Forward the Original Title: Analyzing Lybra Finance Mechanism: Risks, Returns, and the Positive Premium Attributes of Interest-Bearing Assets

1. Sources of eUSD Earnings?

Earnings from eUSD consist of three main sources:

(1) Minting Earnings (Debt Earnings)

(2) Holding Earnings

(3) Mining Earnings

Minting earnings and mining earnings are relatively straightforward to understand. According to official documentation, 78% of esLBR output is allocated to eUSD lenders, and 7% is allocated to the eUSD-USDC Curve pool. Both of these earnings are essentially mining subsidies. It is important to note that minting earnings depend on the debt amount, meaning that even if the minter transfers or exchanges eUSD for other tokens, they can still earn minting earnings.

The holding earnings is a more complex component. According to the official website, eUSD is an interest-bearing stablecoin that earns a 8.47% yield by simply holding. This type of earnings is achieved through eUSD’s rebase mechanism:

(1) Users deposit ETH or stETH, where stETH is also converted into stETH, becoming an interest-bearing asset.

(2) After stETH generates interest, it is all converted into eUSD, with a portion (eUSD minting amount * 1.5%) reserved as protocol income.

(3) The remaining eUSD is distributed to all eUSD holders through the rebase mechanism, automatically increasing the eUSD balance in their accounts.

It is evident that users forfeit the right to stETH income after minting eUSD, replaced by eUSD rebase income, with a portion also deducted as protocol fees.

One intricacy here is that the “8.47%” utilizes eUSD as the base, but the actual yield can be derived by calculating with ETH/stETH from the user’s perspective. Certainly, we can deduce the formula for actual earnings:

User’s actual eUSD received = stETH total value stETH yield - eUSD minting amount 1.5%

eUSD minting amount = stETH total value / Global Collateral Ratio

(Note: Global Collateral Ratio = stETH TVL / Total eUSD)

Using eUSD as the base, the APY = (eUSD minting amount Global Collateral Ratio stETH yield - eUSD minting amount * 1.5%) / eUSD minting amount

Simplified, we get:

APY (eUSD as base) = Global Collateral Ratio * stETH yield - 1.5%

APY (stETH as base) = (Global Collateral Ratio * stETH yield - 1.5%) / Global Collateral Ratio

(Note: Global Collateral Ratio = stETH TVL / Total eUSD)

Based on the current stETH yield of 3.77% and a Global Collateral Ratio of around 200%, the APY with eUSD as the base is approximately 6.04%, and with stETH as the base, it is around 3.15%. It can be observed that even when considering eUSD as the base, the 6.04% yield differs from the project’s official claim of 8.47%. Even accounting for 365 days compounding, it only increases from 6.04% to 6.2%. Of course, we can also verify this difference through on-chain data:

One method is to view the contract history. stETH yield is distributed through the “excess income distribution” function in the eUSD contract. It can be observed that stETH is converted into eUSD, then undergoes rebase, and is injected into Lybrafund (used for staking yield distribution).

Through further analysis, we can find that Lybra’s “excess income distribution” is triggered regularly every day, generating an average of $29,588 in rebase income over the past 5 days. The average annualized APY, calculated over the past 5 days, is approximately 6.07%, closely aligning with the theoretical derivation.

Taking another approach by selecting an on-chain address for calculation, the results show that holding $10,000 eUSD yields an average increase of 1.66 eUSD per day through rebase over the past 3 days, resulting in an annualized APY of 6.06%.

2. How Much Profit Can Lybra Mining Generate?

Specifically, there are two strategies to participate in Lybra mining: (1) Mint and hold; (2) Mint and participate in Curve mining.

Let’s consider a simple scenario: a user deposits $10,000 worth of ETH and mints $5,000 eUSD based on the market average collateral rate of 200%.

The potential APY they could earn is calculated as follows:

APY = eUSD Minting APY / Collateral Rate + eUSD Holding APY / Collateral Rate = 3.02% + 13.42%. The 3.02% represents relatively certain earnings, while the 13.42% is distributed in the form of esLBR, which may take a considerable amount of time to be realized and could be affected by LBR price fluctuations.

