Redemptions
Last updated
Last updated
Redemptions are NOT Liquidations. Redemptions can be viewed as the system automatically maintaining itself so it never carries bad debt.
Redemptions allow USDaf holders to exchange their tokens for underlying collateral at a 1:1 rate. This mechanism helps maintain the peg by ensuring USDaf’s intrinsic value remains stable.
Redemptions serve the crucial purpose of keeping USDaf pegged to the US Dollar, creating a price floor around $1. They do this in a decentralized way without reliance on centralized assets or 3rd parties.
A redemption is essentially swapping USDaf for collateral at face value, as if 1 USDaf is exactly worth $1. Redemptions can be initiated by anyone, but are only profitable when USDaf <$1.
The redeemer sends USDaf to the protocol and in return gets a mix of USDaf's eight collaterals (minus the redemption fee). The redeemed amount is split among the different collateral assets based on their current Stability Pool backing (see link for more info).
Liquity also has a on Redemptions.
Below are four examples of partial and full redemptions with BTC and Stable collateral. Note that these examples are slightly simplified for sake of demonstration.
In this case, the "Last In, First Out" (LIFO) principle applies, meaning the Trove that set its interest rate more recently will be redeemed first.
A redemption can occur at any time, but will likely only happen when it is profitable to do so. This is usually the case when the price of USDaf is less than $1 (minus the current redemption fee).
Any Ethereum address can initiate a redemption, provided that they have a sufficient amount of USDaf to do so. However, it is expected that redemptions to be mainly performed by professional bots rather than humans.
Think of redemptions as if somebody else is repaying your debt and retrieving an equivalent amount of your collateral in return.
If your collateral is redeemed, an equivalent amount of your debt in USD terms is repaid. The redeemer receives your collateral, less the redemption fee, which remains in your Trove. This means that at the time of redemption you have not lost any money in USD terms, likely even made a small gain with the received redemption fee as the peg recovers.
Example with BTC at $100,000:
Before the redemption: 1 wBTC collateral, 40,000 USDaf debt.
After the redemption: 0.5 wBTC collateral, 20,000 USDaf debt, plus the 0.025 ETH redemption fee.
You can see your collateral and debt reduced equally (in USD terms) and the redemption fee (0.025 ETH) being added to your collateral value.
USDaf is backed by a multitude of collaterals. Instead of letting the redeemer freely choose the collateral to redeem, Liquity V2 optimizes the process for economic safety. Redemptions are thus serviced through a collateral mix in a way that enhances the overall backing of USDaf.
The process starts with the Troves paying the lowest interest rates in each collateral market and continues until the full amount of USDaf is exchanged for collateral assets. Redemptions can be partial or full, as illustrated below.
In this simplified example with just three collaterals, the wBTC market shows a full redemption of the first Trove and a partial redemption of the second. The sUSDe and sDAI markets have one partial and two full redemptions, respectively.
The split is dynamic, optimizing for the economic safety of the system. The logic is straightforward: the riskier a collateral is, the more redemption volume is directed to that market. In other words, if a market's Stability Pool is relatively small compared to its total debt, it's considered riskier, as there's a higher likelihood of bad debt occurring in extreme events.
To mitigate this risk, the system redeems proportionally to the "outside debt" of each collateral type. This is calculated as the total debt borrowed against a specific collateral minus the size of the Stability Pool for that borrowing market.
Yes. The redemption fee mechanics are broadly the same as in Liquity V1, but with adapted parametrization leading to a faster fee decay. The redemption fee is taken as a cut of the total collateral drawn from the system in a redemption. The fee stays with users as part of their collateral.
Redemption fees are based on the baseRate state variable, which is dynamically updated. The baseRate increases with each redemption, and exponentially decays according to time passed since the last redemption (half-life of 6 hours).
Upon each redemption of x USDaf: baseRate is decayed based on time passed since the last fee event and incremented by an amount proportional to the fraction of the total USDaf supply to be redeemed, i.e. x/total_USDaf_supply
The redemption fee percentage is given by min (0.5% + baseRate, 100%).
The risk of redemption depends on two factors: the interest rate you set and the price of USDaf.
The interest rate you set determines how much USDaf must be redeemed before it's your turn. The higher your rate, the more USDaf is redeemable before you, and vice versa.
You can see this on any frontend, in the example below the number is 41M.
This means that 41M USDaf must be removed from the system before it would reach you. However, this number is relative, and you also need to consider recent redemption activity. While past events don't guarantee future outcomes, they can serve as a useful guide.
For example, if only 200K USDaf were redeemed in the last week, you're comparatively safer than if 15M were redeemed. You can monitor past redemptions in Asymmetry's Dune dashboard.
The price of USDaf is the second crucial factor. When it trades above $1, redemptions become unprofitable and should cease. If demand for USDaf is strong, it can maintain a price above $1 for an extended period, as was often the case for LUSD.
During such times, you can comfortably reduce the interest rate you're paying without increasing your risk of redemption.
Interest rate delegation is a feature in Liquity V2 that allows borrowers to delegate the management of their interest rate to a third party. This enables them to create a passive, hands-off position, while still keeping a competitive rate and low redemption risk.
There are three types of delegations:
To a third party manager: A specialized entity which provides predetermined strategies for batches of multiple Troves and charges a fee for the service
To an automated and decentralized contract strategy: A predefined strategy managing interest rates in an autonomous manner
To your own wallet: Delegate to a hot wallet when on vacation, or to a friend
It is important to note that a delegate or contract strategy can do nothing else but set the interest rate in a predetermined range, significantly limiting the risks of the borrowers.
Borrowers should thus keep an eye on the interest rate range and the maximum update frequency (relevant in case of premature adjustments) preset by the manager.
Your Trove would not be affected - the only thing would get affected is the interest rate at which your position is set.
Given that the raison d’etre for redemptions is to diminish USDaf supply in response to reduced demand, and interest rates drive demand, rate-based redemption processing is a more sustainable and effective lever to reach market equilibrium. Actively managing for both interest rate and LTV would weaken the ability to enforce market-level interest rates and deposit yields, while complicating the process for the system and its users
If the redeemed amount exceeds the debt of an affected Trove, it doesn’t get closed as in Liquity V1, but remains open with 0 USDaf debt and the remaining collateral. The owner of a fully redeemed Trove may close it by withdrawing the remaining collateral, or borrow anew to bring its debt above the minimum of 2000 USDaf, topping up its collateral if needed.
In the scenario that the redeemed amount of a Trove does not exceed the debt of a Trove, but would leave it between 0 and 2000 USDaf, the Trove would remain open with the remaining debt, and the remaining collateral. The owner of the Trove may close it by paying off the remaining debt and withdrawing the remaining collateral, or borrow anew as described above.
Partially affected Troves whose debt stays above the minimum debt threshold of 2000 USDaf continue to work as before, while Troves whose debt is reduced to a lesser amount (or 0) switch to a dormant operating mode (see below for info).
