Lybra Finance: How stable is it? What are the risks of "two-story matryoshka"

By nobody (Twitter: @defioasis), Colin Wu

With the continuous rise of the ETH pledge rate and the LSD track becoming the largest TVL asset class, more income strategies around xETH, and the integration of DeFi in the LSD field with assets of 18.52 billion US dollars is becoming a new trend of community attention. **Dune Analytics data shows that as of June 13, LSDfi TVL reached US$420 million, only about 2.3% of LSD TVL, of which Lybra Finance accounted for 41.1%, and its single day on May 29 was about US$40 million ETH/stETH inflows set a new one-day growth record, but its market share is declining as competitors join in. **Lybra Finance LBR achieved an increase of more than 30 times in May, but after entering June, it may have fallen sharply from the high point due to the sell-off of previous profit earners, the market’s panic about contract issues, and the macro environment. Investors should pay attention to risks . In fact, Building a stable currency on LSD is the core of Lybra. This article will analyze Lybra Finance around the eUSD stable currency.

Core Business

Lybra Finance allows users to deposit ETH or stETH on the platform as collateral to mint the corresponding eUSD, the liquidation line is 150%, that is, $1 eUSD is collateralized by at least $1.5 equivalent of stETH. By holding the minted eUSD, users can earn interest income from it (just hold it, similar to a bank current deposit), which is supported by the LSD income generated by the deposited ETH/stETH, which means that when the user passes Lybra When depositing ETH/stETH to mint eUSD, the deposited ETH/stETH will be used to participate in LSD, and participation in LSD will be rewarded for verifying and maintaining the security of the Ethereum network. These rewards are generated in the form of stETH , which is converted into eUSD by the Lybra Finance protocol as interest income and distributed to users. As of June 13, the annualized interest income generated by holding eUSD is about 9.08%. (Note: Depositing ETH on Lybra will be converted into stETH)

Agreement income

Lybra does not charge fees for the minting and repayment of eUSD, its main protocol income comes from the service fee collected after the income obtained from LSD, that is, an annualized service fee of 1.5% is charged on the total amount of eUSD in circulation (The service fee will be accumulated once per second according to the current actual eUSD circulation), and the LSD income after deducting the service fee will be distributed to eUSD holders. The collected annual service fee will be allocated to the LBR Staking Pool, and users can obtain 100% of the service fee by staking LBR into esLBR.

stability

eUSD is actually an overcollateralized stablecoin.

(1) At least $1.5: StETH equivalent to $1 is used as collateral, and supports the rigid redemption of eUSD against ETH (0.5% redemption fee is required, denominated in ETH)

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

(3) Based on the former two, when the eUSD price fluctuates, there will be arbitrage opportunities. When eUSD<$1, arbitrageurs can purchase eUSD at a discount in the secondary market, and then rigidly redeem eUSD for ETH worth $1. As the number of arbitrageurs who repeatedly operate increases, the price will gradually be flattened; When eUSD>$1, arbitrageurs can deposit ETH/stETH as collateral to mint new eUSD, and then sell eUSD on the secondary market, waiting for more arbitrageurs to perform this operation, and the price will be slowly lowered , after returning to the anchor, the arbitrageur re-purchases eUSD from the secondary market to repay the loan, and the price difference between eUSD and eUSD is the profit of the arbitrageur.

(4) Curve provides eUSD exit liquidity. As of June 13, the eUSD circulation was about 81.4 million US dollars. Through Lybra's LBR emission incentives, 8.5 million eUSDs have been operating in Curve's eUSD/USD LP Pool, with a TVL of about 21.4 million US dollars and a daily trading volume of about 10 million USD, and the liquidity utilization rate was 0.43%. However, the Curve eUSD/USD LP Pool ratio continues to be out of balance. What is rather strange is that the Curve v2 pool deployed by eUSD is used for volatile asset transactions instead of anchoring pegged assets, which may lead to mischief, triggering liquidation by guiding eUSD to decoupling upwards, and extracting liquidation assets from it.

