LLAMMA: Curve Releases Algorithmic Stablecoin Whitepaper, Gradual Liquidation Solves Lending Liquidity Issues

The DeFi stablecoin trading hub Curve.Finance recently released an algorithmic stablecoin whitepaper: LLAMMA lending-clearing automated market maker algorithm. In the whitepaper, it states: "The core concept is the conversion between collateral and stablecoins. When the price of collateral is high, user deposits will become collateral such as ETH, or when the price of collateral is low, they will all become USD." Sounds a bit magical? This article summarizes the explanation of Twitter celebrity foobar on it.

Old Issues in the DeFi Lending Market

Foobar states that a problem in the lending market is that individuals can manipulate prices to increase the spot price of illiquid collateral to maximize their borrowing limit and then get their collateral liquidated after borrowing. However, due to the poor liquidity of the collateral, lending protocols ultimately terminate due to bad debt issues.

It is this potential manipulation mechanism that inevitably makes lending protocols rely on AMM liquidity. However, these AMMs are external, and liquidity providers (LPs) can withdraw liquidity at any time, so most protocols require active governance to approve or reject new token listings or modify the loan-to-value (LTV) ratio in times of higher risk.

LLAMMA Changing the Old Liquidation Mechanism

Foobar mentions that Curve's newly introduced LLAMMA (Lending-Liquidating AMM Algorithm) addresses the aforementioned issues by internalizing the AMM, making the collateral tokens also LP shares themselves.

For example, when a user collateralizes ETH for a USD loan, the user deposits ETH as collateral, and the deposited ETH becomes an LP position in ETH/USD.

Under this mechanism, as the price of ETH drops, the LP position gradually sells ETH and buys USD, and when the price of ETH rises again, the LP position gradually sells USD and buys back ETH. If ETH drops and does not rise back, the LP position still has enough USD to support the debt.

Foobar explains that LLAMMA shifts the liquidation mechanism from the original "all at once" or "all-or-nothing" to significant slippage losses. If collateral holders can withstand price fluctuations, they may even earn additional AMM trading fees when the price stabilizes again.

Foobar Partially Disagrees with this Approach

While LLAMMA has the potential to address issues with the existing liquidation mechanism, some individuals may not favor this mechanism as it brings more risk to collateral holders, including Foobar, who also holds some opposing views on this practice.

"I disagree because the risk was already there, and if you internalize the risk through the protocol, we will see a cascading collapse," said Foobar.