i mean that's what like the early version like the first version the single collateral i was doing but even with that i mean you lose some portion of your collateral due to the fact that you need to sell it at a discount and that's like how yeah i came to the conclusion that why not like make it so that instead of start instead of like starting looking for a buyer or a bidder once your position becomes under water you can like start earlier and have something around like an insurance or a stability pool as we call it where people can already become guarantors of

borrowers that may need to be liquidated in the future so you don't need to find somebody because you already have them available in your system and that's yeah how the idea came [Music] about cool um so what do you see as kind of the fatal flaw of like um the liquidating systems of that that exist you see it as like a contributing factor in black thursday and you saw that as important uh uh to fix um could you sum up liquity is like really uh doing liquidations better or is there kind of um a broader design choice that you seem

to keep making that that makes it different yeah so it's definitely i think the like the initial uh idea that like led me to start designing it but it's by far not the only like thing that separates us from those other systems like there are other aspects regarding how we achieve price stability but also the fact how we deal with governance or the fact that we don't have like uh voting or governance mechanism in our system but yeah i mean the initial like improvement was all about making liquidations more efficient it's interesting because why is this

like uh last this fast liquidation is very important and this is interesting to me because i think it's been a while it's maybe been like six months or so but we had uma protocol on uh about six months ago and they were actually taking the opposite take where they were saying hey these liquidations don't need to be that fast and like maker is actually liquidating too quickly we want to actually have a slower system for like providing oracle data that triggers liquidation so what do you see as the benefit of these fast liquidations versus what they're saying which is like hey if the price is crashing very quickly something's going bad we want to like take it slow and steady rather than like force liquidating as soon as possible

and people are buying a depreciating asset yeah i think the main underlying issue is that you need to make sure at least if you want to keep your currency stable is that you want to make sure that your debt can always be covered like fully covered now i mean there is some extra margin there because i mean those systems they are over collateralized but if yeah it takes some time to liquidate your position like from the moment on when you trigger this process like an auction that may take up to six hours or longer then during those six hours the price can of course drop even more or and and to account for those um further

price drops during like the time it takes to liquidate the position uh you need to have a higher margin in the first place so if you expect like a maximum price drop during the six hours time span of like let's say 20 percent you need to add those 20 to the like margin that you already wanted to have in the first place so and of course by adding more like margin or by requiring a higher collateralization you make the loans less capital efficient yeah i think there's a lot of questions we'd like to dive into there but before let's actually let's zoom out for one second and make sure uh we give all the listeners a good idea of

what the liquidity protocol is in the first place and can you describe the protocol at a high level first i'm sure yeah i'm happy to i mean there are like three main um differentiating factors like we talked about like maker dao as our main competitor but liquid is a bit different i mean our main focus is about borrowing we want to make borrowing as attractive as possible by doing basically two things by first of all um requiring less collateralization like the minimum collectorization ratio is only 110 which is i think the lowest on the market you can find then the other um differentiating factor or benefit is that we are not charging a recurring fee or interest rate we do

charge like one off fees but that's like a bit different because it's more predictable for the user than a variable interest rate and then last but not least we have this kind of uh very like extreme or radical um decentralization and non-governance approach where we don't really have a governance mechanism everything is immutable and we also have like an incentivization mechanism which allows us to um not be like required as a company to run a front-end or a web interface because we have like incentivized third parties um that will run those front-ends which allow people to access the protocol

so those are the three main points i would like stress here yeah you mentioned uh something really interesting right uh kind of a motivating force is making borrowing as attractive as possible would you describe that as uh one of the main goals of of uh of the protocol uh to make borrowing as attractive as possible and then what steps do you think you guys do differently if that is one of the main goals um that will make liquidy much more attractive than some of the existing alternatives so yeah i mean the two main points i

already mentioned them briefly like or like a lower minimum collectorization ratio which not only like allows you to have a higher like security as a borrower for the same like say collateralization as you would have on a different or another system but it also allows you to be become more risk seeking if you want to and do leverage so you can achieve a much higher leverage up to 11 or 11 sorry 11x by going up by maxing out your your possibilities in our system and that's like more than what you could do on on a similar uh protocol and then the other thing is interest rate which is

like maybe less obvious but the problem with those interest rates is that once you have a position open you may have opened it at a time and the interest rate was low but now you have a debt and and the interest rate increases and that's what just currently happens on like in our competitors uh system like maker and then you you feel obliged or you have this kind of pressure or uneasy feeling as a borrower to repay your debt earlier than you wanted and by replacing like a recurring fee by something which is one off which is an upfront fee when you take out your loan you have this kind of nice feeling that you wouldn't be obliged to pay anything later so you can keep your debt

or position open as long as you want yeah and i want to add on top of that is like floating interest rates have become this sort of norm in d5 and they're not a great deal for borrowers especially if those interest rates are floating upwards so a lot of the times you take out debt and you're expecting to somehow maximize your profit by using that debt or using that leverage and it's a lot harder to do that if you don't know your cost to borrow or if your cost to borrow is constantly fluctuating so let's say you you're intending to borrow for a year and the interest rate changes constantly over the course of that year it's a lot harder for you to quantify the outcomes that you'll be able to get from that leverage and so knowing your cost to borrow up front gives you a lot

