Author: Loki, New Fire Technology
Due to the large amount of information in this article, readers need to have some background knowledge about Lybra’s regulations. Readers who are not familiar with Lybra can first read basic information about Lybra elsewhere before delving into this article.
1. What are the sources of eUSD income?
The income of eUSD includes three parts:
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(1) Minting income (debt income)
(2) Holding income
(3) Mining income.
Minting income and mining income are relatively easy to understand. According to official documentation, 78% of the output of esLBR is allocated to eUSD borrowers, and 7% is allocated to the eUSD-USDC Curve pool. Both of these income sources are essentially mining subsidies. It should be noted that minting income depends on the amount of debt, which means that even if the minter transfers or exchanges eUSD for other tokens, they can still receive minting income.
The remaining source of income is holding income, which is described on the official website as “a stablecoin that generates 8.47% income just by holding it.” This income is realized through the reBase mechanism of eUSD:
- Users deposit ETH or stETH, where stETH is also converted into stETH and becomes an interest-bearing asset.
- After stETH generates interest, it will be fully converted into eUSD, and a portion of it (eUSD minting amount * 1.5%) will be allocated as protocol revenue.
- The remaining eUSD is distributed to all eUSD holders through the Rebase mechanism, automatically increasing the eUSD balance in the holders’ accounts.
It can be seen that once users mint eUSD, they lose the right to receive stETH income and are replaced by eUSD’s Rebase income, while also being charged a portion as protocol fees.
One trick here is that “8.47%” uses eUSD as the base, and the actual income rate can only be calculated by using ETH/stETH from the user’s perspective. Of course, we can also derive the formula for actual income:
Actual eUSD received by the user = stETH total value * stETH yield – eUSD minting amount * 1.5%
eUSD minting amount = stETH total value / Global collateralization ratio
(Note: Global collateralization ratio = stETH TVL / Total eUSD supply)
APY based on eUSD = (eUSD minting amount * Global collateralization ratio * stETH yield – eUSD minting amount * 1.5%) / eUSD minting amount
Simplifying the formula, we get:
APY (based on eUSD) = Global collateralization ratio * stETH yield – 1.5%
APY (based on stETH) = (Global Collateralization Ratio * stETH Yield – 1.5%) / Global Collateralization Ratio
(Note: Global Collateralization Ratio = stETH TVL / eUSD Total Supply)
Based on the current stETH yield of 3.77% and a global collateralization ratio of around 200%, the APY based on eUSD is approximately 6.04%, and the APY based on stETH is approximately 3.15%. It can be seen that even if we consider eUSD as the base, the 6.04% yield is different from the 8.47% displayed on the project’s official website. Even if we consider compounding over 365 days, the yield 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 through contract history. The stETH yield distribution is made through the “excess income distribution” function in the eUSD contract, which shows that stETH is exchanged for eUSD, and then undergoes rebase and injection into Lybrafund (used for staking yield distribution).
Further analysis reveals that Lybra’s “excess income distribution” is triggered once a day, generating an average of $29,588 in Rebase earnings over the past 5 days. The average annualized APY calculated based on the past 5 days is approximately 6.07%, which is consistent with the theoretical derivation.
Another method is to select an on-chain address for calculation. The result shows that holding $10,000 eUSD increases by an average of 1.66 eUSD per day through Rebase over the past 3 days, resulting in an annualized APY of 6.06%.
2. How much yield can mining Lybra generate?
Specifically, there are two strategies:
(1) Minting and holding
(2) Minting and participating in Curve mining
Let’s consider the simplest scenario: a user deposits $10,000 worth of ETH and mints $5,000 based on the average market collateralization ratio of 200%.
In this case, the APY it can obtain is = eUSD Minting APY / Collateralization Ratio + eUSD Holding APY / Collateralization Ratio = 3.02% + 13.42%. Among them, 3.02% is a relatively certain yield, while 13.42% is distributed in the form of esLBR, which takes a long time to receive and may be affected by LBR price fluctuations.
However, even so, Lybra mining is very attractive because compared to direct staking, Lybra only loses a yield rate of 1.5%/2 = 0.75%, but receives a compensation of 13.42% in esLBR. As long as the weighted average decline of LBR during the vesting period does not exceed 94.5%, the actual mining APY will not be lower than pure staking. Of course, the ultimate payers for these compensations are the contributors to the circulating market value of LBR.
The second scenario is to continue mining on Curve based on the holdings. In this case, the user’s $10,000 principal needs to be divided into two parts, with $6,667 deposited in Lybra and minting $3,333 eUSD, and the remaining $3,333 USDC pooled on Curve. The yield is then calculated as (3.02% + 13.42%) * (2/3) + 13.3% * (2/3) = 19.8%. It can be seen that compared to minting and holding, the yield from mining on Curve only increases by 3.38%, while bringing multiple negative impacts to the investment portfolio:
- The portion of the yield value stability decreased from 3.02% to 2.01%.
