“To some extent, liquidity can be considered a public good.”
Among the most promising innovations to look forward to in DeFi as we approach the end of the year and the start of 2025 are Liquity V2 and its stablecoin, BOLD.
In the past, I have written extensively about Liquity V1 and its stablecoin, LUSD, both of which were introduced on Ethereum in April 2021 as a way of offering DeFi users the opportunity to borrow stable value against their ETH holdings in an interest-free manner. LUSD has since set an example to be followed in its commitment to the foundational principles of crypto, and it is described as “the most decentralized stablecoin” by the independent stablecoin rating agency, Blue Chip.
So who better than the Liquity Protocol team themselves to now apply the lessons learned from LUSD to advance innovation in the stablecoin market and better tackle the stablecoin trilemma? Particularly, with its introduction of Protocol Incentivized Liquidity (PIL), Liquity V2 can drive a positive flywheel that sustains BOLD’s liquidity to contribute to its broad accessibility and price stability as a top stablecoin across DeFi.
In this blog post, I therefore propose how progress towards this seemingly insurmountable goal of cracking the stablecoin trilemma can, at the very least, be advanced with BOLD vis-a-vis the consideration of liquidity as a public good for its on-chain DEX pools.
Ahead of its Time: Chicken Bonds as a Precursor to Memecoins
“Market cap is definitely the most talked about data point when it comes to crypto...however, liquidity is more important because liquidity is a measure of the amount of money that is actually inside of the trading pools that you need to participate in if you want to buy or sell...”
Trends have come and gone across the crypto space over the years, and the more recent memecoin craze is quite likely yet another manifestation of that historic tendency.
Nevertheless, it is at this point undeniable that memecoins have instilled the criticality of on-chain liquidity as an underlying metric by which crypto projects will be scrutizined moving forward by both newbies and seasoned market participants alike.
In fact, popular token trackers such as DEX Tools now highlight burned LP tokens and locked liquidity, reflecting the importance of these figures to traders and users across DeFi. Correspondingly, on-chain liquidity lockers such as UNCX have increasingly grown in popularity across various chains.
Interestingly, well before the memecoin hype, the Liquity Protocol team was among the first to embrace the idea of committed and verifiable on-chain value when they introduced Chicken Bonds in October 2022.
Specifically, the Permanent Bucket in the Chicken Bonds setup represents a portion of a user’s bonded LUSD once chickening in that can then shift between Liquity’s Stability Pool and the Curve Pool for LUSD + 3CRV. As noted in the Chicken Bonds documentation, “The Permanent bucket can only increase…,” and even with the wind-down functionality built into the Chicken Bonds system, the value as represented by the Permanent Bucket is ultimately redeemable.
However, with the rise of interest rates across global markets in recent years, LUSD struggled to sustain its demand versus other stablecoins offering more enticing yields to their holders. By extension, the demand for boosted LUSD (bLUSD) through the Chicken Bonds protocol took a hit.
Nevertheless, we can build on the ingenuity that Chicken Bonds introduced as it relates to sustaining liquidity and as further validated by the growing popularity of memecoins when we look ahead and reflect on how BOLD can entrench itself as the stablecoin of choice across DeFi in the future.
The BOLD and LUSD Flywheel Effect
From the get go, the onus will be on LQTY stakers to judiciously steer PIL to uphold BOLD’s value proposition as a premier on-chain stablecoin. Since 25% of Liquity V2’s protocol revenue will be directed to PIL, this represents an ongoing and notable sum of value to be apportioned in support of sustaining BOLD’s on-chain liquidity posture.
It would seem sensible for LQTY stakers to commit to incentivizing a BOLD + LUSD pool with a portion of PIL, since this would foster a sustained demand for LUSD, which by extension would bolster the revenue from Liquity V1 for LQTY stakers, which they’ll be able to earn as incentives while simultaneously directing Liquity V2’s PIL.
“A lot of people automatically dismiss e-currency as a lost cause because of all the companies that failed since the 1990’s. I hope it’s obvious it was only the centrally controlled nature of those systems that doomed them.”
Aside from their own self-interest, LQTY stakers should also be compelled to perpetually incentivize a BOLD + LUSD pool with some of Liquity V2’s PIL because both are synergistic in representing decentralized and immutable attempts at offering stablecoins anchored to on-chain assets with varying degrees of risk, as BOLD will include staked ETH alongside ETH as collateral options, whereas LUSD is only borrowable against ETH itself.