of advantages could you explain a little bit about how you know how do you get this collateral ratio to be much lower so you have this 110 collateralization ratio i mean obviously the lower the collateralization ratio the higher risk the uh someone the system faces both the individual cdp holder but also just the uh system as a whole faces and so what enables you to get this lower rate compared to things like maker at 150 or like you know i think some of the other protocols have like even higher like synthetics goes all the way up to like 750 percent or things like that so yes it's really the fact that we can um trigger

liquidations instantaneously without a need to find anyone to bail out the borrower so by having a stability pool which i can maybe briefly explain so it's you can think of it as an insurance pool where people can put their lusd tokens elias is the name of our native stable coin or token so any holder of lusd can place those tokens in that pool anytime also we draw them basically at any time but then when the system needs to liquidate a borrower which like dropped below the one or ten percent threshold then all the system needs to do is basically take

out an amount of tokens from the stability pool which corresponds to the debt that is about to be liquidated and then basically just burn those lusd tokens and pay off the debt and in return what it also does is that it takes um the ether like the collateral held by the borrower's position and it gives it to uh the pool now the pool will obviously be filled uh or by will be filled up by not just one but like many people so um everything happens like peralta like everybody who deposited a share um would get like we would lose um some alias d in case of liquidation uh in proportion to his deposit the chair but also

gain ether collateral from the liquidated borrower um in proportion to the deposited share that's the idea so if i'm understanding this correct what's happening is there's a stability pool which allows people to deposit lusd and it's basically saying that they get first right access to being the liquidator of choice of the protocol so instead of people have instead of having an auction process where people are competing for to be the one to liquidate a cdp it's saying hey you know the protocol has this preferred liquidator which is the this uh stability pool itself

so what what's the benefit of this like is it to reduce the competition or i mean so on one hand you say it's about speed isn't this actually a scary for the um people who deposit in the stability pool as well because when you have this like liquidators who participate in auction if eath is flash crashing you know they want to actually or if they think it's going to drop further they might want to withhold putting in a bid in the auction but the stability pool is kind of forced to buy ethan even if it's expected that east is going to continue to crash right so so that's right there are risks involved um if you become like a stability depositor but we

chose this like a hundred and ten percent uh by looking at like the past data also of like not just the ether price but the ether price that we can get from chain link which is our oracle and and we just saw that um this 10 margin is about the maximum that could happen or based on the historic data that like could be like the maximum price change between two like price feed updates so theoretically if you as a stability depositor you're running like say an automation tool that would fire sale or sell like the ether that you get from the liquidated position like immediately when you get it then um you should be able to

recoup your like loss in the worst case but i mean that's just the worst case in normal situations liquidations would happen just slightly below 110 percent maybe 109 or 108 so there's still this eight or nine percent net gain um which should uh compensate for like the risk of a loss in let's say in a black swan event you achieve this much faster liquidation mechanism through the stability pool and it allows for much more capital efficiency a rate of 110 so doesn't there still need to be an on-chain transaction to start a liquidation uh how do you kind of incentivize that

on-chain transaction and how do you ensure that on-chain transaction gets into the mempool and gets into a block uh sufficiently quickly as well yeah so um what's pretty cool about liquidations is that anybody can execute them externally um so basically we have what's called a liquidation reserve which basically is um it's almost like a fee but it's a fee that you get back if you pay to pay back your debts so for example you open a trove you put aside 200 lusd or 200 lucs added to your debt but that's kind of like stuck in your trove as this reserve for a liquidator whenever they actually execute a liquidation so

the other part of that is a 0.5 um of the collateral also goes to the liquidator so if i'm somebody who's running a bot who likes to execute liquidations anytime i liquidate a trove i receive 0.5 percent of that trove's collateral along with 200 lusd as a sort of flat rate uh but what's also cool about liquidity is that you could liquidate troves in bulk um and because of the way it's implemented you'll actually save money on gas by doing that so let's say there's 30 troves eligible for liquidation it'll actually probably be more profitable for you to liquidate all 30 in one transaction versus trying to liquidate just five of them or something like that so that's that's kind of the way it's designed for liquidators who who might be running bots or you

know monitoring the troves so this is super cool because it's for a stable coin platform pretty revolutionary to have instant instant liquidations um but for a lending platform like compound uh you already have instant liquidations how would you compare uh liquidity to something like compound for instantaneous liquidations i'll add that i'm not totally familiar with the compound liquidation mechanism i'm mostly familiar with maker's liquidation mechanism because i've been kind of just studying it in a little bit of detail as well as their 2.0 liquidation mechanism that they're working on um

but i don't know robert if you have any anything to add regarding compound yeah so i think compounds liquidation works by like letting people like repay just fraction or like the part that needs to be repaid in order to push the collateralization ratio back to a healthy range so it's like a partial liquidation in a sense not like a complete liquidation if i'm not mistaken um the difference is i mean they still like have higher liquidation ratios than than we do and so as far as i know and uh um the other difference is of course like the interest rate that like with compound is again like a

recurring fee and in our case it's a one-off um issuance or borrowing fee which like leads to a different like experience as a borrower got it got it so it's that combination of um both instantaneous liquidations and this new way of doing like flat fees for a borrow uh that's unique and and kind of uh uncharted territory to a certain extent yeah exactly another another thing though that i saw that was uh i was a bit different about liquidity is that in maker die holders don't have any claim on collateral or at least

