Lybra Finance mechanism breakdown: positive premium attributes of risk, return, and interest-bearing assets.

Original author: Loki, New Fire Technology

Original source: Geek Web3

Introduction: In this article, the author Loki discusses Lybra's sources of income, actual earnings, fair value of eUSD, how eUSD can be unanchored, and new mechanisms introduced in Lybra V2 from 5 perspectives. Combining with on-chain data analysis, the author attempts to answer some questions and provide unique analysis on the profit strategies that can be adopted by Lybra followers/users. Due to the large amount of information in this article, readers need to have some basic knowledge of Lybra's regulations. Readers who are not familiar with Lybra can first read basic information about Lybra elsewhere before delving into this article.

One, what are the sources of eUSD revenue?

The income of eUSD includes three parts: (1) minting income (debt income) (2) holding income (3) mining income.

The understanding of casting income and mining income is relatively easy to compare. 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 casting income depends on the amount of debt, which means that even if the caster transfers or exchanges eUSD for other tokens, they can still receive casting income.

The remaining one is a bit more complicated, which is holding income. According to the official website, eUSD is a stablecoin that can earn a 8.47% yield just by holding it.

This type of profit is achieved through the reBase mechanism of eUSD.

(1) Users deposit ETH or stETH, where stETH will also be converted into stETH and become an interest-bearing asset.

(2) After stETH generates interest, it will be fully exchanged for eUSD, and a portion of it (eUSD minting amount * 1.5%) will be set aside as protocol income.

(3) The remaining eUSD is distributed to all eUSD holders through the mechanism of Rebase, which automatically increases the eUSD balance in the holder's account.

It can be seen that after users mint eUSD, they lose the right to claim stETH income and instead receive Rebase income from eUSD, while also being charged a portion as protocol fees.

One trick here is that "8.47%" is based on eUSD, so to calculate the actual yield from the user's perspective, it needs to be calculated using ETH/stETH. Of course, we can also derive the formula for actual yield:

Actual eUSD received by the user = Total value of stETH * stETH yield - eUSD minted * 1.5%

eUSD Minting=stETH Total Value / Global Health Factor

APY based on eUSD = (eUSD minted * global health factor * stETH yield - eUSD minted * 1.5%) / eUSD minted

After simplification, we can get:

APY (based on eUSD) = Global health factor * stETH yield - 1.5%

APY (based on stETH) = (global health factor * stETH yield - 1.5%) / global health factor

According to the current 3.77% stETH yield and around 200% global health factor, 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 use eUSD as the base currency, the 6.04% yield is still lower than the 8.47% displayed on the project's official website. Even if we consider compounding over 365 days, the yield would only increase from 6.04% to 6.2%. Of course, we can verify this difference through on-chain data.

The first method is to view 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 exchanged for eUSD, and then undergo reBase and injection into Lybrafund (used for staking income distribution).

Further analysis reveals that Lybra's excess income distribution triggers once a day, generating an average of $29,588 in Rebase earnings over the past 5 days. The average annualized APY over the past 5 days is approximately 6.07%, which is consistent with theoretical calculations.

Another way is to select an on-chain address for calculation. The result shows that holding 10000 US dollars of eUSD, the average daily increase through Rebase in the past three days is 1.66 eUSD, with an annualized APY of 6.06%.

二、挖 Lybra 到底可以产生多少收益？

Translation:

2. How much profit can be generated by mining Lybra?

Specifically, there are two strategies: (1) mint and hold, and (2) mint and participate in Curve mining.

We imagine a simplest scenario: the user deposits 10,000 US dollars worth of ETH and mints 5,000 US dollars based on the market average health factor of 200%.

So the APY it can get = eUSD minting APY/health factor + eUSD holding APY/health factor = 3.02% + 13.42%, where 3.02% is a relatively certain income, and 13.42% is distributed in the form of esLBR, which may take a long time to receive and may be affected by LBR price fluctuations.

