How do redemptions work inside the Liquid Loans protocol?
Imagine this hypothetical scenario. You buy a guitar from a music store for $1000, then walk to the store next door and sell it to them for $1100. ‘That was an easy way to make a hundred bucks!’, you think to yourself, so you go and do the same thing over and over and over for the rest of the day.
By the time the sun sets, you would have made a fat stack of cash, and you could go and tell all your friends you had a successful day as an ‘arbitrageur’. Because, in a nutshell, that’s what arbitrage is — making a series of simultaneous purchases and sales of the same asset in different markets in order to profit from price differences.
Now let’s say you saw a stablecoin trading at $0.95, and you knew there was a place where you could sell it for exactly $1 worth of crypto. As long as you bought enough of it to make the trade worthwhile (especially once fees and taxes were taken into consideration), you could make a pretty penny by buying up the stablecoin, then selling the stablecoin for the other crypto, then selling the crypto back into fiat.
That’s what the Liquid Loans redemption function allows you to do — always be able to redeem 1 USDL for $1 worth of PLS right within the protocol. Couple this with the system’s minimum collateral ratio of 110%, and you’ve got the mechanisms for a “hard peg” price floor and price ceiling, respectively.
The Liquid Loans protocol also has two less direct mechanisms for USD parity (known as “soft peg” mechanisms). These are a “Schelling point” (read more here), and the fact that borrowing fees on new loans increase as redemptions increase in frequency and value.
So there’s a lot of clever maths going on behind the scenes, but the main thing you need to know is that the redemption function helps USDL to maintain its US dollar peg.
Can I make money via redemptions?
Yes, it is possible, but it might not be the best idea for someone with less experience or who is new to arbitrage.
It’s more than likely that people will build arbitrage bots to automatically take advantage of any arbitrage opportunities, and you would be competing against these bots to make a profit.
When you can simply deposit stablecoin into the Stability Pool and make a very healthy passive income, why bother competing with arb bots?
Where does the PLS come from?
Let’s say you go and buy $100K of USDL from a centralized or decentralized exchange. (Side note: USDL will definitely be on decentralized exchanges like PulseX, and we’re working hard to hopefully have USDL on centralized exchanges very soon after launch — watch this space!)
Now let’s say you bring that $100K into the Liquid Loans protocol and redeem it for $100K worth of PLS — where does the PLS come from? Well, it comes from people’s Vaults, but it comes from the lowest collateralized Vaults first.
Why? Because the people with the lowest collateralization level chose to take on the most risk, and this is why we are strongly recommending first-time users to stay very highly collateralized (think 500%-1000%) until they are confident they fully understand the Liquid Loans protocol.
(In case you’re not aware, a Vault is what you create when you deposit your PLS into the Liquid Loans protocol and take out a loan against it.)
What happens if my Vault gets redeemed against?
If this were to happen (because yours was the lowest collateralized Vault), then the USDL that is being brought into the system by the redeemer would be used to pay off some or all of your loan, and the equal value (in the form of your PLS) would go to the redeemer. If your loan is fully paid off, then this is known as a ‘full redemption’.
In a full redemption, your Vault is closed and your leftover PLS is sent to a collateral surplus pool where it will stay, waiting patiently for you to come and collect it — and your 200 USDL Liquidation Reserve is returned to your wallet.
In a partial redemption, your Vault stays open, but with reduced collateral and debt, and your Vault is re-sorted in the list of Vaults.
So…I don’t lose money if I’m redeemed against?
Correct. If your Vault is redeemed against, you don’t incur a net loss. However, you lose some of your PLS exposure, and your Vault’s collateral ratio improves a little bit. In other words, it’s not really a big deal.
How can I avoid being redeemed against?
The best way to avoid being redeemed against is to maintain a high collateral ratio relative to the rest of the Vaults in the system. So if everyone else is collateralized at 500% (which is highly unlikely), then you might want to consider being collateralized at 600%, for example. But as we said above, being redeemed against is not really a big deal.
Don’t miss our sacrifice phase
Very soon we will launch a sacrifice phase where you will be able to make a political statement against corporate-owned, censorable, centralized stablecoins, and express your desire to see something better emerge on PulseChain. Should you choose to participate in this sacrifice, you must have no expectation of profit derived from the work of others. To learn more, go to thesacrifice.io or join our highly active community on Telegram.
Disclaimer: Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.