until there's a liquidation uh and they can buy that but like it seems in liberty in l usd holder which is the stable coin which maybe we should have mentioned that earlier yeah l usc is the stable coin in liquidity they can at any time you can redeem your uh even if you're not a cdp holder you can redeem for collateral and how so how do you do that who gets whose collateral are they redeeming here is all the collateral getting pulled together or are do people still have individual cdps or troves and so then who gets liquidated yeah so people do have individual troves but what's really cool about redemptions is that it's this mechanism almost for

uh like bringing back or bringing debt back into the system and then canceling that debt out and so the way it works is whenever the system stores troves in this way that it's from the most risky to the least risky or from the lowest collateralization ratio to the highest collateralization ratio so when somebody comes along and it's profitable to redeem that lusd say there's this arbitrage opportunity luc's floating below the peg they can redeem that lusd at face value against the riskiest trove or set of troves in the system so that redeemed lusd is actually used to pay off the debt of the riskiest troves within the system in return for their collateral so as a as a borrower

you don't incur a net loss you just lose a little bit of your exposure exposure in return for your debt being paid off that's basically allows for people to feel more certain that l usd is actually you know redeemable instantaneously for its value um and how do you kind of ensure that these redemptions are kind of in good faith and then are not arbitrages so for example let's say that um lusd is actually trading at one dollar on other markets secondary markets but the chain link oracle uh there's a

little bit of lag you know it's not instantaneous and so ethe might be trading at a price uh that implies like you can make money by doing an instantaneous redemption right so um is there some kind of fee or how do you ensure that that is is accounted for that or potential for oracle lag yeah so that's a great question that's a point that we have looked into because it is like a potential like issue that that we need to take care of and the way we do that is that we have a redemption fee and the redemption fee even though it has a decaying mechanism which means that it goes up with every redemption and whenever there are no redemptions it

would slowly decay or exponentially decay over time but there is like a minimum fee at 0.5 percent which makes sure that it can never decay below 0.5 and 0.5 percent also happens to be like the the minimum threshold for the chaining oracle in order to trigger a new price update um so of course there can be like maybe like situations with like where the oracle is a bit lagging behind even though there is this 0.5 percent threshold but it can happen that there is like a higher price uh hike so it means that an arbitrager would have this kind of uh um possibility if the price goes up

faster in reality than the oracle keeps track of and in that case yes there can be temporary situations where an arbitrage could make maybe some small profits but it's not something that is there every time and it would be uh it already requires quite some sophistication and also like the fact that the fee would already react and it has this kind of memory that it stays high and it goes down it's not just that it goes up for a second and then it's back to 0 or 0.5 yeah and i'll also add that default minimum v also makes it slightly more expensive than uniswap whenever you know the lusc unit swap pair fee so like

by default you'd get a bad deal if you just made that trade because you'd be pay more in fees by you know redeeming against the system if it wasn't profitable to do so at this lowest collateral debt uh trove that's you know being uh redeemed against is there any chance that this reduces the collateral ratio or will it always increase their collateral ratio so it should always increase the collateral ratio because you are basically taking like you're subtracting the same constant amount both from the debt and from um like the collateral and given that the collateral is higher than the debt i mean this would lead to um an increase

of the collaterization ratio i mean if it was a different it would be different if the debt was higher than the collateral which means that the liquidation mechanism somehow wasn't able to liquidate it fast enough but that shouldn't happen already because there are very strong incentives to liquidate earlier and also we we are not allowing to redeem from troves that are below 110 so those troves would be eligible for liquidation but not for redemption so this should never happen i think you can rule that and i think that's actually a good point because there was an example the other day that i was working on where there was a trove that i redeemed against uh that was right on the border of 110

so it was really close to being liquidated and that redemption saved that trove from liquidation which is a ten percent haircut right like losing your eighth exposure is probably better than just losing ten percent of your entire position so in the event that you get redeemed against in some cases it's probably a good thing because that redeemer could have just saved you from from losing 10 of your whole position another uh mechanism i came across was you guys have this thing called a recovery mode which is basically triggered when the overall collateralization system of the entire uh met system is below 150 percent and so can you can you describe to us a

little bit about how this uh recovery what how this whole recovery mode scheme works so yeah i mean it's um relatively sophisticated because we have to um think in different like cases but generally like it is triggered when the total collateralization ratio of the system drops below 150 percent like all the collateral values summed up divided by all the debt while you summed up that's the total collectorization ratio so that would trigger collateral recovery mode and then what happens is that now every uh trove or position becomes eligible for liquidation

if its own individual collateralization ratio is below the total collectorization ratio which by definition is below 150 percent because that's what triggers recovery mode um so that sounds scary of course because now suddenly people with let's say only one or ten sorry one with even with 140 percent uh collateralization ratio could be liquidated but we do kept the liquidation loss so you would never lose more than ten percent of your collateral or like you never lose more than uh this 10 difference between your collateral and debt so it's basically for you the same as you

as in a case where you're liquidated below 110 because you only lose this 10 percent um above your debt so it's we kept this loss and we give um a way to the user or to the borrower to get the surplus refunded so let's say if you were liquidated at 140 percent um you would basically get back 30 um 30 of your collateral like you had a debt of 100 you had collateral versus 140 and you lose 110 of your collector and you get back 30. so that's uh the way it works like the main mechanism is there an attack here though that can