But even so, Lybra mining is very attractive because compared to direct staking, Lybra only loses a yield of 1.5%/2=0.75%, but receives a compensation of 13.42%/2=6.71% esLBR tokens. As long as the weighted average decline of LBR during the vesting period does not exceed 88.9%, the actual mining APY will not be lower than simple 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 while holding the assets.** In this case, the user's $10,000 principal needs to be divided into two parts, with $6,667 deposited into Lybra and minting $3,333 eUSD, and the remaining $3,333 USDC added to the pool. The earnings would be (3.02+13.42%) * (2/3) + 13.3% * (2/3) = 19.8%. It can be seen that compared to minting and holding, the yield increase from mining on Curve is only 3.38%, while bringing multiple negative impacts to the investment portfolio:

(1) The portion of stable yield value decreased from 3.02% to 2.01%

(2) Need to bear impermanent loss risk (and the potential impermanent loss risk of eUSD/USDC is not low, which will be explained in detail later)

(3) Reduced liquidity of investment portfolio

As for the liquidity issue of investment portfolios, it needs to be explained here that there is an additional problem when users transfer eUSD to Curve, which is that if they need to repay debt, the operation will be more complicated. At the same time, if users want to increase the APY of the portfolio, in addition to mining more Curve, there is another way - to reduce the Health Factor. If users are willing to take on slightly higher risks, they can reduce the Health Factor from 200% to 170%, and the yield will become (3.02% + 13.42%) * 200% / 170% = 19.3%.

The only downside of this approach is that there is a higher settlement risk, but it is not difficult to solve. Lybra's official website has an option for the CR Guardian plugin (provided by a third party, with a one-time fee of 100eUSD), which, in simple terms, can automatically repay in specific situations. With this plugin, eUSD can be minted at a lower collateral ratio, but sufficient eUSD must be left in the wallet for emergency repayments when necessary.

**Compared to the two strategies, mining on Curve is not very attractive.** From the data, the current minting volume of eUSD has exceeded 180 million US dollars, but only 13.6 million US dollars of eUSD have been invested in Curve, accounting for less than 10%. The daily trading volume is only 840,000 US dollars, and most miners participate in minting and holding. Of course, this is closely related to the output distribution of LBR, and the esLBR share of eUSD is more than 10 times that of the Curve Pool.

III. How is the fair value of eUSD, a interest-bearing asset, calculated?

Through the previous analysis, we can find that the essence of eUSD becoming an interest-bearing asset is to transfer the interest-bearing ability of stETH to eUSD, enabling it to obtain an annualized return of 6%. In fact, we can imagine eUSD as a bond that can be exchanged at any time, with a face value of $100 and a coupon 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 that the market discount rate is 2.7% (USDC deposit rate in AAVE), the question is: what do you think is the fair value of this $100 bond?

**We imagine a simplest scenario:** Suppose the market price is 100eUSD=100USDC:

(1) Alice exchanged 100 USDC for 100 eUSD and held it for one year.

(2) One year later, Alice will exchange 106 eUSD for USDC. Assuming that 1 eUSD > 0.995 USDC, Alice can get at least 105.47 USDC.

(3) If 1 eUSD ＜ 0.995 USDC, Alice will not choose to exchange, but will exchange through the forced redemption mechanism for stETH worth 0.995 US dollars.

(4) Based on this, Alice can earn an annualized return of at least 5.47%. If calculated using a discount rate of 2.7%, the fair value of this bond should be at least 102.7 US dollars, which is equivalent to 1 eUSD = 1.027 USDC.

Of course, considering that there are frictions in trading, and the discount rate of 2.7% is not accurate. In addition, various factors such as changes in yield rates and the sustainability of arbitrage periods need to be considered. It is not easy to accurately measure the accurate and reasonable price, but what can be determined is that it is definitely higher than $100.

This is also why I asked a question on Twitter last week: What is the probability that eUSD will break its peg upwards or downwards? How big is the possible range? In my personal opinion, the design of eUSD gives it a counterintuitive feature - a natural tendency to break its peg upwards.

Just a few hours after I finished drafting this section (July 16th), eUSD had already risen to 1.03 USDC. Of course, as the price of eUSD rises, the arbitrage space will be significantly reduced, and there are also limitations to eUSD's upward anchor.

Four, how does the upward unanchoring of eUSD occur?

Next, let's analyze why eUSD's anchor will inevitably occur from the perspective of eUSD's supply and demand in actual operation.

(1) The actions of arbitrageurs result in net buying.

As for this point, detailed theoretical derivation has been given in the previous chapter. In practice, arbitrageurs may directly use USDC to buy eUSD, earning eUSD Rebase profits or Curve mining profits. Here, I also believe that holding and earning Rebase profits is much smarter than Curve mining, because the actual profits may not even cover the impermanent loss. These arbitrageurs' actions will bring net buying to eUSD, driving the demand for eUSD to increase.

(2) Rebase mechanism flaw brings net buying

This issue has already been analyzed in Chapter 1. Approximately $35,000-$40,000 worth of stETH is exchanged for eUSD every day, and since eUSD does not have a liquidity pool with stETH, 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 user's eUSD has increased, the additional eUSD exceeds the user's actual debt, so they can completely sell the eUSD to offset the net purchase of eUSD. However, this is not happening at this stage. 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) Transactions require fees, and users need to accumulate enough before selling.

