Analysis of Lybra Finance (LSDfi): How stable is it? What are the risks of “layer 2 nesting”?

Author: nobody (Twitter: @defioasis), Colin Wu

As the ETH staking rate continues to rise and LSD track becomes the largest TVL asset category, integrating DeFi into LSD with more yield strategies is becoming a new trend in the community. Dune Anlytics data shows that as of June 13, the LSDfi TVL reached $420 million, only about 2.3% of the LSD TVL, with Lybra Finance accounting for 41.1%. On May 29, it set a new single-day growth record of about $40 million in ETH/stETH inflows, but its market share is declining with the entry of competitors. Lybra Finance LBR achieved over 30-fold growth in May, but fell sharply from its high in June due to profit-taking by early investors, market panic about contract issues, and macro environment. Investors need to be aware of the risks. In fact, building a stablecoin on LSD is the core of Lybra. This article will analyze Lybra Finance around the stablecoin eUSD.

Core Business

Lybra Finance allows users to deposit ETH or stETH as collateral on the platform to mint corresponding eUSD. The liquidation ratio is 150%, that is, each $1 eUSD is backed by at least $1.5 worth of stETH as collateral. By holding minted eUSD, users can earn interest income (hold to earn, similar to a bank savings account), which is supported by LSD income generated by the deposited ETH/stETH. This means that when users deposit ETH/stETH to mint eUSD through Lybra, the deposited ETH/stETH will be used to participate in LSD, and the rewards for participating in LSD to verify and maintain the security of the Ethereum network will be provided in the form of stETH, which will be converted to eUSD as interest income and distributed to users. As of June 13, the annualized interest income generated by holding eUSD was about 9.08%. (Note: ETH deposited on Lybra will be converted to stETH.)

Protocol Revenue

Lybra does not charge for the minting and repayment of eUSD. Its main protocol revenue comes from the service fee charged from the income obtained from LSD, which is an annualized service fee of 1.5% on the total amount of eUSD in circulation (the service fee is cumulatively calculated every second based on the current actual eUSD circulation), and the LSD income after deducting the service fee is distributed to eUSD holders. The annualized service fee collected will be allocated to the LBR Staking Pool, and users can convert LBR to esLBR through staking to obtain 100% of the service fee.


eUSD is actually an over-collateralized stablecoin.

(1) At least $1.5 worth of stETH is used as collateral, and rigid redemption of eUSD for ETH is supported (which requires a redemption fee of 0.5% in ETH).

(2) Liquidation mechanism for collateral ratio below 150%: Any user can become a liquidator and purchase the liquidated stETH collateral with eUSD as the payment currency at a discounted price (1-liquidation reward rate).

(3) Based on the first two mechanisms, there will be arbitrage opportunities when the eUSD price fluctuates. When eUSD $1, arbitrageurs can deposit ETH/stETH as collateral to mint new eUSD, then sell eUSD on the secondary market and wait for more arbitrageurs to execute this operation. The price will be gradually pushed down, and after the peg is restored, the arbitrageur will buy back eUSD from the secondary market to repay the loan. The price difference of eUSD before and after the peg is the profit of the arbitrageur.

(4) Curve provides eUSD exit liquidity. As of June 13, the eUSD circulation is about $81.4 million. Through Lybra’s LBR token incentives, 8.5 million eUSD are operating in Curve’s eUSD/USD LP Pool, with a TVL of about $21.4 million and a daily trading volume of about $100,000. The liquidity utilization rate is 0.43%. However, the proportion of Curve’s eUSD/USD LP Pool has been continuously imbalanced. The strange thing is that the Curve v2 pool where eUSD is deployed is used for trading volatile assets, not anchoring hook assets. This may cause malicious actions, guide eUSD to decouple upwards, trigger liquidation, and extract liquidation assets.

Also, the greatest significance of stablecoins is adoption. The utility of eUSD and whether it can be integrated and adopted by other on-chain protocols remains to be observed.