be done where like let's say i wanted to grief someone and they had let's say they had 120 or something and i'm a giant whale could i like add in a bunch of liquidity at like 140 percent just in order so much just to push the global ratio below 150 just to cause a liquidation of the person below me um that's not possible because we uh prohibit every transaction that would trigger recovery mode like every borrower operation that would uh drop or decrease the total collectorization ratio below the 150 threshold would be banned and also we have a set of bands and prohibitions

during recovery mode like we make it so that some operations are not allowed during recovery mode as well as at the cusp of it to make sure that those incentives cannot be easily like abused yeah so that whale would have to be very mean and dump the entire eth price not just to try to attack liquidity they'd have to they'd have to aggressively die right so another thing that uh was was interesting here so it seems like there are a few risks that will in practice push the vault to not be at like a vault or sorry a trove opener to not be around 110 so the first thing is like you could get

uh redeemed upon um so you lose your you know eat position and then you might have to you know repay your flat fee in order to open it again the second is kind of this mechanism we just talked about which is recovery mode uh where the lowest collateralized vaults uh will will be in the liquidation state um and then of course there's just traditional liquidation if you for some reason go below 110 you're also in a little bit of a risk scenario there is another mechanism i believe right so if the entire stability pool uh well actually would love to hear you guys describe it what happens if the stability pool runs out of funds uh

and there needs to be liquidations beyond that amount whenever the stability pool is empty or emptied during um liquidation then what happens is that we basically take uh the position that needs to be liquidated and uh chop it up uh in proportion to all the other borrowers in the system like you just look at their collateral like you have a set of borrowers with their own collateral amounts and what we do is we basically split up the liquidated borrower's position both the collateral and his debt and just give those tiny proportional shares to all the other

borrowers like every borrower would see a slight increase of his own collateral but also an increase of his own debt and given the fact that we do liquidations just slightly or normal situations slightly below 110 it means that uh when you look at the total um net uh change it's like a gain and not a loss because you you get more collateral value then you get debt from the liquidated borrower so that's how the system basically ensures that that can always be redistributed we call it redistribution and of course the collateral is redistributed

according to the same principle got it so if there are multiple different uh vaults or tropes sorry uh that are in a liquidation zone right and the stability pool has kind of been exhausted how do you choose uh or which part of these troves go to different troves that are not under collateralized does that make sense i think i understand your question but the general idea here is that every um trove gets redistributed to every other trove in the system like it's an and a one to all mapping um so to say now maybe you're also wondering about the order of liquidating

like multiple troves which are below the uh threshold so there we don't like we initially wanted to like impose like a strict ordering but then realize that this wouldn't work um because an attacker could clog the system with a huge amount of tiny troves so that's why we had to relax like this liquidation ordering which we initially wanted to have which would have been like that you can only start liquidating the position or at the like trove that like has the lowest collectorization of all troves now we relaxed it so everybody can be liquidated below the 110 percent uh and you can also apply this batch liquidation that colton just explained um to make it more efficient but then

everybody would be on the recipient side if you are near the uh liquidation ratio the even though you are let's say you happen to be at like 111 and you had more debt applied to you yes you you ended up on top because you have more collateral but like you could have been added at a rate that actually pushes you below the liquidation ratio and isn't that actually couldn't that cause like cascading liquidations yeah that's a very good point so we did some simulations and also just some static uh like uh calculations so how that would play out and we realized that it it only really matters or it only puts you

in a position where you as a recipient can oh like where you as a recipient would also become eligible for liquidation only if you're already very close like as you said maybe a uh 111 that would be like a range or like a collateralization ratio where it could happen that you would become liquidatable just due to the fact that you receive those liquidated shares but for higher collateralized troves that wouldn't really happen it's very unlikely if you just look at the numbers yeah and i think even if you're on that 111 threshold you're so close that um if a lot of people are getting liquidated and we're in a phase where

we're doing redistribution i mean the odds that eat drops one percent in that scenario is probably really high so you'd almost like end up being in a in a liquidatable position regardless of whether you got the redistribution or not because of its volatility and so i think what zubin's question was is how much like what how do you decide the distribution of you know you're disputing both this debt and collateral to existing uh trove holders how do you decide like how much of it goes to which person i mean i i assume it can't be per trove because otherwise then i just open a lot of troves just to earn a lot of money that way yeah so the way it works is that it just

looks at the collateral amounts held by all the recipients like by every um active trove owner and it would just give you like a proportional share in proportion to your collateral um as a percentage of the total collector in the system like somebody let's say who has a collateral worth two thousand dollars and another person who has like collateral worth a thousand dollars now that like the trove owner with the two thousand dollars would get like twice uh the share of the debt but also of the collateral like it's really proportional to your own collateral does that make sense there's almost like

two tranches so so when it comes to like earning from liquidations right there's like two tranches right there's the people who providing the stability pool first and then if that gets depleted then it goes to existing trove holders is there a world in which like no one wants to deposit to the stability pool and everyone would rather just use their capital to provide cd to open more troves and like as long as they can like get other people to not put into the stability pool it ends up disability pool never ends up being used and it only becomes like this like that second layer tranche becomes the primary system so i think as long as the price of one

lusd is below one at 110 like which is a hard price floor sorry which is a hard price sailing i can explain it later but as long as the price is below the 1 10 it would mean that basically every liquidation would lead to a net gain for the stability pool providers or the stability providers so um just looking at incentives it's not really conceivable that nobody would want to become a stability depositor because you can there's free money basically on the table it's only like conceivable if the price exceeds 110 because then um like this kind of net gain for you as a

