DeFi Insight: Liquity’s Chicken Bonds
Liquity is a novel borrowing protocol that puts great emphasis on decentralization and immutability. It enables users to provide ETH as collateral and mint LUSD stablecoins in return. The latest product offered by Liquity is Chicken bonds. One of the greatest challenges DeFi is facing is capturing and sustaining liquidity. If we look at the current situation, even tokens in the Top 100 by market capitalization have widely insufficient liquidity. Despite the many innovations in the past years, including liquidity concentration, liquidity incentives, and the Curve wars, protocols haven’t solved the core liquidity problem. If new projects want to acquire liquidity, the solutions they are offered are either very expensive or quite detrimental to the token price. The usual approach of liquidity mining is followed by a massive drop in the token price because of the generous incentives given to liquidity providers. Chicken bonds are trying to solve the problem of providing sufficient liquidity in a sustainable way. In essence, Chicken bonds are an engine to capture liquidity over time. It is not like liquidity mining, where you can throw a massive budget and grow a massive pool. A project that harnesses Chicken bonds will be able to effectively capture liquidity progressively while allowing token holders to get additional yields. Chicken bonds are first aimed at LUSD — the stablecoin of Liquity. In the near future, protocols will also be able to acquire Protocol Owned Liquidity.
Authors: Valentin Kalinov, Christian Viehof
Liquity started with a simple design that works similarly to MakerDAO. The feature that added the most value to the protocol was the instant liquidation mechanism of undercollateralized Troves(similar to Maker’s Vaults). It is enabled by a liquidation mechanism that requires LUSD to be staked in a Stability Pool. LUSD providers could contribute to the Stability Pool with the intent to benefit from the LQTY rewards, but also, whenever a liquidation event is triggered, they would receive ETH as well. This could also be a great strategy to hedge capital efficiently and receive a decent return during rapid drops in ETH’s price.
What are Chicken Bonds?
Chicken bonds are a unique bonding model which is gamified and provides better guarantees and less downside for users than existing approaches. Bonders will benefit from principal protection: they will always have the option to cancel their bond and claim their principal back. Rather than purchasing or renting liquidity, the system freely acquires treasury assets over time in a self-bootstrapping manner. Liquidity acquisition is incentivized by the amplified yields that are attainable by bondholders. Bonds accrue a virtual balance of boosted LUSD tokens(bLUSD) over time. At any time, the bonder may choose to claim their bLUSD(“chicken in”) in exchange for their LUSD or cancel(“chicken out”) their bond to recover their deposited LUSD. Another innovation is the gamification part of the mechanism. The protocol features dynamic NFTs, which will evolve based on the user’s interactions with the protocol.
The NFT visual will either be an egg (while bonding), a chicken (after claiming the bond — “Chickening In”), or a run-away chicken (after canceling the bond — “Chicken Out”). The NFT gets minted when a user creates a bond. Chicken bond NFT artwork traits are in part randomized and depend on different factors such as the bond size, size of Liquity Trove, LQTY staked or veCRV gauges on Convex. All of these factors determine and influence the rarity of the NFT. The NFT is closely tied to the bond, and transferring the NFT would also transfer the bond ownership, which opens new market opportunities for bondholders. NFTs can be sold on the secondary market, which can be attractive for bonds that have accumulated a significant amount of bLUSD.
Chicken bonds open new earning opportunities in addition to Liquity’s Stability Pool. The bLUSD captures an amplified, auto-compounded yield, which can be held or traded. bLUSD also has a guaranteed floor price which is backed by pool reserves.
The underlying sources of Chicken Bonds yield are: the Stability Pool and the Curve LUSD/3CRV Pool. The auto-compounding is handled by two other protocols: Yearn Curve Vault and B.Protocol:
“B.Protocol deposits the LUSD in the Stability pool and auto-compounds the revenues by selling the LQTY rewards and ETH liquidation gains back to LUSD.The Yearn Curve vault deploys the LUSD to Curve and stakes the LUSD-3CRV LP token in Convex finance, converting and auto-compounding the gains back into more LUSD.” Source: liquity.gitbook.io
The deposited LUSD funds from the bonds are collected in a treasury consisting of three buckets: Pending Bucket, Reserve Bucket, and Permanent Bucket. Each bucket plays a different role. The Pending Bucket collects LUSD from users that are still active bondholders. The yield earned by the Pending Bucket is credited to the Reserve Bucket. The Reserve bucket backs the whole bLUSD supply and guarantees the bLUSD floor price. The Permanent Bucket serves as protocol backup. The LUSD held by it is protocol-owned and can never be redeemed. The yields generated in the Permanent Bucket are also credited to the Reserve Bucket. bLUSD is the first use case of Chicken Bonds. Liquity wants to expand the service to other projects looking to bootstrap liquidity for their token. Use cases include: increasing DEX liquidity, funding lending markets, and bootstrapping algorithmic market operators.