In addition, the greatest significance of stablecoins lies in their adoption. It remains to be seen how effective eUSD is and whether it can be integrated and adopted by other on-chain protocols.

There are two points to note for rigid redemption:

One is that rigid redemption needs to pay a fee of 0.5% of the redeemed ETH, which may lead to a 0.5% default room for fluctuations if eUSD shifts to $1 underwater, because for For arbitrageurs, only when the downward deviation is greater than 0.5%, there is room for profit arbitrage.

**Secondly, rigid redemption is not equal to repaying eUSD debts. **Users who have minted eUSD can choose to provide rigid redemption services and receive 0.5% redemption payment fees, as well as higher LBR APY and handling fee compensation etc. as an incentive. If a redemption occurs, the user who provides the redemption service will lose part of the collateral, reduce the corresponding debt, and get the 0.5% redemption fee paid by other users, which means that after the service is turned on, the user The collateral will become the redemption liquidity for other users.

Risk Response

eUSD, or the entire LSDfi track, is essentially a second layer of matryoshka. After depositing ETH/stETH into Lybra, it will be uniformly converted into stETH. Relying on the original asset ETH and the reputation of the largest ETH2.0 platform Lido, stETH has become a reliable asset in the DeFi field, so **stETH can be regarded as a Matryoshka ** for ETH; **eUSD is a stable currency minted on top of stETH collateral, which is the second layer of dolls. **Users can obtain two incomes, deposit ETH into Lido to obtain the first pledge income and stETH certificate, and then mint the stETH mortgage into eUSD to obtain the second interest income. Through the double-layer nesting doll, users increase the income of holding ETH. High returns and high risks often complement each other, 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 collateralized by at least $1.5 equivalent of ETH/stETH, this means that under normal circumstances, the overall collateralization rate of the Lybra Finance protocol must be above 150%. **

For liquidation that does not touch the platform's risk control (that is, the overall mortgage rate of the agreement is > 150%), **When the borrower (casting eUSD) is liquidated, the user can become the liquidator, with the help of Keeper (a specific participant who plays the role of liquidation) ) use their own eUSD balance to liquidate up to 50% of the borrower’s collateral, and get 109% of the repaid eUSD value as collateral assets, and Keeper gets 1% of the repaid eUSD value as collateral assets. ** (Note: 10% is the liquidation reward, of which 9% is given to the liquidator and 1% is given to the Keeper, but it is only applicable to liquidation using official liquidation tools)

For example: A deposited 1 stETH as collateral a week ago and minted 1400 eUSD. During this week, the dollar value of ETH dropped from $2200 to $2000. At this time, A’s mortgage rate = 2000/1400=142% <150%. At this time, B acts as a Keeper to initiate liquidation against A, and the maximum liquidable collateral is 1 stETH*0.5=0.5 stETH. Liquidator C has a balance of 500 eUSD, which is all used to repay on behalf of A. C will get 500/2000*109%=0.2725 stETH, which is equivalent to 545 eUSD, and B as a Keeper will get 500/2000*1%=0.0025 stETH, which is equivalent to 5eUSD. After C repays the debt for 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 mortgage rate is 0.725*2000/900=161%＞150%

It can also be seen that there is a time difference between the liquidation initiated by the Keeper and the liquidation performed by the liquidator. Therefore, it is not as long as the mortgage rate is lower than 150%, it will be liquidated immediately. There is a process similar to queuing. The liquidation of the above lending agreement is relatively similar.

**Another extreme case is that the overall mortgage rate of the Lybra Finance agreement is lower than 150%. In this case, borrowers with a mortgage rate lower than 125% will face full liquidation of their collateral. *In the case of complete liquidation, the liquidator pays eUSD equivalent to the debt of the borrower (liquidated person) to obtain a collateral value equivalent to the debt of the borrower (mortgage rate-1%), which is deducted 1% is owned by Keeper. The collateral and debts of the borrower, that is, the liquidated party, are cleared. If in a more extreme case, the mortgage rate is lower than 101%, that is, the mortgage rate < (100% + Keeper reward ratio), the Keeper will not receive any rewards.