stability depositor is turned into a net loss but this is a very extreme scenario which we don't expect to happen exactly because we have this uh kind of hard price boundary at 110. so isn't there also additional rewards i think you might have mentioned where you get uh liquid t tokens lqty liquity tokens for being in the stability pool could you uh explain about that that seems very very interesting yeah so lqty is the sort of secondary uh token of the system it is not a governance token uh but it is a token that allows its holders to

sort of have a claim on fees in the system so as you're earning lqty for being a stability pool depositor you can then turn around and stake those lqty tokens in order to earn fees that are accrued uh from people who are borrowing from the system and then people who are redeeming for this from the system so those fees end up going to the staking contract and are distributed amongst the stakers ah so this is really interesting this is almost like uh the opposite of the paradigm that's existing right now right now we have lots of governance tokens which don't really get cash flows at least at this point but this is uh this is almost more like a token that does get cash flows but not governance

rights yeah and the reason there's no governance rights it's because there's nothing nothing to govern so basically um everything within liquidity is handled algorithmically from monetary policies to everything else so there's nothing to govern which is like kind of a blessing for some you know like governance governance processes can just be long and boring and frankly they could suck um and a lot of people don't enjoy them and a lot of that also has to do with the culture you've built around your governance and stuff but for the most part governance can be a really hard problem to solve for so if you can come up with a solution where you don't need governance and you don't need a community of people pretending they're the federal reserve or something like

that you end up in a pretty good spot so that's kind of our our opinion when it comes to that how do you do protocol upgrades without a governance token have you thought about uh lido liquity v2 how do you work on those kinds of protocol upgrades yeah i think our current headspace is that it'll be very similar to uniswap's approach where they deploy the system in an immutable way and if we end up doing a v2 later or maybe a v3 after that whatever we come up with one a migration plan and then two uh we end up launching a completely separate system um almost similar nature to what maker did when they went from single

collateral dye to multi-collateral dye or what unit swap did from v1 to v2 and then eventually v3 does the liquidity token act as you know in maker the other purpose of the mkr token is also active this like global backstop kind of thing does the liquidity token take on any such a role in this system or not really no it does not what i'm kind of seeing that what liquidity is doing is that in maker it's sort of every cdp is sort of this like standalone unit and they there's no sense that there's all these things are actually sharing a protocol but what's happening in liquidity is it's like hey

we're kind of taking the assumption that because some people are more conservative with their like collateralization ratio some people are want to maintain 300 percent ratios or something like that that they're they're allowing enabling some people to take on more risky ratios um and it has this sort of somewhat socialization of risk a little bit but then shouldn't the people who are taking on those higher collateralization ratios be compensated for that because so so currently you're saying that like the liquidation liquidations are getting given pro rata so once this ability

pulls out it's getting given pro rata based off of collateralization amount shouldn't there be some sort of weight given as well to the collateralization ratio where if you have a higher ratio you should be getting rewarded slightly higher than people with a even if someone has a higher amount collateral amount but lower ratio than you so yeah i think that's an interesting uh point which we also looked a bit into so i mean that would mean it would have like a super proportional or yeah not sure what the right word is like share of the liquidation gains if the stability pool is empty um now the problem with that is we have we are bound to some like implementation details around um like

keeping the troves in an ordered list because like it was quite tricky to do all this in a scalable manner like implementation was not easy as i can tell you because exactly due to the fact because the troves are so interrelated and interdependent rather than just being standalone um beings um and for that matter i mean it was just it's not possible to um do any kind of redistribution that leads to a reordering like that may breaks the ordered list because some troves would then um suddenly like get like a higher or lower collateralization ratio than their neighbors in the list

and it turned out that like the way we do the redistribution is more or less the only way it's not the only way but it seems to be that there's only a very thin design space that allows you to redistribute that and collateral in an order preserving way one thing i wanted to ask about um shifting gears a little bit you would mention that lusd uh has a price ceiling of a dollar 10 cents it seemed like that was one of the the weaknesses of uh of maker in a liquidity crunch is that dye can be trading far above its peg um you mentioned that you have like a hard ceiling how do you

kind of create that that mechanism yeah so it's basically a simple arbitrage cycle that becomes possible thanks to the 110 collectorization ratio because when the price of one usd of one lusd is above 110 then you can basically take out the maximum amount of debt that you can get from the system against your ether collateral and sell the lusd on the market for a price that's higher than basically the value of your collateral so you can theoretically even forget about your collector because it doesn't matter for you whether your trove gets liquidated or not because you already made

a profitable transaction just by opening a maximum uh collette or um lowest collateralized strobe and selling uh your lsd right aren't there the flat uh issuance fees that we talked about earlier though that would make it effectively higher than one dollar and 10 cents so that's right so it's basically there is this 0.5 percent in like like because we cap it at 0.5 percent as a minimum but whenever there is a situation where this happens then we can be more or less sure that um the fee would be around this 0.5 percent

because like the way we set the fees or the way that the protocol like said the fees is by measuring the amount of redemptions or the redemption volumes and redemptions only make sense if the price is below one dollar so nobody would redeem is the prices above 110 so that means that the fee would eventually relatively quickly go back to one 0.5 percent which as you like uh correctly mentioned would mean that the price saving is not exactly at 110 but at 1 10.5 as also with the price uh floor there we also have the redemption fee which makes it a little bit fluffy so we have like both sailings and floors or they

