Redemptions & Price Stability

How does USDL closely follow the price of USD?

The ability to redeem USDL for ETH at face value (i.e. 1 USDL for $1 value worth of ETH) and the minimum collateral ratio of 110% create a price floor and price ceiling (respectively) through arbitrage opportunities. These are called "hard peg mechanisms" since they are based on direct processes.

USDL also benefits from less direct mechanisms for USD parity, which are called "soft peg mechanisms". One of these mechanisms is parity as a Schelling point (cooperation without communication). Since Liquid Loans treats USDL as being equal to the USD value of an asset, parity between the two is an ‘implied’ equilibrium state of the protocol.

Another of these mechanisms is the borrowing fee on new debts. As redemptions increase (implying USDL is below $1 value worth of ETH), so too does the baseRate — making borrowing less attractive, which keeps new USDL from hitting the market and driving the price below $1 value worth of ETH.

What is the USDL token redemption?

Any USDL holder (whether or not they have an active Vault) may redeem their ETH directly with the system. Their USDL is exchanged for ETH, at face value: redeeming x USDL tokens returns $x worth of ETH value (minus a redemption fee).

When USDL is redeemed for ETH, the system cancels the USDL debt from Vaults, and the ETH is drawn from their collateral.

In order to fulfil the redemption request, Vaults are redeemed from, in an ascending order of their collateralization ratio.

A redemption sequence of n steps will fully redeem from up to n-1 Vaults, and, and partially redeem from up to 1 Vault, which is always the last Vault in the redemption sequence.

Redemptions are blocked when TCR < 110% (there is no need to restrict ICR < TCR). At that TCR, redemptions would likely be unprofitable, as USDL is probably trading above $1 of ETH value if the system has crashed that badly, but it could be a way for an attacker with a lot of USDL to lower the TCR even further.

Note that redemptions are disabled during the first 14 days of operation immediately following deployment of the protocol to protect the monetary system in its infancy.

• Partial redemption

Most redemption transactions will include a partial redemption, since the amount redeemed is unlikely to perfectly match the total debt of a series of Vaults.

The partially redeemed Vault is re-inserted into the sorted list of Vaults and remains active, but with reduced collateral and debt.

• Full redemption

A Vault is defined as “fully redeemed from” when the redemption has caused its debt to be fully absorbed. Then, its Liquidation Reserve is cancelled (and returned to the borrower) and the debt is zeroed.

Before closing, we must handle the Vault’s collateral surplus; that is, the excess ETH collateral remaining after redemption, due to its initial over-collateralization.

This collateral surplus is sent to a collateral surplus pool, and the borrower can reclaim it later. The Vault is then fully closed.

How do redemptions create a price floor?

Economically, the redemption mechanism creates a hard price floor for USDL, ensuring that the market price stays at or near to $1 USD value of ETH.

Is a redemption the same as paying back my debt?

No, redemptions are a completely separate mechanism. All one has to do to pay back their debt is adjust their Vault's debt and collateral.

How is the redemption fee calculated?

Under normal operation, the redemption fee is given by the formula (baseRate + 0.5%) * ETH drawn.

How is the baseRate calculated?

Redemption fees are based on the baseRate state variable in Liquid Loans, which is dynamically updated. The baseRate increases with each redemption, and decays according to time passed since the last fee event – i.e. the last redemption or issuance of USDL.

Upon each redemption: baseRate is decayed based on time passed since the last fee event – baseRate is incremented by an amount proportional to the fraction of the total USDL supply that was redeemed – the redemption fee is given by (baseRate + 0.5%) * ETH drawn

As a borrower, do I lose money if I'm redeemed against?

If your Vault is redeemed against, you do not incur a net loss. However, you will lose some of your ETH exposure. Your Vault's collateral ratio will also improve after a redemption.

How can I avoid being redeemed against?

The best way to avoid being redeemed against is by maintaining a high collateral ratio relative to the rest of the Vault's in the system.

Consider using a Debt In Front (DIF) indicator to gauge the cumulative total value of USDL debt of all Vaults that have a lower collateral ratio than your Vault's individual collateral ratio position.

This value can be useful for determining a Vault's redemption risk, since the riskiest Vaults (Vaults with the lowest collateralization ratio in the protocol at the time of redemption) are first in line when a redemption takes place.

Can the USDL stablecoin become unstable?

Yes. The outside market may trade the stablecoin for less than the one USD equivalent. However, the redemption function decreases the likelihood, because anyone can redeem 1 USDL for $1 USD of ETH value at any time.

How does the protocol know how much USDL to mint from deposited ETH?

It looks at the price of ETH:USD and mints the required amount of USDL being requested, assuming the chosen parameters meet the minimum loan requirements defined within the protocol.