Learn the key differences between Liquity protocol and MakerDAO in one article

Key Differences between Liquity Protocol and MakerDAO

By DerrickN

In this article, I will focus on the main differences between the Liquity protocol and MakerDAO.

Let’s start with the basics.

What is Liquity? Liquity is a decentralized lending protocol that allows you to withdraw interest-free loans against ETH used as collateral. Loans are paid in LUSD (a stablecoin pegged to the US dollar) and require a minimum collateral ratio of 110% to be maintained.

What is MakerDAO? MakerDAO is a decentralized borrowing protocol that allows you to draw variable rate loans against a variety of collateral. Loans are paid in DAI (a USD-pegged stablecoin) and the minimum collateral ratio required to be maintained varies by Vault type.

Learn the key differences between Liquity protocol and MakerDAO in one article

It’s no secret that Maker is dominating the ethereum ecosystem. Since its launch in late 2017, Maker has been firmly in the forefront for years, and at the time of writing, it ranks #1 on every DeFi chart with a total value of approximately $9B (total value lock).

Liquity has ranked #10 on the DeFi charts with a TVL of over $2B since its launch on April 5, 2021 (about two months ago at the time of this writing).

Liquity set out to create a more efficient lending protocol with a focus on decentralization and capital efficiency. As the chart above shows, users quickly realized that Liquity is one of the most innovative and useful lending protocols available today.

The key differences between the two protocols, from technical differences to philosophical differences, are described below.

Governance vs. no governance

First, let’s look at the biggest philosophical difference between Maker and Liquity: governance.


Governance plays an important role in the Maker protocol and ecosystem. Using their governance token MKR, users can vote on protocol parameters (e.g., stabilization fees, debt caps, minimum collateral ratios) as well as important ecosystem things (e.g., funding working groups, grants, etc.).

The governance process is quite lengthy, but there are several core groups of participants who make sure everything runs “smoothly” and hold regular public meetings for all to attend and listen to. Most of the discussion takes place in the Maker Governance Forum, and all votes are consolidated through on-chain MKR voting. the Maker improvement proposal process is shown below.

Learn the key differences between Liquity protocol and MakerDAO in one article


Liquity takes a completely different approach to governance, as it chooses not to govern itself manually at all. System parameters are either set in stone or “algorithmically controlled”. In Liquity, system parameters such as allowed collateral types, minimum collateral ratios, etc. cannot be changed. In addition, Liquity’s lending and redemption fees are determined solely by mathematics – i.e., there is no opportunity for human intervention. Even Liquity’s ability to determine which prophecy machine to use is handled in this manner. For example, if the ETH/USD Chainlink price feed drops, it knows how to automatically switch to Tellor, and vice versa.

While we may nitpick about the lack of “human governance” nuances, at least users can rest assured that the code will work as promised and perform as promised.

Why is this important?

Engaging in governance can be a headache with a learning curve that causes most users to not engage – ultimately making the protocol more centralized than one might think. Here’s an interesting visualization of Maker’s need to govern over time.

Learn the key differences between Liquity protocol and MakerDAO in one article

While the “idea” of governance is powerful, we often see the opposite. As the overhead of governance increases, so do the requirements of each user involved in governance. As a result, governance turnout for various protocols is low – including Maker’s turnout – and many people need to move to the governance model of Compound delegates (aka Protocol Politicians). It seems that in the current state of DeFi governance, your choices are not enforced, but rather a delegate model where 20 people (i.e., whales) make all the decisions, or still 20 people make all the decisions, which is far from ideal.

By removing the governance and trust math, Liquity’s ecosystem can instead focus on its own development without the burden of governance and internal politics. Instead of spending entire weeks preparing for a vote, community members can focus on the content they want to create, the tools they want to build, and the communities with which they want to collaborate. If Liquity V2 is needed, community members and users can use their capital to vote on which version they prefer, without imposing that will on the users of the current Liquity protocol version. We have seen this work successfully in the Uniswap ecosystem, and I believe we will see the same in the Liquity ecosystem.

Multi-collateral vs. single collateral

Another significant difference between Maker and Liquity is the type of collateral allowed – that is, the type of collateral a user can borrow.


The Maker system supports multiple collateral types, from ETH to any ERC20 to Uniswap pairs of LP tokens. This diverse set of collateral types may allow for a wide range of borrowers, but introduces new risks to the system, which I will describe later.


In line with its decentralized philosophy, Liquity only allows Ether as collateral and it is not possible to add new collateral types, which means that no new asset risk can be introduced into the system.

Why did Liquity do this?

Liquity chose ETH as its only collateral type for two reasons: 1. the majority of borrowers in DeFi use ETH as collateral, and 2. decentralization and risk minimization are highly valued.

Many would agree that Ether is the most decentralized, liquid and in-demand token in the ethereum ecosystem; so it makes sense to prioritize ETH in any decentralized lending protocol. This, coupled with learning from the history of MakerDAO, led Liquity to aim to create an efficient system built around a single collateral-backed stablecoin, rather than a multi-collateral-backed stablecoin like DAI. Allowing other collateral types (e.g. USDC, WBTC) could be a slippery slope and potential point of failure – posing serious risks not only to the protocol, but also to its users.

To expand on what I mean, let’s zoom in on MakerDAO’s collateral breakdown.

