Liquity: Q4 Quarterly Report 2022

While the bear market dragged on, and in some ways intensified, DeFi mainstays like Liquity continued to prove their resilience by operating uninterrupted through quite the turmoil. The quarter by quarter picture of the increases in troves, ETH locked, integrations, and liquidity in this report should serve as a great example. The key takeaway remains: Liquity isn’t going anywhere, and while volume is partially reliant on the sentiment surrounding ETH and market appetite for leverage, the utility that LUSD provides as a decentralized stablecoin is evergreen.

Below, we will present and analyze the key health and usage metrics surrounding Liquity in Q4, cover the impact of Chicken Bonds over its first quarter of operation, and highlight the integrations that are expanding LUSD’s utilization across the DeFi landscape. The following is our Q4 report for the Liquity protocol.

Perhaps the most exciting development of Q4 was the expansion of LUSD liquidity venues, especially when it came to optimistic rollups and lending protocols. After seeing significant usage on Optimism over the past two quarters, LUSD makes its debut in the booming Arbitrum ecosystem. Decentralized lenders are primed to scoop up market share after the exit of CeFi players like BlockFi and Celsius, and many of the top protocols are incorporating LUSD into their systems.

1. LayerZero’s Stargate bridge, which allows users to quickly move native assets across chains without the use of wrappers, added LUSD transfers from mainnet to Optimism, and will be doing the same for Arbitrum early in Q1 2023. With L2s becoming increasingly popular, this streamlined access to cross chain LUSD will make it easier to bootstrap new pools and deepen existing ones.

2. Camelot Dex has added an ETH/LUSD pool incentivized with $GRAIL rewards, marking LUSD’s entry to the Arbitrum ecosystem.

3. The integration with Velodrome remains strong with LUSD pools frequenting the epoch top 10 bribes list, and APRs for stable and variable pools looking healthy relative to similar pairs.

4. Back on mainnet, the new Liquity Trinity pool was launched on Balancer in late November, pulling in over $400,000 in LUSD, ETH, and LQTY liquidity over its first month. This pool was also introduced on Balancer aggregation platform Aura Finance, which now contains over $320,000.

On top of the increased liquidity, multiple lending platforms also integrated LUSD as collateral. The highlights which were:

1. Gearbox introduced the use of LUSD/3CRV LP tokens as collateral with the launch of v2.

2. Silo Finance now offers LUSD and LQTY collateralized borrowing.

3. Euler added LUSD as a cross tier asset, & LQTY to its isolated borrowing markets.

4. Angle, which also offers LUSD collateralized borrowing, removed minimum borrowing requirements to make agEUR more accessible.

The two essential charts to analyze when discussing protocol utilization are active trove count and ETH deposits. Trove count gives an approximation of user base growth, while ETH deposited will show the amount of capital entering the system. Visible gains in both metrics from Q3 to Q4 can most likely be attributed to increases in appetite for leveraged long ETH exposure, as well as desire to hold LUSD given the existing and new yield earning capabilities (Chicken Bonds, new pools).

Total LUSD supply was also slightly positive in Q4, which directly correlates to ETH deposits and ETH price.

Total supply rose 3.8%, or ~6 million LUSD, which is a solid figure in its own right during a bear market, but looks much more impressive when compared against fellow CDP protocol MakerDAO’s DAI supply numbers. DAI supply over Q4 dropped 15% from 6.8 billion down to 5.8 billion.

While LUSD’s design allows it to safely oscillate within the soft peg range of $1.00-$1.10, keeping the peg as tight to $1.00 as possible is ideal for maximizing its utility as a stablecoin. Previous reports have explored the “decentralization premium” where stablecoin holders seeking insulation from the centralization risks of USDC, USDT, and to some extent DAI, are willing to swap to LUSD at a higher exchange rate. This dynamic was seen once again among the market turmoil of November, but price stabilization has since returned due to increased liquidity. Driving factors include the increase in LUSD supply, deeping of liquidity on exchanges such as Curve, and the introduction of Chicken Bonds which will be further explored in the next section.

