Updated: Dec 13, 2022
Imagine this: Pulsechain goes love and you put $1000 into Pulsechain’s native token, Pulse (PLS), only to see it do a 1,000x. Yes, you now have one million dollars! Feels pretty good, doesn’t it? Now, you probably want to treat yourself with something nice, but the problem is you now must sell some of your beloved PLS to take some profits, even if it’s just a few thousand dollars of your total profits. Those tokens are gone from your bag until you decide to put money back into PLS; Hopefully the price isn’t much higher than when you sold as it may cost you far more to get the same number of tokens you sold.
This is the unfortunate truth about most cryptocurrencies or investments, period. You finally get your sweet, sweet gains only to have to get rid of the very thing that made you the money, which could be worth even more in the future if you hold.
So, what if there were a way to utilize your PLS tokens as collateral to take a stable coin loan with no scheduled repayment terms? What if this protocol, also allowed you to make passive income to earn more of the same stable coin you loaned plus PLS tokens? What if you could build a passive income generating machine that allowed you to never have to sell your original investment?
Introducing Liquid Loans: the first truly decentralized lending protocol built specifically for Pulsechain. It has an algorithmic stable coin, low 110% collateral ratio minimum, no repayment schedule, no admin keys, no governance, and is completely immutable. It solves many issues that most stable coins run into, helps against sell pressure for the PLS token, and adds a way for users to make passive income utilizing two different staking pools. Oh, and depending on where you’re from, taking a loan may not be taxable. Do your own research and find out for yourself because this is not tax or financial advice.
Liquid Loans opens a whole world of possibilities in terms of passive income and growing your portfolio through numerous strategies. Before we dive into exactly how you can utilize it, let’s look at how it operates.
There are 5 main pieces to the system: Vaults, Redemptions, The Stability Pool, the Staking Pool, and Recovery mode.
To take a loan using the Liquid Loans protocol, a user must place a Minimum Collateral Ratio (MCR) of 110% PLS collateral into a ‘Vault’ to receive the USDL tokens they want to receive as a loan. The minimum amount of USDL that can be borrowed is $2000, meaning the minimum that can be deposited in the in the vault is $2200 in PLS. To retrieve the PLS tokens back, the $2000 USDL plus a fee must be repaid before the vault can be closed. This fee ranges for 0.5%-5% and fluctuates based on how much USDL is being redeemed for PLS within the system, more on the redeeming mechanics later though. When a loan is repaid either through liquidation or repayment, the USDL that was used to pay off the debt is burnt from supply. If a vault has a 0.5% fee for borrowing, this fee is attached to the total debt of the vault and only needs to be paid when paying the total debt out. For example: if a user Places $5500 of PLS in a vault at a 110% collateral ratio, they would be able to withdraw 5000 USDL. The total debt needed to pay back the loan would be 5000 USDL + a 0.5% fee for a total of 5025 USDL required to pay back the loan and retrieve the PLS tokens put up as collateral.
With each creation of a Vault, a 200$ deposit from the collateral is taken and reserved in the form of USDL. This $200 will either be returned to the owner of the vault once the debt has been repaid or given to a user who liquidates the vault if the vault collateral percentage falls below the 110% minimum. This deposit is the same for an amount deposited as collateral and is a one-time event.
If the collateral of a vault falls below 110%, the vault can be liquidated by anyone. If this is your vault, this means your debt is paid off by USDL from the stability pool and your PLS is distributed to stakers in the stability pool. You are left with the USDL that you loaned and have forfeited your deposit to the user that paid for the gas fee to liquidate your vault.
So, when it comes to creating a vault, the higher your collateral percentage the better. Liquid Loans recommends at least a 250% ratio; however, a 250% ratio can only withstand a 56% drop in the price of PLS before it hits the liquidation point. It is important to pick a ratio that allows you to feel comfortable with not having to watch the price every single day, however if you are participating in this protocol, you will want to be monitoring and maintaining your vault over time. This is not a set it and forget it protocol unless you are putting +5500% PLS collateral in your vault, as at that point you could survive a 98% drop before hitting the liquidation point.
To see what different collateral percentages of vaults can survive in in terms of a price drop, click the link to this file:
That being said, even if you can withstand a 98% drop to stay above 110% collateral, the system has what is called Recovery mode, where all vaults below 150% are liquidated to some degree. More on that later, but for now let’s move to the USDL Redemptions.
Within the protocol, there is a redemption function that allows for one USDL to always be redeemable for $1 in PLS tokens. This function is the first form of defence in the system to prevent user vaults from becoming liquidated when their collateral ratio falls below 110%.
When a user wants to redeem their USDL for PLS, the USDL used to redeem goes towards paying off some or all the debt associated with the riskiest vaults in the system – vaults closest to the liquidation point of 110% collateral. When this happens, the redeemed USDL lowers the total debt in the vault and in return, removes the equivalent amount of PLS in the vault and issues it to the redeemer. There can be partial redemptions which lower the debt and collateral equally but keep a vault open, or there can be full redemptions which pay off the debt in its entirety and close the vault.
Let’s look at a scenario to understand how this works when a debt is fully redeemed against.
If a vault has 150% and is fully redeemed against, 100% of the debt is paid off. Since the collateral was set to 150%, there will be 1/3rd of the total collateral value in PLS remaining after it has been redeemed. This value in PLS can be claimed by the vault owner in a surplus pool any time after the vault has been closed.
This mechanism is a way for the system to prevent users from getting liquidated and losing their funds.