are like a bit not clear lines i would say i i guess we should talk then a little bit about how this like uh these fees are decided and so you know as you mentioned this is meant to be governance minimized this is done purely algorithmically um you can talk a little bit about how about this algorithm how is this done and like how do you have a purely algorithmic like input into what the price of lusd is so the main way is that we can measure like the redemption volumes uh and by volume i mean the volume

uh in proportion to the total uh supply like the total alias z supply uh can be set uh in relation to the redeemed amount or the redeemed amount in relation to the total luc supply and then based on this fraction uh we can determine like the amount by which the fee needs to be increased like we have a base rate which serves as the base this for both the so do you mean like over like a over a window like you're saying like oh in the last 24 hours this is what percentage has been redeemed or what do you what do you mean by fracking so actually yeah so actually it's like every single redemption

uh is like effects like some percentage of the total usd supply now what we do is we take the current base rate and we add basically the redeemed fraction of the total supply times 0.5 which is a constant parameter we add this to the current base rate so let's say the base rate is at one percent and now somebody redeems two percent of the total alias d supply then we we calculate 0.5 times two which is one we add one to one which gives us like two as the new fee like and then it would decay over time how long is this window for decaying yeah so for the decaying we we just uh

set like a half-life of eight hours um but we are still like tweaking the parameters so um that's something we are still finalizing but i would say it would this one will stay uh probably at eight hours so it would just go down by fifty percent by it in eight hours why use this sort of indirect calculation of like you know trying to estimate whether what l usd is trading at instead of just using a oracle like you know using unisopt wap or if you're already using chain link for like your eth price why not just have it also tell you what lusd is trading at so this is also a bit like a chicken and

egg problem if you want to use an external oracle for something that you are just issuing or creating because i mean chaining doesn't have come with like an luc oracle um in the first place so you first need to have some kind of token that gets large enough uh to be like have a large enough market cap in order to be sufficiently traded so that you can get like a reliable price from like uni-swap or or an off-chain oracle so we think that by measuring our own like transactions or the redemptions we can basically just use what we already have as a signal we don't need to rely on something where there is just less

liquidity because i mean if only five percent of the lusd supply is let's say in a unisop pool then it's much easier to manipulate that price because you only need to manipulate a fraction of this five percent then in our system which basically measures redemptions as a percentage of the total alias d supply so we should have a much higher resilience against manipulation if we use our own numbers zubin had a interesting uh attack that he was thinking about which is can you hold like the whoever has the lowest collateral ratio can you hold them hostage by like

threatening to redeem against them and like if they want to regain their eath exposure then they have to go keep adding back in eath and have to keep paying that issuance uh base fee and so is this like an issue maybe zuma maybe you want to explain the attack better than i did so it's not necessarily an attack it was like can what i was wondering is like there are some kind of for being the lowest uh vault or trove there are some kind of stresses that you put against the system that you should have to pay for so i'm wondering like economically if there are ways for the system to extract that from you so for example um anyone could redeem against like a

very low collateralized vault which is good for system health but is bad very likely bad for that that individual because that individual wants that eath exposure and so in order to get that exposure they're going to have to pay an issuance fee again right so basically they don't want to pay the issuance fee so they would pay up to the issuance fee to a to a contract which like threatened to um redeem against them if they didn't pay uh like this this this floating rate that was like a that was like a weird

thing that i was thinking about does that make sense i can like reiterate what exactly that means so yeah i'm not 100 sure but maybe i mean like the idea here is that you should always be like exposed to redemption risk if you are the lowest trove and the price is below one dollar minus the redemption fee so that's like a situation where the system where like it's the feature not a bug that redemptions would happen because that's what we want we want to like reduce the total currency supply by um burning lusd and by making it maybe costly to reopen a new position because we don't want people to just being

redeemed against and then immediately reopen the same position because that would be a zero-sum game so in those scenarios we want that now i'm not quite sure whether you're referring to a situation where the price is above one dollar or maybe exactly at one dollar and now somebody wants to do harm to some uh trove owner at the lower end of the scale yeah so so there's a few things there i think like one thing that was interesting that you mentioned um it seems like a big motivating factor for liquidity is for in order to allow uh much lower collateralization ratios um but at the same time it seems like if you're at 111 percent 115 percent 120

um there are all these things in place to uh for example redemption the this mechanics we just discussed to discourage you from being that uh that like least collateralized or being near 110 what do you think is like an effective rate right that uh people should aim for then right because it seems like you know at 111 112 we want people to get redeemed upon because it increases the health of the system what is the rate then that you see is like truly healthy for the system to a certain extent yes so i think here we we looked a bit

at the numbers from like our competitors and we saw that like let's say the maker system normally hovers around 300 percent collateralization or at least a single collateral die had this kind of average now with multi-collateral its work really it depends on the collateral type so it's hard to compare but for ether i think 300 percent on the maker system is not just an average but it's also something which is relatively safe now in our case we don't need that much because we have this faster liquidation but what you can see there is that the 300 percent is basically twice the minimum like it's two times the 150 minimum so in our case that would