Moreover, since LUSD is not tied to off-chain assets and custodians, it is shielded from the “real world” counter party risks that invariably would need to be accounted for by LQTY stakers in supporting pools of BOLD paired with more widely available yet centralized stablecoins such as USDC and USDT. This is self-evident from the precarious history of traditional financial institutions, as the Silicon Valley Bank fiasco in the Spring of 2023 most recently confirmed. Satoshi’s early elevator pitch for Bitcoin similarly cautioned against centrally controlled systems and should be considered in this regard as well.
In my estimation, there will remain an ongoing demand for LUSD as a stablecoin, as it offers an interest-free approach to borrowing against ETH for users who would continue to favor that, and since it continues to be minted, despite alternative stablecoin options offering better yields in the present high-interest rate macro environment.
Assuming demand for LUSD is better upheld as a result of a BOLD + LUSD pool being continually incentivized vis-a-vis PIL from Liquity V2, this may also revive Chicken Bonds as a DeFi protocol and rejuvenate the utility of bLUSD, alongside LUSD and LQTY too, as collateral assets.
Liquity as the Antithesis of a Liquidity Black Hole
“Financial liquidity matters. In general market participants have a strong preference for trading in the most liquid markets...As important as the level of liquidity, is its uncertainty...”
Considering the above, it would be opportune for LQTY stakers to cultivate LUSD’s appeal alongside BOLD. In so doing, the antithesis of a liquidity black hole could be spawned across the Liquity Protocol ecosystem at large, through an amount of BOLD from Liquity V2’s PIL being contributed to a permanently locked liquidity pool position alongside LUSD.
To facilitate the creation and growth of such a permanently locked liquidity pool, a defined amount of LQTY could be sold from Liquity V1’s Community Reserve and/or the Liquity AG Endowment and then converted to LUSD. Then, a corresponding amount of BOLD could be allocated by LQTY stakers from PIL over some period of time and subsequently paired with the LUSD to initiate the locked pool.
The locked BOLD + LUSD pool could be constructed vis-a-vis a UNCX liquidity locker for Uniswap V3, as this would enable concentrated liquidity within a defined and narrow price range around a dollar value, as the presumption is both BOLD and LUSD will trade roughly around a dollar each. Accordingly, the pool itself could then be further incentivized by LQTY stakers through PIL to attract individual users to provide liquidity on top of this baseline and continuous level of liquidity too.
In this manner, the initiator of the locked BOLD + LUSD pool could collect the associated trading fees from Uniswap V3 and feed them back into the pool or use them for funding ecosystem growth initatives, as the UNCX locker for Uniswap V3 allows for the trading fees to separately be collected. Assuming the initiatior is Liquity AG, for example, it could then perhaps categorize the locked liquidity as falling under the Community Reserve, such that its trading fees can then be directed by LQTY stakers engaged in steering PIL for Liquity V2; a smart contract approach to managing this may also be explored, if possible.
Full Circle Virtuous Cycle
By extending the above-described locked liquidity model to Liquity V2’s licensed forks, LQTY stakers could also encourage aligned forks to initiate permanently locked positions and direct a baseline amount of their respective stablecoins to be paired with BOLD. As the initiators of the pools, the fork teams could similarly collect the corresponding trading fees and channel them back into their pools or use them for their distinct ecosystem’s growth purposes, assuming they use UNCX’s Uniswap V3 locker or a similar example.
In approaching the build out of BOLD’s on-chain liquidity in such a manner, there would be both a certain and verifiable level of liquidity that is enabled to gradually increase over time. Forks could be incentivized to continue to support such permanently locked pools for their stablecoins even after the contractual end dates of their licenses pass, since LQTY stakers could show preference for routing PIL from Liquity V2 to such forks that remain supportive of the Liquity ecosystem as a whole. By extension, the demand and liquidity for such stablecoins would continue to be supported.
Thus, through promoting a “give to receive” relationship with its fork partners via the use of PIL from Liquity V2 as leverage, LQTY stakers could anchor the Liquity brand as the hub around which DeFi’s premier stablecoins can ultimately grow and prosper together. This strategy may not solve the stablecoin trilemma in its entirety, but it would help to better address liquidity as a primary concern underlying the key question of price stability.