Analysis of LSDfi Leader Lybra Finance: Project Characteristics and Potential Risks

Analysis of Lybra Finance: Project Features and Risks

Author|nobody (Twitter: @defioasis)

Editor|Colin Wu

Note: This article is for information sharing only, and is not associated with any project, nor does it endorse in any form.

As ETH staking rates continue to rise and LSD becomes the largest TVL asset category, integrating DeFi around xETH to do more yield strategies in the LSD field with $18.52 billion in assets is becoming a new trend of community attention. According to Dune Anlytics data, as of June 13, LSDfi TVL reached $420 million, only about 2.3% of LSD TVL, of which Lybra Finance accounted for 41.1%, and on May 29, a record $40 million of ETH/stETH inflows were created in a single day, but its market share is declining with the entry of competitors. Lybra Finance LBR achieved more than a 30-fold increase in May, but has fallen sharply from its high since entering June, due to profit-taking by previous winners, market panic over contract issues, and macro environment. Investors should be aware of the risks. In fact, building stablecoins on LSD is Lybra’s core, and this article will analyze Lybra Finance around the eUSD stablecoin.

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Core Business

Lybra Finance allows users to deposit ETH or stETH as collateral on the platform to mint corresponding eUSD, with a liquidation line of 150%, that is, $1 eUSD is at least backed by $1.5 equivalent stETH as collateral. By holding the minted eUSD, users can earn interest income (held as is, similar to bank demand deposits), which is supported by LSD income generated from the deposited ETH/stETH. This means that when users deposit ETH/stETH into Lybra to mint eUSD, these deposited ETH/stETH will be used to participate in LSD, and 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, holding eUSD to generate interest income is about 9.08% per annum. (Note: ETH deposited on Lybra will be converted to stETH).

Protocol Income

Lybra does not charge fees for the minting and repayment of eUSD. Its main protocol income comes from the service fee charged from the income obtained from LSD, that is, a 1.5% annualized service fee is charged on the total amount of circulating eUSD (the service fee will accumulate every second according to the actual circulating amount of eUSD currently), and the LSD income after deducting the service fee is distributed to eUSD holders. The annualized service fee collected will be distributed to the LBR Staking Pool, and users can convert LBR into esLBR through staking to get 100% of the service fee.

Stability

eUSD is actually an over-collateralized stablecoin.

At least $1.5:1 equivalent stETH is used as collateral, and rigid redemption of eUSD for ETH is supported (0.5% redemption fee payable in ETH).

Liquidation mechanism with less than 150% collateralization: Any user can become a liquidator and purchase liquidated stETH collateral with eUSD at a discounted price (1-liquidation incentive rate).

Based on the first two mechanisms, arbitrage opportunities arise when the eUSD price fluctuates. When eUSD$1, arbitrageurs can deposit ETH/stETH as collateral to mint new eUSD, sell eUSD on the secondary market, and wait for more arbitrageurs to execute the same operation, which will gradually lower the price. After the redemption anchor, arbitrageurs buy eUSD back from the secondary market to repay the loan, and the price difference between eUSD before and after the operation is the profit of the arbitrageurs.

Curve provides eUSD withdrawal liquidity. As of June 13, the circulation of eUSD is about $81.4 million. Through Lybra’s LBR emission incentives, 8.5 million eUSD is already operating in Curve’s eUSD/USD LP Pool, with a TVL of about $21.4 million, a daily trading volume of about $100,000, and a liquidity utilization rate of 0.43%. However, the proportion of Curve eUSD/USD LP Pool has been continuously unbalanced. Interestingly, the Curve v2 pool deployed by eUSD is used for trading volatile assets rather than anchoring pegged assets, which may lead to malfeasance, triggering liquidation by guiding eUSD to decouple upwards and extracting liquidation assets from it.

In addition, the greatest significance of stablecoins lies in their adoption. The utility of eUSD and its integration and adoption by other on-chain protocols remains to be seen.

Two points to note about rigid redemption:

First, a 0.5% fee is charged for the redemption of ETH, which may result in a 0.5% implied volatility range if eUSD deviates below $1 because arbitrageurs will only have a profit opportunity if the degree of downward deviation is greater than 0.5%.

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

Risk response

eUSD, or the entire LSDfi track, is essentially a second-layer nested doll. After depositing ETH/stETH into Lybra, it will be converted into stETH uniformly, and stETH, relying on the original asset ETH and stETH’s reputation as the largest ETH2.0 platform Lido, has become a trusted asset in the DeFi field. Therefore, stETH can be regarded as a nested doll for ETH; eUSD is a stablecoin minted on top of stETH collateral and is a second-layer nested doll. Users can obtain two sources of income by depositing ETH into Lido to obtain the first pledge income and stETH certificates, and then by mortgaging stETH to mint eUSD to obtain the second interest income. Through the double-layer nested doll, users increase the return on holding ETH. High returns and high risks are often complementary, which is a major test for the platform. 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 ETH/stETH equivalent to $1.5, 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>150%), when the borrower (minting eUSD) is liquidated, the user can become a liquidator, and using their own eUSD balance as collateral, they can liquidate up to 50% of the borrower’s collateral and obtain 109% of the collateral asset value already repaid eUSD. The Keeper then 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 the official liquidation tool)

For example: A deposited 1 stETH as collateral and minted 1400 eUSD a week ago. Within this week, the US dollar value of ETH dropped from $2200 to $2000, so A’s collateral ratio is 2000/1400=142%＜150%. At this point, B, as a Keeper, initiated liquidation against A. The maximum amount of collateral that can be liquidated is 1 stETH*0.5=0.5 stETH. 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 the Keeper, will receive 500/2000*1%=0.0025 stETH, equivalent to 5 eUSD. After C repays A’s debt, A’s debt is reduced to 900 eUSD, and the collateral value is 1-0.2725-0.0025=0.725 stETH. At this point, the collateral ratio is 0.725*2000/900=161%＞150%

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

Another extreme case is that the overall collateralization ratio of the Lybra Finance protocol is less than 150%. In this case, borrowers whose collateral ratio is lower than 125% will face complete liquidation of their collateral. In the case of complete liquidation, the liquidator pays eUSD equal to the borrower’s (liquidated person’s) debt to obtain collateral worth the same as the borrower’s debt * (collateral ratio-1%), with the 1% deducted by the Keeper. The borrower, that is, the liquidated person’s collateral and debt are both cleared to zero. In an even more extreme case, if the collateral ratio is less than 101%, that is, the collateral ratio＜(100%+Keeper reward ratio), the Keeper will not receive any rewards.

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