Hey folks, if you’ve been following me for some time, you’ll know that I’m an extremely big fan of . From their success of creating one of the best immutable and fully decentralized stablecoins($LUSD) that has withstood extreme market rigors, it should also come to no surprise that there is a great deal of hype of what they have in store for Liquity V2. If you’re unfamiliar with what Liquity is, I highly recommend that you check out one of my previous articles where I explain V1’s mechanics before going further.
With how beloved Liquity V1 is, it should be noted that Liquity V1 is not going anywhere, and in fact as one of the most decentralized and trusts protocols out there, I suspect that Liquity will continue to be highly utilized and highly forked. Due to its market-tested success, it should come to no surprise that Liquity is one of the top 5 forked protocols out there and I would imagine that there’s more coming down the pipe:
Decentralization has always been at the heart of Liquity, and that isn’t going to change. V2 will build upon some of the back bone existent in V1, but essentially become a reserve-backed protocol that incentivizes all of its functioning parts. In a way, Liquity will become sort of a decentralized version of Circle (the parent company who controls $USDC), except instead of yield and money circulating mostly at the top, yields will instead be flowing throughout each member of the V2 Protocol. Let me explain…
If you’re unfamiliar with Circle and $USDC, essentially Circle takes your fiat and issues you $USDC. Circle will then take all the fiat and earn yield through the U.S. Treasury (roughly now at around 5%) in order to turn a profit. Conversely instead of taking $USD, Liquity is taking users’ $ETH (and now also Liquid-Staked $ETH) and dispersing that yield amongst the protocol — position holders, stakers, stability pool entrants, etc. In a decentralized manner, Liquity V2 aims to become a reserve-backed protocol where everyone is incentivized to participate through the yield generated by the underlying assets.
And as we’ll dive into this article, with brand new features and some original ones that have been tweaked, it’s very evident that the Liquity team has been working intensely on V2, with the goal is to make V2 just as immutable (and just as unstoppable) as V1. Let’s dive in shall we?
The New V2 Features
There’ll be a stablecoin for Liquity V2, but it won’t be the same $LUSD from V1. The one of V2 will earn #realyield.
One of the big catalysts for creating V2 was to solve the stablecoin trilemma, and make $LUSD (Liquity’s native stablecoin) more scalable with a better peg.
On V1, $LUSD was as decentralized as a stablecoin could be (completely controlled by code, minted with $ETH collateral), but there were always some concerns with efficiency as $LUSD could depeg, albeit temporarily and also with the feasibility for $LUSD to be minted or redeemed. On V2, the new stablecoin will essentially be reserve backed with yield essentially getting shared to incentive all parts of the Liquity V2 ecosystem. In other words, stablecoins can also be staked in order to earn yield, received from the underlying $ETH yield by V2’s reserve.
Liquidation free leveraging
Liquity V2 also has the potential for users to re-think how collateralization and lending work, possibly allowing users to leverage up their positions with minimal risk.
The key feature that will be introduced in Liquity V2 is its ability for users to open leveraged principal protected positions— a way for holders to deposit their staked $ETH into leveraged long positions, yet who are able to exit at any time without fear of getting liquidated, regardless if there’s a market downturn and there’s a loss on the underlying assets.
To note, in order to enter a principal-protected position, there is a fee that the user needs to pay, but we’ll get into a bit later.
Wait…how can V2 work if positions are undercollateralized?
If a position falls below a designated collateralization ratio, instead of getting liquidated (as they would in Liquity V1), a secondary marketplace will be created in V2 where these underwater positions can be bought or sold essentially like they would via OTC/p2p, thus not impacting the price or amount in Liquity’s reserves. If there are no offers to buy the position, Liquity will step in gradually adding more and more incentives until the position is eventually sold.
The “incentives” that Liquity provides will primarily be funded by premiums that Liquity collects from users that pay for the principal protection in the first place. These premiums are collected once a person opens a principal protected position — they pay a dynamic fee that increases or decreases, dependent upon their collateralization ratio and the collateral price — if the collateral price falls the premium falls and vice versa.
The proof will be in the math
In the coming months as more details roll out, it will be interesting to see how exactly the premium dynamic pricing will work, and if it will be enough of an incentive for people’s underwater positions to be sold. I don’t believe an official statement has been released about how much the premiums will be, but an example given in an earlier interview with co-Founder Robert Lauko, was a a 2 $ETH deposit on top of a 10 $ETH deposit. It’s doubtful that this will be the exact ratio to be set, but what he did allude to though however, is that in market down turns, premiums could be decreased in order to incentive more liquidity coming in.
My take: I feel like this is one of those things that might sound good in theory, but we won’t actually find out until it happens. If $ETH suddenly tanks and loses more than 90% of its value, I imagine that it would eat up a lot of protocol costs to cover some of these underwater positions, especially if the protocol isn’t generating as much money in premiums because they were reduced before. Regardless however if there really was another 90% collapse, I think we would be dealing with a lot more headaches and questions than if simply V2’s model was successful.
Another question remains as to whether or not the market demand for degenerate leveraging will outweigh the pressure on solvency. What I suspect that the Liquity team is trying to figure out right now are these exact scenarios — how our degenerat eindustry might behave given certain market pressures, including when are we likely to sell, when are we likely to buy, etc. There’s a better chance for V2’s success if they can accurately gauge how significant the demand is to open these leveraged positions up, and whether or not it will outweigh the risks taken in doing so in order to generate enough premiums to fully stock its reserves in order to prepare for when people exit.
Tweaks on original Features
With some big fundamental changes coming V2, the team has also been able to admit that some of the forks have been able to innovate on top of Liquity’s original model, and these features (in addition to lessons learned from V1) will most likely be upgraded and introduced with the release of V2.
Liquid Staked $ETH — on V1 you could only borrow against $ETH, but in V2, you’ll be able with both $ETH Liquid-Staked $ETH, although there hasn’t been mention of which version(s) of Liquid-Staked $ETH that will be. (My guess is Lido’s).
Collateralization Ratios — will still be present to help ensure overall protocol health yet at a possible slightly lower rate (105% LTV) which would result in better capital efficiency and more borrowing power.
Stability Pools — There will still most likely be stability Pools in V2, yet with its core function to help back the reserve and loans, rather than liquidations.
Liquity’s V2 won’t be rolled out until at least Q2 of 2024 so as they’re still continuing to run some of the numbers, I imagine we’ll see more updates and/or changes until then. Personally I’m extremely excited about the idea of principle-protected free loans, but I also still have my it’s-too-good-to-be-true doubts, and I’ll actually have to see it work live with my own two eyes. If you have more questions about what V2 has to offer, I recommend stopping by the #V2 channel on Liquity’s — most likely the same questions have already been asked, plus they post all the latest updates/releases/interviews that have come up with different team members in regards to V2’s progress.
as always, thanks for taking the time to read this and be sure to follow me on twitter (https://twitter.com/CryptosWith) to get all my latest updates. If you want to get access to all my draft links or get an idea about what’s next on my docket before I publish, find me on Friend.tech, where I share all that information in my chatroom. Also, looking for a gift for your Crypto-loving/hating friend? Give them a REKT journal to cheer them up!
Disclaimer: And as a final reminder, this is not financial advice and this is for educational and entertainment purposes only. Please as always, do your own research and find what investments are best for you. Cheers everyone!