Maybe now, you might be asking the question: what prevents endless redemptions from happening in the system? Here is where we would normally get into a rather complex equation, but for the sake of this write-up and our brains I will summarize the effects. Essentially, based on the last number of vaults created or redemptions made, the base fee for a redemption starts at 0.5% and will rise based on how long it has been since the last redemption or vault created. Unlike the vault, there is no cap on how high this percentage can be. This increasing fee disincentivizes redeeming to allow the market to resolve any issues after a certain point in time.
The main incentive to redemptions is an arbitrage opportunity where a user can redeem USDL for more PLS via the system, than on the market. When the fee’s climb too high or the price on the market returns close to its $1 peg, the redemptions will be less incentivized or not incentivized at all.
The Stability Pool
The stability pool is both a tool for the system to keep itself in perfect working order and a staking pool that allows users to generate yield in the form of PLS and the secondary system token LOAN. Users can participate in this pool by staking their USDL tokens that were either loaned or purchased off the market. There are no required lockup periods or stake lengths that you must serve to earn rewards.
The Stability Pool maintains system solvency by utilizing USDL in the pool to pay and liquidate any vaults that go below the 110% Minimum Collateral Ratio required by the system. When a debt with a collateral percentage under the 110% minimum is paid off, this removes the vault from hurting the systems required Total Collateral Ratio of 150% or greater and will increase it ever so slightly. If the System falls below its 150% Total Collateral Ratio, the system goes into Recovery Mode. We will cover that in detail in a later section.
If you decide to stake some USDL in the stability pool, you are agreeing to allow the system to use your USDL proportionately to your share of the pool to pay off debt owed on liquidated vaults. This means that if there are any liquidations during the time you have USDL in the pool, you would lose some of the USDL you had staked in the protocol permanently but would get PLS in return for the system using your USDL. Before you can claim your PLS rewards out of the pool, there must be no vaults up for liquidation.
If there are vaults ready to be liquidated, they must be liquidated before anyone can leave the stability pool to claim rewards in the form of both PLS and LOAN.
LOAN is the secondary token to the Liquid Loans protocol and is earned by staking in the stability pool. It has a maximum supply that will be announced before launch and can be staked in the Staking Pool to capture fee revenue that is generated by the system in both PLS and USDL tokens. In the Stability pool, LOAN will be decreasing the number of tokens going to the pool as rewards by 50% each year. Early adopters of the Stability Pool will benefit the most in terms of capturing LOAN rewards.
The Staking Pool is the secondary pool where users can stake their LOAN token without a lock-up period to earn both PLS and USDL. The PLS and USDL given as rewards to stakers come from the borrowing and redemption fees collected based on their share of the pool at that moment when rewards are issued.
LOAN has no other internal function aside from being staked in the Staking Pool. It carries no weight for governance, since there is no need for it in the system, or any other purpose.
The amount of fees you will receive as yield is proportional to your share of the pool.
To understand what Recovery Mode is, we must establish the 3 ratios within the system: Minimum Collateral Ratio (MCR), Individual Collateral Ratio (ICR), and Total Collateral Ratio (TCR). MCR is the minimum ratio a vault can have before it gets liquidated, ICR is the ratio of a specific vault, and TCR is the average ratio across all ICR’s. If the TCR ever falls below 150%, the system falls into recovery mode to protect itself from becoming undercollateralized. If the TCR of the system falls below 150%, several actions are taken by the system based on how far below the TCR each vault is until the TCR of the system rebounds above 150%.
All vaults with an ICR less than 100% have their collateral and debt redistributed evenly among vaults not under this threshold. All vaults with an ICR between 100-110% are liquidated and paid off using the USDL in the stability pool. All PLS used as collateral in those vaults is redistributed to stakers of the stability pool.
If the number of liquidations required by Recovery mode does not have sufficient USDL in the stability pool to cover the liquidations, debts are paid off using all USDL available, PLS is redistributed to stakers in the stability pool, and all remaining debt and collateral are distributed to other vaults.
Any vaults that sit between 110-150% ICR are liquidated using the USDL in the stability pool. Since the USDL is only sufficient to pay off the 110% amount of collateral in the vault, the remaining PLS can be claimed by the owners of the vaults. For example, if a vault has 148% collateral during recovery mode, 110% of the PLS over the debt would be redistributed to the stability pool and the remaining 38% could be reclaimed by the vault owner.
During recovery mode it is not possible to increase debt of existing vaults, retrieve collateral from existing vaults, to adjust the vault in a way that leads to a TCR reduction or an ICR reduction of less than 150%, or create a new vault with an ICR less than 150%.
Because the penalties during Recovery mode or so harsh, users are disincentivized from ever letting the system reach this state and incentivized to add collateral top ups and pay off debt. When this mode is in effect, the borrowing fee goes to 0% to incentivize creating new vaults that meet the previously stated criteria.
Moral of the story here, is to always keep your vault above 150% or you run the risk of getting caught in recovery mode.
While Liquid Loans itself has not been audited, the original code from Liquity that is being forked to create Liquid Loans has had two audits complete that can be viewed here:
Because Liquity has had flawless operation, it gives me great confidence that Liquid Loans will also see the same perfect operation. The sentiment in the community is fantastic and all major concerns have been flushed out and solved through debate as far as I have been able to find so far.
I am personally very excited about Liquid loans on Pulsechain. I think it opens a world of strategies and possibilities for passive income that is worth understanding fully to see if it is a fit for your investment thesis. From positive feedback loops for earning yield to preventing PLS from being sold on the market, Liquid Loans has the potential to serve Pulsechain in an incredibly positive way. Please continue to do your own research on the Team, the protocol, Liquity, etc., as this is not financial advice but instead a guide to the inner workings of the system.
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