Stability Pool and Liquidations
The Stability Pool is the first line of defense in maintaining system solvency. It achieves that by acting as the source of liquidity to repay debt from liquidated Troves—ensuring that the total LUSD supply always remains backed.
When any Trove is liquidated, an amount of LUSD corresponding to the remaining debt of the Trove is burned from the Stability Pool’s balance to repay its debt. In exchange, the entire collateral from the Trove is transferred to the Stability Pool.
The Stability Pool is funded by users transferring LUSD into it (called Stability Providers). Stability Providers lose a pro-rata share of their LUSD deposits, while gaining a pro-rata share of the liquidated collateral. However, because Troves are likely to be liquidated at just below 110% collateralization ratios, it is expected that Stability Providers will receive a greater dollar-value of collateral relative to the debt they pay off.
Stability Providers will make liquidation gains (see below) and receive early adopter rewards in form of LQTY tokens.
To ensure that the entire stablecoin supply remains fully backed by collateral, Troves that fall under the minimum collateral ratio of 110% will be closed (liquidated).
The debt of the Trove is canceled and absorbed by the Stability Pool and its collateral distributed among Stability Providers.
The owner of the Trove still keeps the full amount of LUSD borrowed but loses ~10% value overall hence it is critical to always keep the ratio above 110%, ideally above 150%
Anybody can liquidate a Trove as soon as it drops below the minimum collaterization ratio of 110%. The initiator receives a gas compensation as reward for this service.
The liquidation of Troves is connected with certain gas costs which the initiator has to cover. The cost per Trove was reduced by implementing batch liquidations of up to 40 Troves but with the aim of ensuring that liquidations remain profitable even in times of soaring gas prices the protocol offers a gas compensation given by the following formula:
gas compensation = 50 LUSD + 0.5% of trove's collateral (ETH)
The 50 LUSD is funded by a Liquidation Reserve while the variable 0.5% part (in ETH) comes from the liquidated collateral, slightly reducing the liquidation gain for Stability Providers.
As liquidations happen just below a collateral ratio of 110%, you will most likely experience a net gain whenever a Trove is liquidated.
Let’s say there is a total of 1,000,000 LUSD in the Stability Pool and your deposit is 10,000 LUSD.
Now, a Trove with debt of 200,000 LUSD and collateral of 400 ETH is liquidated at an Ether price of $545, and thus at a collateral ratio of 109% (= 400 * 545 / 200,000). Given that your pool share is 10%, your deposit will go down by 10% of the liquidated debt (20,000 LUSD), i.e. from 100,000 to 80,000 LUSD. In return, you will gain 10% of the liquidated collateral, i.e. 40 ETH, which is currently worth $21,800. Your net gain from the liquidation is $1,800.
Note that depositors can immediately withdraw the collateral received from liquidations and sell it to reduce their exposure to ETH, if the USD value of ETH is expected to decrease (for an exception see Can I withdraw my deposit whenever I want?).
First you need to open a Trove, borrow LUSD, and deposit it to the Stability Pool. After making your deposit, you will start accumulating a reward (in LQTY) on a continuous basis. The reward is calculated according to the rewards schedule and the kickback rate of the front end that you used for making the deposit. Rewards will be the highest for early adopters of the system.
At any point in time, you can withdraw your pending rewards to your Ethereum address.
As a general rule, you can withdraw the deposit made to the Stability Pool at any time. There is no minimum lockup duration. However, withdrawals are temporarily suspended whenever there are liquidatable Troves with a collateralization ratio below 110% that have not been liquidated yet.
We are using Chainlink’s ETH:USD price feed.
While liquidations will occur at a collateralization ratio well above 100% most of the time, it is theoretically possible that a Trove gets liquidated below 100% in a flash crash or due to an oracle failure. In such a case, you may experience a loss since the collateral gain will be smaller than the reduction of your deposit.
If LUSD is trading above $1, liquidations may become unprofitable for Stability Providers even at collateral ratios higher than 100%. However, this loss is hypothetical since LUSD is expected to return to the peg, so the “loss” only materializes if you had withdrawn your deposit and sold the LUSD at a price above $1.
Please note that although the system is diligently audited, a hack or a bug that results in losses for the users can never be fully excluded.