Learn the key differences between Liquity protocol and MakerDAO in one article

The DAI is backed by 41.9% PSM-USDC, 34% ETH, 5.6% WBTC, 5% USDC-A, 4.6% ETH-C and 6.5% Other. In other words, 52.5% of the DAI is backed by centralized assets: USDC and WBTC. most of the remaining borrowing demand comes from ETH holders. If anything, the collateral breakdown of DAI highlights the very real risk of centralization that comes with allowing non-ETH collateral types. If a decentralized stablecoin is mostly backed by centralized assets, then …… perhaps it is not as decentralized as one would hope.

To make matters worse, a governance proposal to raise the PSM-USDC-A debt ceiling by $1B was recently passed. In this case, they are willing to further increase DAI’s USDC exposure and keep DAI pegged, at least for a short time.

Learn the key differences between Liquity protocol and MakerDAO in one article

The Maker community realizes that their reliance on USDC is an existential threat, and I would like to see them reduce their reliance on USDC in the near future. Fortunately, Liquity is not subject to this type of centralization risk because of its focus on ETH as collateral and its immutability – making LUSD more decentralized by default.

PSM and Redemption Mechanisms

I can’t attack Maker’s reliance on USDC if I don’t explain why they’re moving in that direction. Remember, LUSD and DAI are stablecoins pegged to the US dollar. As such, they have economic mechanisms that encourage them to keep their prices around $1. I will briefly describe these mechanisms in this section.


The primary mechanism that Maker’s Peg maintains is the PSM (Peg Stability Module), which allows users to exchange a given collateral type directly for DAI at a fixed rate, rather than borrowing DAI. the PSM contract is designed with stablecoin collateral in mind, allowing users to exchange other stablecoins for DAI at a fixed rate to help maintain a tighter peg.

While the technical details of PSM are beyond the scope, it is important to remember that PSM allows for profitable arbitrage opportunities to remain pegged to the DAI when the DAI diverges from $1.


A similar but unique mechanism exists in Liquity called the Redemption Mechanism. The redemption mechanism allows users to exchange LUSD for ETH at par, or 1 LUSD = 1 USD of ETH. users can always exchange their LUSD for the riskiest Troves (loans) of ETH collateral. This mechanism is used to maintain the LUSD peg and protect its price floor of about $1. It works because when the LUSD falls below $1, arbitrageurs can redeem the LUSD as if it were worth $1 and keep the difference as profit – destroying the LUSD and restoring parity to the peg in the process. Once again, the technical details are a bit out of scope.

The two are somewhat different in that they serve opposite functions; Maker’s PSM brings in collateral in exchange for DAI, while Liquity’s redemption mechanism reduces global LUSD debt in exchange for ETH collateral.

Why compare the two?

They are both key stability mechanisms and both introduce trade-offs, but the key difference is that they introduce centralized trade-offs and introduce a new type of risk to the system.

The PSM was introduced to maintain the DAI peg through a more centralized stablecoin (specifically USDC) intentionally increasing its support. As I mentioned above, trade-offs are decentralized. As a result of this mechanism, as mentioned, DAI is now backed by USDC by >~40%. maker is aware of this, but I’m not sure what they can do to fix it.

On the other hand, Liquity’s redemption mechanism does not increase centralization, does a good job of keeping LUSD pegged, and increases system health (total collateral ratio). On top of that, it means that LUSD can be directly converted to the underlying collateral ETH at any time, while DAI cannot.

Stabilization fees and interest free

The last difference I wanted to compare in the first part of this series is Maker’s stabilization fee and Liquity’s one-time fee (i.e. interest free) model.


Maker’s stabilization fee is continually credited to your loan until you pay off your debt (basically, it’s an interest rate). Depending on governance, this rate may increase or decrease over the life of your loan. Currently, the stabilization fee for the Maker ETH Vault ranges from 3% to 10%. You pay a premium based on the Vault’s minimum collateral ratio. The lower the minimum collateral ratio, the higher your stabilization fee will be.


When borrowing from Liquity, users pay a one-time borrowing fee to mint LUSD, which is added to your debt as a lump sum (unless more LUSD is borrowed later), and that’s it. The borrowing fee ranges from 0.5% to 5%, although it has ever peaked at about 1% and usually stays around 0.5%. Borrowing fees fluctuate with the volume of redemptions, and increase if a large amount of LUSD is redeemed. If no LUSD is redeemed, the borrowing fee drops to 0.5% – no governance is required.

Which model is more cost effective?

This is more of a perspective/preference type thing, but I will try to guide you to

Short-term loans (1 month or less): Maker’s short-term loans are more cost effective because all interest is charged over time and there are no prepayment fees.

Long-term loans (more than 1 month): Liquity is more cost effective for long-term loans because there is only a one-time borrowing fee and you know the cost of borrowing up front. No variable interest rates to worry about.

As a quick comparison, let’s look at the cost difference between borrowing from Maker’s ETH-A Vault and borrowing from Liquity.

Maker: 10,000 DAI borrowed x 5.5% = ~$46 per month in interest

Liquity: 10,000 LUSD borrowed x 0.5% = $50 upfront lending fee

After about a month, borrowing DAI becomes much more expensive than borrowing LUSD. In addition, you get less capital efficiency because ETH-A Vault requires a minimum collateral ratio of 150% while Liquity only requires 110%. If you are in high yield agriculture, borrowing LUSD up front at 0.5% and knowing your loan costs will allow you to extrapolate your profits more effectively. Better yet, you can borrow LUSD, swap it for another stablecoin, and then lend it out to maintain the spread – making LUSD loans attractive for a variety of use cases.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/learn-the-key-differences-between-liquity-protocol-and-makerdao-in-one-article/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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