LSD stable currency leader Lybra Finance mechanism detailed: risk, income and positive premium attributes of interest-earning assets

Author: Loki, Xinhuo Technology

Due to the large amount of information in this article, readers are required to have some reserve knowledge of some of Lybra's regulations. Readers who don't know about Lybra can first read the basic information about Lybra in other places, and then develop an in-depth understanding of this article.

1. What are the sources of eUSD income?

eUSD revenue consists of three parts:

(1) Minting proceeds (debt proceeds)

(2) Holding income

**(3) Mining income. **

Mining revenue and mining revenue are relatively easy to understand. According to the official document information, 78% of esLBR output is allocated to eUSD lenders, and 7% is allocated to the eUSD-USDC Curve pool. These two incomes are essentially mining subsidies. It should be noted that the minting income depends on the amount of debt, that is to say, even if the minter transfers or converts eUSD into other tokens, the minting income can still be obtained.

The remaining one that is more complicated is holding income. According to the official website description, eUSD is an [interest-earning stable currency that can earn 8.47% income if you hold it]. This benefit is realized through the reBase mechanism of eUSD:

1. The user deposits ETH or stETH, and stETH will also be converted into stETH to become an interest-earning asset.
2. After stETH generates interest, it will be fully converted into eUSD, and part of it (eUSD minting amount*1.5%) will be accrued as agreement income.
3. The remaining eUSD will be issued to all eUSD holders through the Rebase mechanism, which will automatically increase the eUSD balance in the holder's account. **

It can be seen that after minting eUSD, **users lose the right to claim the stETH income, but are replaced by the rebase income of eUSD, and a part of it will be taken as the agreement fee. **

**A trick here is that "8.47%" uses eUSD as the base, **From the perspective of users calculating the actual rate of return, only ETH/stETH can be used to calculate the actual return. Of course, we can also deduce the formula of actual income:

The eUSD actually obtained by the user = total value of stETH*stETH yield rate - eUSD minted amount*1.5%

eUSD minting volume=total value of stETH/global mortgage rate

(Note: Global mortgage rate = stETH TVL / eUSD total amount)

APY based on eUSD= (eUSD minting amount* global mortgage rate* stETH yield-eUSD minting amount*1.5%)/eUSD minting amount

After simplification, we can get:

APY (eUSD as the base) = global mortgage rate* stETH yield -1.5%

APY (stETH is the base) = (global mortgage rate* stETH yield-1.5%)/global mortgage rate

(Note: Global mortgage rate = stETH TVL / eUSD total amount)

According to the current stETH rate of return of 3.77% and the global mortgage rate of about 200%, the APY based on eUSD is about 6.04%, and the APY based on stETH is about 3.15%. It can be seen that even if eUSD is used as the base, the rate of return of 6.04% is still different from the 8.47% displayed on the project's official website. Even if we consider 365-day compound interest, it only increases from 6.04% to 6.2%. Of course, we can also verify this difference through on-chain data:

The first method is to check the contract history. The stETH income distribution is distributed through the [excess income distribution] function in the eUSD contract. It can be seen that stETH will be converted into eUSD, and then rebase and injected into Lybrafund (for pledge income distribution).

After further analysis, we can find that Lybra's [excess income distribution] is triggered regularly once a day, generating an average of $29,588 in rebase revenue in the past 5 days, and the average annualized APY converted in the past 5 days is about 6.07%, which is basically consistent with the theoretical derivation . **

Another way is to select an address on the chain for calculation. The result shows that for every 10,000 US dollars of eUSD held, the average daily increase of 1.66 eUSD through Rebase in the past 3 days, and the annualized APY is 6.06%.

2. How much profit can mining Lybra generate?

Specifically, there are two strategies:

(1) minted and held

(2) Cast and participate in Curve mining

Let's imagine the simplest situation: the user deposits $10,000 in ETH, and mints $5,000 according to the market average mortgage rate of 200%.

Then the APY it can get = eUSD casting APY/mortgage rate + eUSD holding APY/mortgage rate = 3.02% + 13.42%, of which 3.02% is a relatively certain income, and 13.42% is issued in the form of esLBR. For a long time, it is likely to be affected by LBR price fluctuations.

But even so, Lybra mining is very attractive, because compared with direct pledge, Lybra only lost 1.5%/2=0.75% yield, but got 13.42% esLBR compensation, then As long as the weighted average drop of LBR during Vesting does not exceed 94.5%, the actual mining APY will not be lower than that of pure staking. Of course, the final payers for these compensations are the contributors to the circulating market value of LBR.