translate to 220 which is uh two times 110 so i think 220 would be like the lower end of where we would consider our system to be safe but we would generally recommend or hope that it would probably hover around 250 percent so over time but people are crazy these days so who knows it's hard to tell yeah that's super interesting yeah yeah and i think it's an interesting point i just think it's interesting point that i mean you really get more leverage for the same amount of safety because of the 110 minimum so that's the important fact to consider you definitely don't want to be hanging out around 110 just because it exists but if

you're a maker user who is used to a 300 collateralization ratio you can transfer over and you know hang around 250 220 and take advantage of better capital efficiency that way right and it seems like there's a trade-off there you get a better liquidation uh ratio that makes you feel comfortable as an individual to not get liquidated but you also have uh these other kind of variables to think about redemptions etc so it'll be really interesting to see the dynamic between like maker and trove and uh on on liquity and see what kind of market forms between people

shifting back and forth do you think this will become like a much harder or higher mental overhead for like people trying to open positions on liquidity because you know in maker i just have to think about the only thing i have to be thinking about really is the eath price but now here in liquidity it seems that there's like all these different things i have to start like paying attention to i have to pay attention to you know how many people are redeeming lusd i have to look at you know what is the over the global collateral like ratio i have to start paying attention to what is this like stability pool rate because you know things in the system act differently like this is so much more i have to be paying attention to and do you think

this is a higher cogni this is gonna this cognitive overhead is gonna cause ux issues it's possible but i also think you know users are starting to become more advanced so they want more advanced access to leverage um i i think we've done a pretty good job in explaining how liquidy works like within our documentation explaining how it works within the uis we've made available and i think people are um i think people are going to get the hang of it you know like like all new things um they come with headaches sometimes sometimes they don't um and it just depends like are people willing to sacrifice um capital efficiency for maybe like

one one or two more things they have to consider right and i even think i'm not totally convinced that redemption risk is like this massive risk that people will have to be thinking about all of the time because it only comes into play within certain situations and you know i would rather be protected in those situations anyway so i don't think it's something that will be just constantly prodding in the back of their head as soon as they kind of get the hang of the system and maybe one thing i would add to it is that we can also think of the market in of the like the borrowing market in segments so for those who are willing to be on the safer side like maybe have a position that's less

capital efficient um those people only need to maintain um a collateralization ratio above 150 percent which is what they are used to from like using like ether a on maker so they don't really have to worry about anything else because it's practically impossible that they would get redeemed against and even if the system enters recovery mode they would be on the safe side it only affects like those risk seeking people who are already like um maybe more djinn or more um yeah just trying their their luck so i think those people they folks they they will need to be a bit more cautious or a bit more attentive to those changes but

i mean there are also troll automation tools that we encourage uh people to build for our system and uh and at some point we assume that this will all be automated like at least uh like the sophisticated borrowers would use those kind of two links carlton i heard you mentioned the uis uh so i i know that a lot of your docs you guys talk a lot about uh like you know incentivize front ends and things like this so uh why like you know i i know like a lot of people care about like you know decentralized front ends like you know uta swap has a number of front ends and things like this but like you guys seem to put a lot of stress on it so why is this such an important focus for you guys i mean one of them is philosophical the

big one of the cornerstones of liquidity is decentralization and immutability and so one of the best ways to achieve that is not only at the protocol level but at the front end level too right like if you have one access point to your entire protocol and somebody shuts it down or you have like a dns hijacking or something you never know what happens these days all of a sudden you put all of your users at risk and the other side of it is we're starting to see the market evolve such that interfaces like xerion and zapper and argent are starting to become more popular than the interfaces of the protocols that they're plugging into so these like third-party front-ends are becoming a sort of staple in the industry and we think that one those are important but two it's

also important to incentivize those and not many people have really given that a try uh we're kind of the one of the first ones i think yarn is starting to experiment with it a little bit i know xerox tried it way back in the day but the incentive mechanism was uh maybe not completely fleshed out at the time so i think that's one of the big reasons we want to focus on it is because one we can maximize decentralization not only at the protocol level but the sort of product level where you people actually access the protocol but two we can find a way to incentivize uh this new like sort of budding segment of of the crypto industry yeah i thought that was really cool um so how does that mechanism work how is it like a dow that's giving

liquity lqty tokens from my understanding it's not it's actually built into the the protocol yeah it is actually built in so we have this uh basically pool of lqty rewards that is going out to stability pool providers how that works for front-ends is that whenever they facilitate a stability pool deposit through their front end they tag it with an ethereum address that's associated with their front end and it tracks the rewards of the users that they uh sort of bring in to the system and it also applies another thing called a kickback rate which specifies how the rewards are split between the users and the front end who facilitated that user's deposit

so let's say i have a kickback rate of eighty percent i'm a front-end you guys all deposit through my front end i'll receive 20 of the rewards that you guys earn over the course of of your participation in the stability pool and so that's distributed straight to my ethereum address as um as my users earn those rewards got it would you expect to see kind of front ends competing for four rates yeah exactly we expect to see um the sort of kickback rate to be a competitive market but also the features you offer your users to be a competitive market so two things to touch on really quickly we provide

a front-end launch kit which is basically this cookie cutter template that anybody can deploy just from the command line it comes with built-in features and stuff but we also provide a front-end sdk for more maybe advanced products who want to integrate liquidy into their existing system and so those two types of um ways to build a front end will also have a competitive advantage so if you're launching the cookie cutter thing that we provide and you try to say like i want all the rewards i don't think anybody is going to be excited to use your front end but if you provide a custom integration maybe with some custom tools then people are going to be more willing to accept you know some kickback rate that is a little more favorable to the front end so we expect those two