Now that Chicken Bonds have been live for a full quarter, there’s a bit of clarity regarding how the system is being utilized, the level of demand for the boosted yield offered, and how beneficial it is to the protocol involved (Liquity for now, with expansions to other protocols and DAOs in Q2 of 2023.) All metrics for CBs are quoted in LUSD. For an introduction and deep dive into CB mechanisms and strategy please see the Frogs primer report.

Starting off with TVL growth, we can see that there was a good chunk of early adoption upon launch, with 7 million LUSD flowing in during the first week. This remained stable for the next two weeks, presumably due to the 14 day post-launch moratorium on chicken ins/outs, as well as the DeFi community waiting to see some early outcomes before bonding themselves. What followed was a 10x surge in TVL over the remainder of Q4, bringing the total to just over 70 million LUSD by year’s end.

The most vital component of this chart from a protocol perspective is the blue area at the bottom, representing the 960,000 LUSD accrued to Liquity in the highly desirable form of protocol owned liquidity. This allows for deeper liquidity in the primary venue for LUSD swaps, the 3CRV pool, which in turns brings LUSD price closer to its ideal $1.00 peg. The ingenuity of this PoL acquisition mechanism is no doubt one of the main reasons CBs were considered DeFi Breakthrough of the Year by the Defiant.

As is its intended nature, bLUSD floor price continued to steadily rise due to the increase in redemption value as the treasury earns yield. Over CB’s first quarter in action, the floor price has risen by a quite respectable 10%. It’s also interesting to note the relationship between market price and “fair price” throughout the quarter, as fair price is calculated based on the yield amplification properties of bLUSD vs. standard LUSD. When this fair price is higher than the going market price for bLUSD it indicates that the market may be undervaluing bLUSD given its future yield earning potential. This pricing model, developed by RiskDAO, attempts to solve the difficult task of accurately pricing bLUSD. However, as demonstrated by the chart below, the market’s views on bLUSD value are often divergent from this model. This chart as well as the development of optimal bonding strategies will be interesting to keep an eye on over 2023.

Looking at the liquidity for bLUSD on Curve, it can be seen that there was a large spike in December, which was catalyzed by the activation of CRV gauge rewards for the pool. This governance decision was a big win for bLUSD liquidity, with the primary reasoning behind the proposal being the 3% chicken in fees that are directed to the pool’s LPs, as well as the potential for additional bToken pools to trade on Curve once the CB system is deployed for other protocols in the future. TVL for the pool currently sits at $16.2 million, and APR is quite healthy at 3.33% in CRV rewards plus 4.022% in LUSD. Usage has seen a significant uptick as well, with 24 hour volumes frequently over $500,000 since gauge activation.

This has also resulted in a growing bLUSD presence on Convex, where the corresponding pool has garnered $8.7 million and boasts an 8.64% APR. This combination of liquidity attraction incentives, along with the boost received from chicken bonds POL, should continue to dampen volatility within LUSD heading into the new year.

Q4 was defined by the self-imposed destruction of CeFi, but true crypto natives recognize the immense opportunity for DeFi that lies in the aftermath. While Liquity’s utility as a provider of truly decentralized borrowing and stablecoins was never in question, the exit of centralized pseudo-competitors has opened the door for wider adoption of the protocol. Q4 metrics across the board trended in a positive direction, as usage increased, liquidity got deeper, and the LUSD peg tightened. The team has delivered what is shaping up to be a breakthrough system for POL acquisition with Chicken Bonds, and it will be exciting to see how adoption by other protocols and DAOs takes place in 2023. Layer 2 usage of LUSD has been quite strong on Optimism over the past few quarters, and moves are being made to replicate that success on Arbitrum. Further integrations across DeFi will only accelerate this process.

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