**The second case is to continue mining in Curve on the basis of holding. **Then the user’s USD 10,000 principal needs to be divided into 2 parts, of which USD 6,667 is deposited into Lybra and USD 3,333 is minted in eUSD, and the remaining USD 3,333 USDC is pooled. Then profit = (3.02+13.42%)*(2/3)+13.3%*(2/3)=19.8%. It can be seen that compared to casting and holding, the rate of return of mining in Curve has only increased by 3.38%, and it has brought multiple negative effects on the investment portfolio:

1. The part of the stable yield value decreased from 3.02% to 2.01%
2. Need to bear the risk of impermanent loss (and the potential risk of impermanent loss of eUSD/USDC is not low, which will be elaborated later)
3. Reduced portfolio liquidity

As for the liquidity of the investment portfolio, here is an additional explanation. When the user transfers eUSD to Curve, there will be a problem, that is, if the debt needs to be repaid, the operation will be more complicated. At the same time, if the user wants to increase the APY of the portfolio, in addition to digging more Curve, there is another way - to reduce the mortgage rate, if the user is willing to take a slightly larger risk, the mortgage rate can be reduced from 200% is reduced to 170%, so the rate of return will become (3.02% + 13.42%)*200%/ 170% = 19.3%.

The only disadvantage of this approach is that there will be a higher liquidation risk, but it is not difficult to solve, Lybra’s official website has a CR Guadian plug-in option (provided by a third party, and a single fee of 100eUSD will be charged for actual execution) , simply put, this plugin can automatically repay under certain circumstances. Relying on this plugin, eUSD can be minted with a lower pledge ratio, but at the same time, enough eUSD needs to be left in the wallet for emergency repayment when necessary.

**Compared with these two strategies, mining on Curve is not very attractive. ** It can also be seen from the data that the current minting volume of eUSD has exceeded 180 million US dollars, but only 13.6 million US dollars of eUSD has been invested in Curve, less than 10%, and the daily transaction volume is only 840,000 US dollars. Most miners are Participate with a minted and held factor. Of course, this is inseparable from the output distribution of LBR, and the esLBR share of eUSD is also more than 10 times that of Curve Pool.

3. How to calculate the fair value of the interest-earning asset eUSD?

Through the previous analysis, we can find that the essence of **eUSD becoming an interest-earning asset is to transfer the interest-earning ability of stETH to eUSD, so that it can obtain an annualized return of 6%. **In fact, we can think of eUSD as a bond that can be redeemed at any time, with a face value of 100 US dollars and a coupon rate of 6%. At the same time, considering eUSD's Redeemer function, this bond also provides a rigid redemption term of $99.5, assuming a market discount rate of 2.7% (USDC's deposit rate in AAVE). So here comes the question: What do you think is the fair value of this $100 piece?

**We imagine the simplest situation: **If the market price is 100eUSD=100USDC:

Alice converts 100USDC to 100 eUSD and holds it for one year

One year later, Alice converts 106 eUSD into USDC. If 1 eUSD > 0.995 USDC, then Alice can get at least 106*0.995=105.47USDC

If 1 eUSD < 0.995 USDC, then Alice does not choose to exchange, but exchanges it into stETH worth $0.995 through the forced redemption mechanism

Based on this, Alice can obtain an annualized return of at least 5.47%. If calculated at a discount rate of 2.7%, the reasonable value of this bond should be at least US$102.7, that is, 1 eUSD = 1.027USDC.

Of course, this takes into account that transactions are frictional, and the discount rate of 2.7% is not accurate. In addition, factors such as changes in various yields and the sustainable period of arbitrage must also be considered. It is not easy to accurately measure reasonable prices, but For sure,** it's definitely higher than $100. **

**This is why I asked a question on Twitter last week: Is there a greater probability of eUSD unanchoring upwards, or is it more likely to unanchored downwards? What is the range of possibilities? As far as my personal opinion is concerned: the design of eUSD makes it face an anti-common sense characteristic-it has a natural upward tendency to unanchor. **

**And just a few hours after I finished writing the draft of this part of the content (July 16), eUSD has risen to 1.03USDC. Of course, as the price of eUSD rises, the arbitrage space will be significantly reduced, and the upward unanchoring of eUSD is not unlimited. **

4. How does the upward unanchoring of eUSD happen?

Next, let’s analyze why the unanchoring of eUSD will inevitably happen from the perspective of supply and demand of eUSD in actual operation:**

The behavior of arbitrageurs brings net buying

The previous chapter has given a detailed theoretical derivation on this point. In reality, the behavior of arbitrageurs includes directly using USDC to buy eUSD, earning eUSD Rebase income or Curve mining income. Here I also think that holding and earning Rebase income is far smarter than Curve mining, because the actual income may not even cover impermanent losses. The behavior of these arbitrageurs will bring net purchases to eUSD, driving the demand for eUSD.

Rebase Mechanism Defects Bring Net Buying

This problem has been analyzed in the first chapter. About 35,000-40,000 US dollars of stETH will be converted into eUSD every day, and eUSD does not have a liquidity pool with stETH, so the routing path must be stETH-USDC-eUSD, Also net buying for eUSD.