- There is a need to bear impermanent loss risks (and the potential impermanent loss risk of eUSD/USDC is not low, which will be detailed later).
- The liquidity of the investment portfolio decreases.
As for the liquidity issue of the investment portfolio, it needs further clarification. When users transfer eUSD to Curve, there is a problem: if they need to repay debts, the operation will become more complex. At the same time, if users want to increase the portfolio’s APY, in addition to mining more Curve, there is another way – reduce the collateral ratio. If users are willing to take on a slightly higher risk, they can reduce the collateral ratio from 200% to 170%, in which case the yield will become (3.02% + 13.42%) * 200% / 170% = 19.3%.
The only downside of this approach is a higher liquidation risk, but it is not difficult to resolve. Lybra’s official website has an option for the CR Guardian plugin (provided by a third party and will charge a one-time fee of 100 eUSD), in simple terms, this plugin can automatically repay under specific circumstances. By relying on this plugin, eUSD can be minted at a lower collateral ratio, but sufficient eUSD needs to be kept in the wallet for emergency repayments when necessary.
Compared to these two strategies, mining on Curve is not very attractive. From the data, it can also be seen 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, accounting for less than 10%, and the daily trading volume is only 840,000 US dollars. Most miners participate based on minting and holding factors. Of course, this is closely related to the production allocation of LBR, and the esLBR share of eUSD is also more than 10 times that of the Curve Pool.
3. How is the fair value of interest-bearing asset eUSD calculated?
Through the previous analysis, we can find that the essence of eUSD becoming an interest-bearing asset is to transfer the interest-earning ability of stETH to eUSD, enabling it to obtain a 6% annualized return. In fact, we can imagine eUSD as a bond that can be redeemed at any time, with a face value of $100 and a coupon interest rate of 6%. At the same time, considering the Redeemer function of eUSD, this bond also provides a rigid redemption clause of $99.5. Assuming the market discount rate is 2.7% (the deposit interest rate of USDC in AAVE), then the question is: what do you think is the fair value of this $100 bond?
Let’s imagine the simplest scenario: Suppose the market price is 100 eUSD = 100 USDC:
Alice exchanges 100 USDC for 100 eUSD and holds it for one year.
After one year, Alice exchanges 106 eUSD for USDC. If 1 eUSD > 0.995 USDC, then Alice can get at least 106 * 0.995 = 105.47 USDC.
If 1 eUSD ＜ 0.995 USDC, then Alice will not choose to exchange, but instead exchange it for stETH worth 0.995 USD through the forced redemption mechanism.
Based on this, Alice can earn an annualized return of at least 5.47%. If calculated at a discount rate of 2.7%, the fair value of this bond should be at least 102.7 USD, that is, 1 eUSD = 1.027 USDC.
Of course, this takes into account the friction in transactions, and the discount rate of 2.7% is not accurate. In addition, various factors such as changes in yields and the sustainability of arbitrage need to be considered. The accurate and reasonable price is not easy to measure accurately. But what can be determined is that it is definitely higher than 100 USD.
This is also why I asked a question on Twitter last week: Is there a greater probability that eUSD will deviate from the anchor upwards or downwards? How large is the possible range? In my personal opinion, the design of eUSD makes it have a counterintuitive feature – a natural tendency to deviate from the anchor upwards.
Just a few hours after I finished writing this part of the draft (on July 16th), eUSD has risen to 1.03 USDC. Of course, as the price of eUSD rises, the arbitrage space will be significantly reduced, and the upward deviation of eUSD is not unlimited.
IV. How does eUSD deviate from the anchor upwards?
Next, let’s analyze why eUSD’s deviation from the anchor will inevitably occur from the perspective of eUSD’s supply and demand in actual operation:
Arbitrageurs’ behavior brings net buying
Detailed theoretical derivations have been given in the previous chapter regarding this point. In practice, the behavior of arbitrageurs includes directly buying eUSD with USDC to earn eUSD Rebase income or Curve mining income. Here, I also believe that holding and earning Rebase income is much smarter than Curve mining, because the actual income may not even cover the impermanent loss. The behavior of these arbitrageurs will bring net buying to eUSD and drive the growth of eUSD’s demand.
Net buying caused by flaws in the Rebase mechanism
This issue has been analyzed in Chapter 1. About $35,000 to $40,000 worth of stETH is exchanged for eUSD every day, and eUSD does not have a liquidity pool with stETH, so the routing path must be stETH-USDC-eUSD, which also brings net buying to eUSD.