The classification of LUSD according to the ITC:
Economic Purpose (EEP): LUSD is listed as a fiat-pegged payment token (EEP21PP01USD) similar to the other stablecoins in the industry.
Industry Type (EIN): The issuer of LUSD is active in the field of Payment Services and Infrastructure (EIN06PS).
Technological Setup (TTS): LUSD is an Ethereum ERC-20 Standard Token (TTS42ET01). The Class “Ethereum ERC-20 Standard Token” captures every token that is implemented by means of the ERC-20 Standard on top of the Ethereum blockchain.
Legal Clam (LLC): The LUSD token does not entitle its holder to any legal claim or rights against the issuing organization, therefore it is listed as a No-Claim Token (LLC31).
Issuer Type (LIT): The dimension “Issuer Type” provides information on the nature of the issuer of the token. Liquity AG initially developed the protocol, but LUSD has no legally represented issuer; hence Issuer Type is an Entity without Legal Personality (LIT62).
Regulatory Framework (EU) (REU): The dimension “Regulatory Status EU” provides information on the potential classification of a token according to the European Commission’s proposal for a Regulation on Markets in Crypto Assets (MiCA, Regulation Proposal COM/2020/593 final). The LUSD token qualifies as a Non-Authorized Significant E-Money Token (REU51EM12) according to the definition provided in Article 3 (5) of Regulation Proposal COM/2020/593 final.
The International Token Standardization Association (ITSA) e.V.
The International Token Standardization Association (ITSA) e.V. is a not-for-profit association of German law that aims at promoting the development and implementation of comprehensive market standards for the identification, classification, and analysis of DLT- and blockchain-based cryptographic tokens. As an independent industry membership body, ITSA unites over 100 international associated founding members from various interest groups. In order to increase transparency and safety on global token markets, ITSA currently develops and implements the International Token Identification Number (ITIN) as a market standard for the identification of cryptographic tokens, the International Token Classification (ITC) as a standard framework for the classification of cryptographic tokens according to their inherent characteristics. ITSA then adds the identified and classified token to the world’s largest register for tokens in our Tokenbase.
- The International Token Identification Number (ITIN) is a 9-digit alphanumeric technical identifier for both fungible and non-fungible DLT-based tokens. Thanks to its underlying Uniform Token Locator (UTL), ITIN presents a unique and fork-resilient identification of tokens. The ITIN also allows for the connecting and matching of other media and data to the token, such as legal contracts or price data, and increases safety and operational transparency when handling these tokens.
- The International Token Classification (ITC) is a multi-dimensional, expandable framework for the classification of tokens. Current dimensions include technological, economic, legal, and regulatory dimensions with multiple sub-dimensions. By mid-2021, there will be at least two new dimensions added, including a tax dimension. So far, our classification framework has been applied to 99% of the token market according to the market capitalization of classified tokens.
- ITSA’s Tokenbase currently holds data on over 4000 tokens. Tokenbase is a holistic database for the analysis of tokens and combines our identification and classification data with market and blockchain data from external providers. Third-party data of several partners is already integrated, and API access is also in development.
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Valentin Kalinov is an Executive Director at International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database, including a classification framework and unique token identifiers and locators. He has over five years of experience working at BlockchainHub Berlin in content creation and token analysis, as a project manager at the Research Institute for Cryptoeconomics at the Vienna University of Economics and token analyst at Token Kitchen. You can contact Valentin via email@example.com and connect on Linkedin if you would like to further discuss ITSA e.V. or have any other open questions.
Christian Viehof is an Executive Director at the International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database including a classification framework and unique token identifiers and locators. He completed his Bachelor in Economics at the University of Bonn, the Hong Kong University and the London School of Economics and Political Science with a focus on Behavioral Economics and Finance. Currently pursuing his Master of Finance at the Frankfurt School of Finance and Management, you can contact him via firstname.lastname@example.org and connect with him on Linkedin, if you would like to further discuss ITSA e.V. or have any open questions.