In fact, this is an inherent defect of the eUSD Rebase mechanism. In theory, although the user's eUSD has increased, the increased eUSD exceeds the user's actual debt, so they can sell eUSD to offset the net purchase of eUSD, but at this stage, this will not happen. The reasons include: 1) Some users are not familiar with the rebase mechanism 2) eUSD can generate interest, and users are more willing to hold it than USDC 3) Users do not want to repay their debts and quit Lybra in the short term 4) The operation requires handling fees, and they need to save enough to sell .

Lybra's Design Flaws

The first is the lack of a stabilizing mechanism for upward unanchoring (v2 version is solving this problem). The bigger problem is that eUSD is deployed in the Curve v2 pool instead of the stable currency pool. The v2 pool is for assets with more volatility. As mentioned in the previous analysis, Lybra users are not willing to participate in Curve mining, so the thickness of Curve will be relatively limited.

According to the data of Curve, eUSD in the current pool is about 13 million US dollars, and USDC is 20.6 million US dollars, about 40%: 60%. In other words, net buying of just a few million dollars resulted in a 3% unanchor. In fact, pools such as crvUSD-USDT and Frax-USDC also maintain a ratio of 40%:60%, but the prices of these pools have not deviated in any way.

I really can't understand Lybra's approach on this point, because all the above factors are very slow to take effect, and the team has sufficient time to solve these defects. But choosing v2 Pool will make this happen quickly. In a sense, the current unanchoring, the choice of Curve v2 Pool is the decisive factor.

Five, Lybra V2: what happens next

In the past few months, Lybra has achieved significant growth in TVL and circulation, but hidden dangers still exist. The good news is that in Lybra v2, I have seen many meaningful solutions. :

eUSD price stabilization mechanism

v2 introduces a series of mechanisms to solve the eUSD peg problem, including the introduction of the stable currency pool 3pool to replace the current unstable pool, premium protection mechanism (use USDC as a substitute reward when there is a premium, and reduce the net purchase of eUSD caused by rebase), These two measures will significantly improve the positive premium of eUSD; while the dLP mechanism will mainly play a role in avoiding the negative premium of eUSD.

Reduce Foam

mainly include:

• **dLP mechanism: **It is necessary to hold the LP of LBR-ETH at the same time through coin minting, otherwise the income will drop, which is equivalent to mandatory holding of LBR
• ** Vesting period extended: ** Extended from 30 days to 90 days, early redemption charges a penalty
• **Boost: **The lock-up period affects mining yield

These measures are essentially adding friction to mining. While reducing the selling pressure of mining inflation bubbles, they may also lead to the outflow of funds. Objectively speaking, these are not great innovations, and there is no way to fundamentally solve them. The [Mining Coin] trait of LBR.

peUSD: New Growth Possibilities

**peUSD is the most important function in the v2 version in my opinion, because it solves the contradiction of eUSD: the contradiction between eUSD as an interest-earning asset and circulation attributes. **

The eUSD price stabilization mechanism of v2 hopes to limit the value of eUSD between 0.995-1.005, but this cannot fundamentally solve the fluctuation problem of eUSD, because anytime the price of 1USDC is greater than or equal to 1eUSD, it is a problem to exchange USDC into eUSD It is cost-effective, because this exchange is equivalent to "exploiting" the pledge income of stETH; correspondingly, eUSD holders will have a very strong incentive to hold eUSD instead of putting it into circulation or trading, because the intrinsic value of 1eUSD If it is higher than 1USDC/USDT, there will be a dilemma: the vast majority of eUSD will not be put into circulation, but will be idling in the LBR mining reward system.

And peUSD can solve this problem. According to the v2 plan, users can use Rebase LST to mint the interest-earning asset eUSD, and use non-Rebase LST to mint the 0-interest asset peUSD, and eUSD can be converted into 1peUSD at a 1:1 ratio. This exchange essentially combines the circulation and interest-generating properties of eUSD Stripped, the circulation attribute is transferred to peUSD, put into trading and circulation, while the interest-earning attribute remains on the eUSD holder, avoiding the plundering of the LST income of the eUSD holder. (I am always willing to convert 1USD to 1eUSD, but I will never convert 0.995USDC to 1peUSD)

In addition to solving the problem of LST revenue plundering, it can also create a new growth flywheel. After the establishment of the peUSD mechanism, the collateral is not limited to stETH, but also includes all non-Rebase LSTs. Potential TVL growth and LBR governance value will also appear; peUSD can Invest in trading and circulation (such as LP pairs, collateral, margin, etc.), bringing real demand beyond arbitrage and mining, and driving non-bubble growth. (Lybra's 1.5% capital cost is also lower than Maker's 3.49%) At the same time, eUSD can also rely on interest-bearing attributes to create its own scenarios, such as DAO treasury, VC idle fund management; trust scenarios, etc.