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Liquity on Aztec: Privacy for the Most Decentralized Stablecoin

Liquity on Aztec: Privacy for the Most Decentralized Stablecoin

Co-authored by Frogs Anon

February 28, 2023

Zk rollups continue to draw attention in 2023, primarily for the role they play in the future of Ethereum scaling. While this is a strong narrative for zk’s, there is another, equally important side to their utility: the serious privacy advantage offered by zero knowledge cryptography. While most zk layer 2s are still working on Ethereum compatibility, Aztec Network is ahead of the curve, already providing privacy-protected access to multiple L1 dApps through their Aztec Connect platform. Today we’ll be looking at the recent addition of Liquity to that roster, highlighting the benefits of Aztec for Liquity users, and why this decentralized stablecoin fits nicely into the zk privacy narrative. To set the stage, let’s get into what Aztec is, as well as the benefits it offers from a rollup standpoint. 

Aztec Network Basics: Bringing Privacy to a Public Blockchain

Aztec Network is leading the way for privacy-focused rollups, providing seamless interaction between both encrypted and unencrypted applications. As you probably know, all the transactions made by a wallet on Ethereum are publicly viewable through explorers like Etherscan. This is how services like Nansen are able to associate wallets with certain entities such as VC and trading firms. Basically, if you know a user’s address, then you have access to all the transactions that user is making. 

There are obviously plenty of scenarios where someone would want to keep their transaction records private, especially in a future where a growing amount of real world transactions will be processed on-chain. Similarly, institutional investors entering the blockchain would value a level of confidentiality surrounding their portfolio. This is where zero knowledge proofs and the Aztec value proposition comes into play. 

User accounts on Aztec have a public key, but also two private keys - one for viewing and one for spending. The viewing key allows holders on the network to see the balances of their encrypted funds, but without anyone else being able to. The spending key is used to unlock these funds for use throughout the network. Upon moving funds onto Aztec, the transactions made from there are no longer visibly associated with a user’s specific address. The privacy base layer is in place, now the task at hand is integrating useful applications into the ecosystem.

Aztec’s platform, when initially launched last year, solely functioned as a venue for sending crypto to other wallets privately. With the introduction of Aztec Connect, has expanded into a DeFi aggregator for the protocols that have been able to integrate with Aztec, giving users access to a growing number of dApps. Currently available are an assortment of DeFi staples, including Yearn, Aave, Compound, and now Liquity.

Integrating Liquity

The Aztec community have long been fans of Liquity, and with its integration they’ve brought the full functionality of the protocol on layer 1 over to Most importantly, they’ve done so without sacrificing the stable & immutable nature of the Liquity protocol. Users are able to mint LUSD for ETH, repay their loans, and earn yield on LUSD using the Yearn yield vault the same as they could on mainnet. This is accomplished through two troves that Aztec has established, which act as bridges between the rollup and Liquity’s mainnet smart contracts. When users borrow or repay LUSD on Aztec they are doing so through shares of these troves. 

The only downside here is there are currently two available troves, with set collateral ratios of 275% and 400%. This does sacrifice some of the capital efficiency that Liquity is known for with the 110% minimum collateral ratio on mainnet, but as with most pioneering projects, tradeoffs are sometimes necessary. Since the troves are essentially acting as bridges, the team has chosen conservative collateral ratios, but will potentially add more options in the future as demand dictates. 

With this design, repayments also work differently, as users can only repay debt by flash swapping their ETH collateral to LUSD in order to repay the bridge. This means borrowers keep the borrowed LUSD and the remainder of ETH collateral after repaying, unlike Liquity on layer 1, where repaying your loan unlocks a user’s ETH collateral.

Using LUSD on Aztec

For users, this integration offers the option to borrow the most decentralized stablecoin on the market, do so with complete privacy, and enjoy gas fees 26x lower than on mainnet. The reason gas fees are so minimal is that Aztec uses batched transactions, meaning that the network groups similar transactions together before posting them to layer 1. 

In the case of Liquity, this means that a user’s borrows and repays are not done in their own troves, but rather within the two troves that Aztec has already established as bridges to layer 1. Just as on mainnet, LUSD borrows incur no interest payments, but one key difference is that there is no minimum borrowing amount. Another key point to cover is that while LUSD cannot currently be bridged from layer 1 to Aztec, LUSD minted on Aztec can be withdrawn back to layer 1.

As on L1, LUSD on Aztec can be staked into the Stability pool, where it will be used to absorb liquidations, earning ETH for stakers. Besides the stability pool, borrowed LUSD on Aztec can be used to earn yield through vaults on Yearn Finance, another DeFi mainstay which has joined the ranks on Aztec. This is currently the only venue for depositing LUSD on Aztec to earn yield, but expect more options to become available in the future, as Aztec will soon be releasing their secure mainnet SDK. This will allow developers to create frontends for their dApps that integrate with Aztec Connect smart contracts. 

Another interesting note, there is a trade section within the platform, and although nothing is live at the moment, expect Dexes and LPing to arrive on Aztec in the near future. Ultimately, these are still extremely early days for zk rollups, so the fact that Aztec is already onboarding protocols like Liquity and offering (limited) yield opportunities is quite impressive.

Due to the private nature of transacting through Aztec, quantifying adoption on a user basis isn’t possible, but aggregate volume for the bridge contract is still available. Over the two weeks that Liquity has been live on Aztec, a total of 53 ETH has been deposited as collateral, and 30,000 LUSD has been borrowed. This calculates out to a 293% collateralization ratio, which is strong in terms of trove health. Given the nascent state of Aztec and zk rollups in general, the demand for Liquity on Aztec has been solid thus far, and will be an important metric to track as the zk privacy develops. 

Why Privacy Matters

One of the key differentiators between LUSD and other stablecoins is the decentralization factor, since it doesn’t rely on any USD reserves to solidify its peg. This is why LUSD often trades at a premium during times of uncertainty surrounding centralized crypto entities and stablecoins. Like decentralization, personal privacy is another key element of the crypto value proposition. One easy comparison to make is that Aztec acts as essentially a VPN for your on-chain activity, obfuscating transactions through zk proofs to prevent tracking. It’s truly exciting to see long-awaited zk rollups coming together, and Aztec is an early leader boasting quality integrations. In Liquity’s case, the integration is a great step forward for both.