(3) Design flaws of Lybra

First of all, there is a lack of mechanism for upward anchoring (this issue is being addressed in version 2), and a bigger problem is that eUSD is deployed in the Curve v2 pool instead of the stablecoin pool. The v2 pool is aimed at more volatile assets. As mentioned earlier, Lybra users are not very interested in participating in Curve mining, so the thickness of Curve is relatively limited.

From Curve data, the current pool has approximately $13 million worth of eUSD and $20.6 million worth of USDC, roughly 40% to 60%. In other words, a net purchase of just a few million dollars caused a 3% deviation. In fact, pools such as crvUSD-USDT and Frax-USDC also maintain a 40% to 60% ratio, but their prices have not shown any deviation.

I really can't understand Lybra's approach on this point, because all the factors mentioned above take effect very slowly, and the team has plenty of time to address these issues. However, choosing v2 Pool will make this happen quickly. In a sense, the current anchor is the decisive factor in choosing Curve v2 Pool.

Five, Lybra V2: What's Next

Over the past few months, Lybra has achieved significant growth in TVL and circulation, but there are also hidden dangers. The good news is that I have seen many meaningful solutions in Lybra v2.

(1) eUSD Price Stabilization Mechanism

V2 introduced a series of mechanisms to solve the pegging problem of eUSD, including the introduction of stablecoin pool 3pool to replace the current non-stable pool, premium protection mechanism (using USDC as a substitute reward when there is a premium, reducing the net purchase of eUSD caused by Rebase), these two measures will significantly improve the positive premium problem of eUSD; while the dLP mechanism will mainly play a role in avoiding negative premium of eUSD.

(2) Reduce the bubble

Mainly includes:

**dLP Mechanism:** To mine coins, it is necessary to hold LBR-ETH LP tokens. Otherwise, the yield will decrease. This is equivalent to forcing the holding of LBR.

Extended Attribution Period: From 30 days to 90 days, early redemption incurs a penalty.

**Boost:** Lock-up period affects mining yield.

These measures are essentially adding friction to mining, reducing the inflationary pressure of mining bubbles, and may also lead to capital outflows. Objectively speaking, these are not particularly innovative and cannot fundamentally solve the "mining coin" characteristics of LBR.

(3) peUSD: New Growth Potential

peUSD is, in my opinion, the most important feature in version 2, as it solves the contradiction between eUSD's attributes as an interest-bearing asset and a circulating asset.

The price stabilization mechanism of eUSD v2 hopes to limit the value of eUSD between 0.995-1.005. However, this cannot fundamentally solve the volatility problem of eUSD, because it is always profitable to exchange USDC for eUSD at a price of 1USDC greater than or equal to 1eUSD, as this exchange is equivalent to "exploiting" the stETH staking yield. Correspondingly, eUSD holders will have a strong incentive to hold eUSD instead of putting it into circulation or trading, because the intrinsic value of 1eUSD is higher than 1USDC/USDT. This creates a dilemma: the vast majority of eUSD will not be put into circulation, but will be idle in 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 1peUSD at a 1:1 ratio, which essentially separates the circulation and interest-bearing properties of eUSD, transferring the circulation property to peUSD for trading and circulation, while the interest-bearing property remains with the holder of eUSD, avoiding the LST income of eUSD holders being plundered. (I am always willing to exchange 1USD for 1eUSD, but I will never exchange 0.995USDC for 1peUSD.)

除了解决 LST 收益掠夺难题以外，还能创造新的增长飞轮，peUSD 机制建立以后，质押品不局限于 stETH，还包括所有的非 Rebase LST，潜在的 TVL 增长和 LBR 治理价值也会出现；peUSD 可以投入交易与流通（例如做 LP 对、抵押品、保证金等），带来出套利和挖矿以外的真实需求，驱动非泡沫的增长。（Lybra1.5% 的资金成本也低于 Maker 的 3.49%）与此同时，eUSD 也能依靠生息属性创造自己的场景，例如 DAO 金库、VC 闲置资金管理；信托场景等。

Apart from solving the problem of LST yield plunder, it can also create new growth flywheels. After the establishment of the peUSD mechanism, collateral is not limited to stETH, but also includes all non-Rebase LST. Potential TVL growth and LBR governance value will also appear. 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 also create its own scenarios based on its interest-bearing properties, such as DAO treasury, VC idle fund management, trust scenarios, etc.

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