The Liquid Loans protocol is one of those systems that is both super basic and super complicated at the same time.
Maybe it’s a characteristic of beauty…
Anyways, here’s a simple analogy, using traditional finance, to help you understand how the protocol works.
Imagine you have $100,000 worth of physical gold.
You want to extract value from it, but you don’t want to sell it.
You don’t want to sell it because you believe in the investment long term, but you need liquidity…NOW!
So you go to the “bank” and here’s how it works.
You stepped through the ornate wooden doors into the hushed marble interior of the Gold Bank, a heavy satchel of gold bars clasped under one arm.
Approaching the clerk's window, you lift your cargo onto the polished counter.
"I'd like to deposit this gold as collateral for USDG," you inform the clerk. She nodded crisply and inspected the gleaming bars.
"Current market value for your gold looks to be $100,000. Now how much USDG were you looking to withdraw against your deposit?" she inquires.
I knew USDG, or US Dollar Gold, was the banks’ certificate which trades at 1 US Dollar on the open market because it is fully-backed and redeemable by the gold reserves.
"I'll take the maximum allowed - 100,000 USDG please," I responded eagerly.
The clerk shook her head. "Our policy only allows 100 USDG to be borrowed for every 110 dollars worth of gold deposited. For your own protection, we recommend limiting borrows to just 50 USDG per 100 USD collateral."
You decide to heed the conservative advice and request 50,000 USDG against your $100,000 gold deposit.
The clerk nods approvingly and disappears to lock up my bullion in the vault.
Upon returning, she counts out 49,750 USDG notes and hands them over.
You quickly realize she had deducted 250 USDG.
"Sorry, there's a one-time 0.5% borrowing fee, so your net borrow is 49,750," she explains. You nod, accepting the reasonable charge.
"So when will I need to repay this loan and what interest rate do I owe?" I asked.
The clerk laughed lightly. "Oh you must be new to decentralized finance! There is no repayment schedule - you can hold your USDG as long as you like. And we don't charge interest here. The Gold Bank is owned by the community, not run for profit."
I was stunned by such generous terms. This decentralized bank offered credit with no repayment pressures or compounding interest.
As the clerk passed me a brochure, I realized I had much more to learn about this bank.
You begin reading the procure.
Holders of USDG have the option to give us back the certificates they minted and become ‘Stability Providers’.
Stability Providers benefit in two ways from their service:
Stability Providers perform the service of repaying the debt of vaults with less than 110% collateral ratio (i.e. 110 USD worth of gold/100 USDG borrowed)
For example, if the price of gold falls 10%, then vaults at 115% collateral ratio would drop under the minimum required collateral levels.
To ensure that USDG is fully-backed by gold at all times, these vaults need to be liquidated from the system.
This is where the Stability Pool comes into play. The USDG in this pool pays back the debt of the liquidated vault.
The BANK certificates, such as the ones you earn from the Stability Pool, can be staked in the Staking Pool to earn the borrowing and redemption fees of the protocol.
Therefore, whoever owns the BANK certificates, technically owns the bank.
The BANK Certificates can also be sold on the free market, much like shares in a company.
Redemptions ensure that USDG trades at 1 USD on the open market.
Anytime the price of USDG falls below 1 USD, traders are incentivized to buy that cheap USDG off market and redeem it.
For example, if the price of USDG falls to 98 cents, traders can buy it up and redeem it for 1 USD worth of Gold at the bank.
The Stability Pool and Liquidations ensures that there is always enough gold backing every USDG in circulation, so redemptions will never be unavailable.
Liquid Loans offers a SUPERIOR service than the one detailed above.
First, there is NO central party which holds your gold.
The code is extremely secure, having multiple audits. It is also immutable, which means it can never be changed to harm the users.
Secondly, the PLS held in reserves will ALWAYS exceed the USDL minted.
This means that it is completely impervious to bankruns that have become characteristic of both centralized crypto projects and traditional, brick and mortar banking.
When PLS is locked in the vaults, it cannot and will not be diverted to other risky investments and lost (see Sam Bankman-Fried).
Third, every action within the Liquid Loans protocol is digital. All you need is a wifi connection and a self-custody wallet.
You don’t need to bring your asset to a physical location and the USDL, PLS and LOAN tokens can be brought across borders with just your seed phrase.
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Disclaimer:Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.
Connor is a US-based digital marketer and writer. He has a diverse military and academic background, but developed a passion over the years for blockchain and DeFi because of their potential to provide censorship resistance and financial freedom. Connor is dedicated to educating and inspiring others in the space, and is an active member and investor in the Ethereum, Hex, and PulseChain communities.
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