Redemption & Capital efficiency

Overcollateralized protocols face the issue of capital efficiency, as vault holders need to maintain enough collateral for their position not to accrue bad debt in case of flash crash

However, another problem is that hard redemptions push the collateral ratio of vaults upward. In Liquity for example, the minimum Collateral to Debt Ratio (CDR) is 120%. However the hard redemptions target the lowest LTV vaults first. This mechanism therefore inevitably slowly pushes the actual minimum CDR higher than it needs to be, currently over 340% (2024/02/28). Given that the minimum is 120%, the difference of 220% represents high capital inefficiency.

This can create huge disincentive from opening new vaults lower than the CDR of the accepted number as they would be redeemed against first.

Lybra attempted to improve on this problem by only allowing hard redemptions against vaults that had opted-in, for an additional yield. In theory this appeared to be an elegant solution. However, in practice, in a flash crash the opt-in vaults were quickly redeemed against and once the peg went below the hard floor set. There was no assets left to defend the stablecoin peg and its price goes into free fall. Confidence in the stablecoin erodes and the project inevitably loses its growth trajectory.

We improve the Liquity model without compromising security by allowing hard redemptions against all the vaults simultaneously pro rata.

Sample Flow: Assuming Token $1,000 Debt $500

With this mechaism the effect for Monroe hard redemptions:

• are always available to secure the peg

• are fair, as they do not particularly penalize the lowest LTV pools who are the most capital efficient

• push the LTV of the protocol up as a whole, improving the protocol overall healthiness