How Does Liquity V1 Work?

Users deposit ETH as collateral to mint LUSD stablecoin at a minimum 110% collateralization ratio, with a one-time borrowing fee (no ongoing interest)

Elegant simplification of the MakerDAO CDP model. No interest rate means no governance attack surface for rate manipulation. 110% MCR is aggressive but enabled by efficient liquidation design.

Any LUSD holder can redeem 1 LUSD for $1 worth of ETH from the riskiest Trove (lowest collateral ratio), creating a hard price floor at $1

Redemption mechanism provides strong peg floor but can be disruptive to borrowers with low collateral ratios who get partially redeemed against. This is a feature, not a bug — it's the protocol's primary stability mechanism.

Stability Pool depositors provide LUSD as a buffer to absorb liquidations; in return they receive discounted ETH collateral from liquidated Troves plus LQTY rewards

Stability Pool is the primary liquidation mechanism. When pool is sufficiently funded, liquidations are near-instant and gas-efficient. SP depositors face impermanent loss risk if ETH drops further after they receive liquidated collateral.

No admin keys, no governance, no upgradeability — Liquity V1 smart contracts are completely immutable and run autonomously

Radical design choice that eliminates governance attack surface entirely but also eliminates the ability to patch bugs or respond to changing conditions. This is the strongest and weakest feature simultaneously.

Primary Chainlink ETH/USD oracle with Tellor fallback; automated switching logic if Chainlink fails or becomes stale

Dual oracle design with fallback is more robust than single-oracle protocols. Chainlink failure would trigger Tellor fallback, which has less economic security but provides continuity.

LQTY stakers earn 100% of borrowing fees (one-time) and redemption fees (variable) — direct protocol revenue pass-through with no DAO treasury intermediary

Clean value capture mechanism. Revenue directly to stakers without governance friction. However, one-time fees mean revenue is front-loaded at borrowing time and dependent on new borrowing activity.

Recovery Mode activates when system total collateral ratio drops below 150%, enabling liquidation of any Trove below 150% CR regardless of individual MCR

System-level safety mechanism. Has only been triggered once (for 2 minutes in May 2021). Provides systemic protection but borrowers between 110-150% CR face unexpected liquidation risk during Recovery Mode.

The 110% MCR leaves only 10% buffer before positions become undercollateralized. In a flash crash scenario where ETH drops 15%+ in minutes, the Stability Pool may not absorb liquidations fast enough, leading to bad debt that cannot be recovered due to the immutable contract design.

If a subtle oracle manipulation vector is discovered, the immutable contracts cannot be patched to add additional validation logic. The protocol must rely entirely on the existing oracle switching logic, which was designed for Chainlink/Tellor circa 2021.

Aggressive redemptions target the lowest-CR Troves, effectively punishing conservative borrowers who maintain low collateral ratios. This creates a chilling effect on borrowing, reducing LUSD supply and contributing to persistent above-peg pricing that limits LUSD adoption.

LQTY emissions to the Stability Pool follow a declining schedule. As rewards diminish (98% of max supply already circulating), SP deposits may decrease, weakening the liquidation buffer. Reduced SP depth increases the risk of cascading liquidations during market stress.