There are two things to note about rigid redemption:

Firstly, rigid redemption requires a fee of 0.5% of the redeemed ETH, which may lead to a 0.5% implicit fluctuation space if eUSD deviates below $1. This is because for arbitrageurs, there is only profit space when the downward deviation is greater than 0.5%.

Secondly, rigid redemption does not mean repayment of eUSD debt. Users who minted eUSD can choose to provide rigid redemption services and receive 0.5% redemption payment fees, as well as higher LBR APY, handling fee compensation, etc. as incentives. If redemption occurs, users who provide redemption services will lose a portion of their collateral, reduce their corresponding debt, and receive a 0.5% redemption fee paid by other users. This means that after this service is enabled, users’ collateral will become the redemption liquidity of other users.

Risk Response

eUSD, or the entire LSDfi track, is essentially a second-layer nesting game. After depositing ETH/stETH into Lybra, it will be uniformly converted into stETH, which relies on the native asset ETH and stETH, with the largest ETH2.0 platform Lido’s credibility already established in the DeFi field as a trusted asset. Therefore, stETH can be regarded as a nesting game for ETH ; eUSD is a stablecoin minted on top of stETH collateral, making it a second-layer nesting game. Users can obtain two sources of income by depositing ETH into Lido to obtain the first staking income and stETH vouchers, and then using the stETH collateral to mint eUSD to obtain the second interest income. Through the two-layer nesting game, users increase the return on holding ETH. High returns and high risk often go hand in hand, which is a major test for the platform, and the liquidation mechanism is an important guarantee for the platform to prevent risks and block the spread of risks.

Generally speaking, since 1 eUSD is at least collateralized by $1.5 worth of ETH/stETH, this means that under normal circumstances, the overall collateralization ratio of the Lybra Finance protocol must be above 150%.

For liquidation that does not touch the platform’s risk control (that is, the overall collateralization ratio of the protocol is above 150%), when a borrower (minting eUSD) is liquidated, users can become liquidators and use their eUSD balance to liquidate up to 50% of the borrower’s collateral, and obtain 109% of the collateral asset value already repaid eUSD. The Keeper obtains 1% of the collateral asset value already repaid eUSD. (Note: 10% is the liquidation reward, of which 9% is given to the liquidator and 1% is given to the Keeper, but it only applies to liquidation behavior using official liquidation tools.)

For example: A deposited 1 stETH as collateral and minted 1400 eUSD a week ago. Within this week, the USD value of ETH has dropped from $2200 to $2000. At this time, A’s collateral ratio is 2000/1400=142%<150%. Then, B, as a Keeper, initiated liquidation against A, and the maximum collateral that can be liquidated is 1 stETH*0.5=0.5 stETH. The liquidator C has a balance of 500 eUSD, which is used to repay A. C will receive 500/2000*109%=0.2725 stETH, equivalent to 545 eUSD, and B as a Keeper will receive 500/2000*1%=0.0025 stETH, equivalent to 5 eUSD. After C repays the debt on behalf of A, A’s debt is 1400-500=900 eUSD, and the collateral value is 1-0.2725-0.0025=0.725 stETH. At this time, the collateral ratio is 0.725*2000/900=161%>150%

This also shows that there is a time difference between the Keeper initiating the liquidation and the liquidator executing the liquidation, so it is not the case that once the collateral ratio falls below 150%, it will be liquidated immediately. There is a process similar to queuing, which is similar to the liquidation of DeFi on-chain lending protocols.

Another extreme case is that the overall collateral ratio of the Lybra Finance protocol is less than 150%. In this case, borrowers with collateral ratios below 125% will face complete collateral liquidation. In the case of complete liquidation, the liquidator pays eUSD equal to the borrower’s (the liquidated person’s) debt to obtain the collateral value equivalent to the borrower’s debt*(collateral ratio-1%), and the 1% deduction belongs to the Keeper. The collateral and debt of the borrower, the liquidated person, are both cleared to zero. In even more extreme cases, if the collateral ratio is lower than 101%, i.e., collateral ratio<(100%+Keeper reward ratio), the Keeper will not receive any reward.

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