In fact, this is an inherent flaw in the eUSD Rebase mechanism. Although theoretically the increase in user eUSD exceeds their actual debt, they can sell the increased eUSD to offset the net buying of eUSD. However, this does not happen at this stage. 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 compared to USDC 3) Users do not want to repay their debts and exit Lybra in the short term 4) Operations require fees, so they need to accumulate enough before selling.
Design flaws in Lybra
Firstly, there is a lack of upward anchor mechanism (this issue is being addressed in v2 version). A bigger problem is that eUSD is deployed in the Curve v2 pool instead of the stablecoin pool. The v2 pool is designed for more volatile assets. As mentioned earlier, Lybra users have limited interest in participating in Curve mining, so the thickness of Curve will also be relatively limited.
Looking at the Curve data, the eUSD in the pool is approximately $13 million, while USDC is $20.6 million, about 40%:60%. In other words, a net purchase of just a few million dollars results in a 3% deviation. In fact, pools like crvUSD-USDT and Frax-USDC also maintain a 40%:60% ratio, but their prices do not deviate at all.
I really cannot understand Lybra’s approach in this regard because all the factors mentioned above take effect very slowly, and the team has ample time to address these flaws. However, choosing the v2 Pool would make this issue happen quickly. In a sense, the choice of Curve v2 Pool is the determining factor for the current deviation.
Five, Lybra V2: What will happen next
Lybra has achieved significant growth in TVL and circulation in the past few months, but risks still exist. The good news is that I see many meaningful solutions in Lybra v2:
eUSD price stabilization mechanism
V2 introduces a series of mechanisms to solve the anchoring problem of eUSD, including introducing the stablecoin pool 3pool to replace the current unstable pool, and implementing a premium protection mechanism (when there is a premium, use USDC as a substitute reward to reduce the net purchase of eUSD caused by Rebase). These two measures will significantly improve the positive premium problem of eUSD. The dLP mechanism will mainly play a role in avoiding negative premium of eUSD.
Reducing the bubble
- dLP mechanism: Minting mining requires holding LBR-ETH LP at the same time, otherwise the yield will decrease, which is equivalent to forcing the holding of LBR.
- Extension of vesting period: Extended from 30 days to 90 days, with fines for early redemption.
- Boost: Lock-up period affects mining yield.
These measures essentially add friction to mining, reducing the selling pressure of mining inflation bubble. However, they may also lead to capital outflow. Objectively speaking, these are not groundbreaking innovations and cannot fundamentally solve the characteristics of LBR as a “mining coin”.
peUSD: New growth potential
In my opinion, peUSD is the most important feature in the v2 version because it solves the contradiction of eUSD: the contradiction between eUSD as an interest-bearing asset and its circulation attribute.
The price stabilization mechanism of v2 hopes to limit the value of eUSD between 0.995 and 1.005. However, this does not fundamentally solve the volatility issue of eUSD. Because at any time, it is profitable to exchange USDC for eUSD when the price of 1 USDC is greater than or equal to 1 eUSD, as this exchange is equivalent to “exploiting” the stETH staking yield. In contrast, eUSD holders have strong incentives to hold eUSD instead of putting it into circulation or trading, because the intrinsic value of 1 eUSD is higher than 1 USDC/USDT. This creates a dilemma: the majority of eUSD will not be put into circulation but will be circulating within the LBR mining reward system.
And peUSD can solve this problem. According to the v2 plan, users can use Rebase LST to mint interest-bearing asset eUSD, while using non-Rebase LST to mint zero-interest asset peUSD. eUSD can be exchanged for 1:1 with 1 peUSD. This exchange essentially separates the circulation attribute and interest attribute of eUSD, transferring the circulation attribute to peUSD for trading and circulation, while the interest attribute remains with eUSD holders, avoiding the plunder of LST earnings from eUSD holders. (I am always willing to exchange 1 USD for 1 eUSD, but I will never exchange 0.995 USDC for 1 peUSD)
In addition to solving the problem of LST earnings plunder, it can also create new growth flywheels. After the peUSD mechanism is established, the collateral is not limited to stETH but also includes all non-Rebase LST. Potential TVL growth and LBR governance value will also emerge. peUSD can be used for trading and circulation (such as LP pairs, collateral, margin, etc.), bringing real demand beyond arbitrage and mining, driving non-bubble growth. (Lybra’s 1.5% cost of funds is also lower than Maker’s 3.49%) At the same time, eUSD can create its own scenarios relying on the interest attribute, such as DAO treasury, VC idle fund management, trust scenarios, etc.