aspects of it to be an interesting competitive market another thing i kind of wanted to ask um especially for you colton was what is the growth strategy right there's there's so many moving parts and making a stable coin platform to be highly liquid uh and there's so many moving parts for also the borrowing aspect and and you have also a stability pool on top of that uh and lqty uh as well how do you bootstrap all of these different parts of the protocol um and and make this a really liquid experience for users yeah that's a good question it's something we think about a lot too because i think

you know it's really interesting the state of the industry now is that you kind of launch this governance token and you expect like a community to just pop up around it and it's kind of like the it's like low-hanging fruit um a lot of the time these days and so since we don't have that approach uh we really have to focus on building these like paths to success for all of these different users within the ecosystem and so what i've really been focused on is building this sort of foundation for a community to grow whether you're a borrower an arbitrage or a staker a front end like you need all of these different resources to actually succeed and so that's where a lot of our focus has been we think that the front end rewards scheme will help a lot on the adoption front but also on

the user acquisition front and as far as liquidity goes we plan on providing some lqti rewards to an lusd eth uniswap pool to help bootstrap liquidity for the first six weeks and then from there we want to pursue ecosystem integrations outside of that that we think will be beneficial for the growth of the ecosystem so you know like curve integrations maybe shell protocol etc there's a bunch we've been considering and looking at um and more pop up each day so that that's where we've been looking first focusing internally and making sure we have everything set up and ready to go for launch for a community to grow and thrive and focus on things besides governance so they can kind of succeed within the ecosystem

and then we want to start pursuing integrations as best we can in ways that benefit liquidity one thing i also wanted to ask was kind of uh how you think about the regulatory question and especially having a token lqty which will get cash flows how are you thinking about these kinds of questions and and creating a decentralized protocol as well the different regulatory regimes that exist yeah that's also an important point for us and uh i think you are um referring here or you may be referring to like u.s securities laws security laws because like there it could matter whether you are issuing a token that has some like

reward capture mechanism or not but i think here we are taking a little bit of a different approach so what we are really trying to do is making sure that the token is sufficiently decentralized and not just the token but also the whole system and including the front end so that it doesn't really matter what your token is because the entire protocol is so decentralized that there is nobody who is like really an issuer i think that's um like the point now i know there are like systems which have like this opinion that oh they are just giving out a governance token and that's not a security and that's it and they are like somewhat more centralized because they have their own

front end and they they maybe they even have like majority voting rights or at least like a large impact on the votes uh through their like own tokens but i think that's yeah that's also a dangerous strategy because i mean a governance token can easily be turned into something that gives you a cash flow and and i think that's like eventually the goal i mean we've seen it with uni swap that they now have like or even in version two they have some kind of mechanism for um diverting some income to um the token holders like the uni token holders so i think our approach is really about decentralization which we think is um the way to minimize legal risks and then one other question kind of

around this how how did you kind of bootstrap uh your team and uh how do you like fund development uh especially without a dow that can give uh you know give rewards to to developers so i mean we are mostly vc funded um so that means we we had a few uh two um like rounds of financing which gives us um a nice runway so that we can also like see what we want to build in the future but uh currently we are really focused on just uh releasing and launching this uh liquidity protocol and

and yeah i mean we are now not that much worried about like fundraising anymore or at least for the time being yeah and it helps that we're we're quite a small team there's about eight of us so it's not like we're having to fund like you know 20 plus developers or anything like that we're pretty scrappy and so what's the roadmap here so you know you guys aren't launched yet but should be coming soon i believe right so i think this week okay um so if it comes out after today i guess uh we could share that the official launch date is april 5th uh which we haven't shared which we plan to share

uh actually shortly after we finish recording this so that'll go out um today the roadmap so far has been wrapping everything up we were able to uh fit in another audit in march um i think it was three weeks with coinspect and then after that the plan is to uh ship it and make it go live so and so where can uh people learn more and connect with and you know uh do you have like some community channels that you wanna suggest or where can people just go learn more about the information and launch and all that kind of stuff yeah definitely the best place is liquidy.org and then we also have docs.liquidy.org which we think is quite extensive for mostly an faq and then we also have

technical documentation that you could find through that faq so anything you want to learn about liquidity you could do so through there hopefully if not anybody feel free to reach out and ask questions and we'll get them added we also have a community discord which is relatively active we also have a chinese-speaking telegram group that is quite active as well so if you're international in that way feel free to participate there um and then twitter we're at liquidy protocol i believe so those are the main main sources probably more to come but other than that those are the best ways to keep up well thank you guys so much for coming on and sharing what you guys are building and really excited to see it come a lot come live in the next couple weeks

likewise appreciate it it's great to be on the show thank you thank you for joining us on this week's episode we release new episodes every week you can find and subscribe to the show on itunes spotify youtube soundcloud or wherever you listen to podcasts and if you have a google home or alexa device you can tell it to listen to the latest episode of the epicenter podcast go to epicenter.tv subscribe for a full list of places where you can watch and listen and while you're there be sure to sign up for the newsletter so you get new episodes in your inbox as they're released if you want to interact with us guests or other podcast listeners you can follow us on twitter and please leave us a review on itunes it helps people find the show and we're always happy to read them

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