Even with these considerations, Lybra staking remains attractive. Compared to direct staking, Lybra sacrifices only 0.75% of the yield but gains a 13.42% esLBR compensation. As long as the weighted average decline in LBR during the vesting period does not exceed 94.5%, the actual staking APY won’t be lower than pure staking. Of course, these compensations ultimately come from the contributors to LBR’s circulating market value.

In a second scenario, users continue to mine Curve while holding Lybra. In this case, the user’s initial $10,000 capital is divided into two parts: $6,667 is staked in Lybra, minting $3,333 eUSD, forming a pool with the remaining $3,333 worth of USDC. The total profit is calculated as (3.02% + 13.42%) (2/3) + 13.3% (2/3) = 19.8%. Compared to minting and holding, the additional yield from Curve mining is only increased by 3.38%, bringing multiple negative impacts to the portfolio:

(1) The yield on the stable value portion decreases from 3.02% to 2.01%.

(2) It introduces impermanent losses (and the potential impermanent losses of eUSD/USDC is not low, as will be detailed later).

(3) Liquidity of the investment portfolio is reduced.

Regarding the issue of portfolio liquidity, I want to explain it further. When users transfer eUSD to Curve, there is a complexity in operations if they need to repay debt. Additionally, if users want to increase the portfolio’s APY, apart from mining more on Curve, there is another way, i.e. reducing the collateral rate. If users are willing to take on a slightly higher level of risk, they can decrease the collateral rate from 200% to 170%, resulting in a yield of (3.02% + 13.42%) * 200% / 170% = 19.3%.

The only downside to this approach is increased liquidation risk, but it is not difficult to address. The Lybra website offers an option for a CR Guardian plugin (provided by a third party, and there is a one-time fee of 100 eUSD for actual execution). In essence, this plugin can automatically repay under specific circumstances. By relying on this plugin, users can mint eUSD with a lower collateral ratio, but at the same time, they need to keep enough eUSD in their wallet for emergency repayment when necessary.

Comparing these two strategies, engaging in Curve mining does not exhibit strong appeal. Data also indicates that the current minting volume of eUSD has exceeded $180 million, but only $13.6 million eUSD has been deposited into Curve, accounting for less than 10%. The daily trading volume is only $840,000, and most miners participate in the minting and holding strategy. Of course, this is closely tied to the distribution of LBR output, and the esLBR share of eUSD exceeds the Curve Pool by more than 10 times.

3. How is the fair value of interest-bearing asset eUSD calculated?

From the previous analysis, we can observe that the essence of eUSD becoming an interest-bearing asset is transferring the interest-earning capability of stETH to eUSD, enabling it to gain a 6% annualized return. In essence, we can think of eUSD as a bond with a face value of $100, a coupon rate of 6%, and considering the redeemer feature of eUSD, it also provides a rigid redemption clause of $99.5 (assuming a market discount rate of 2.7% based on USDC deposit rates on AAVE). Now, the question is: What do you think is the fair value of this $100 bond?

Let’s consider the simplest scenario: assuming the market price of 100 eUSD is 100 USDC:

(1) Alice exchanges 100 USDC for 100 eUSD and holds it for a year.

(2) After a year, Alice exchanges 106 eUSD for USDC. If 1 eUSD > 0.995 USDC, Alice can get at least 106 * 0.995 = 105.47 USDC.

(3) If 1 eUSD < 0.995 USDC, Alice chooses not to exchange but instead redeems it through the forced redemption mechanism for stETH worth $0.995.

(4) Based on this, Alice can earn an annualized return of at least 5.47%. If calculated based on a 2.7% discount rate, the fair value of this bond should be at least $102.7, i.e., 1 eUSD = 1.027 USDC.

Of course, this takes into account friction in transactions, and the 2.7% discount rate may not be accurate. Additionally, factors such as changes in various yield rates and the sustainability of arbitrage need to be considered. The accurate and reasonable price is not easy to measure precisely. Still, what can be confirmed is that it is definitely higher than $100.

This is also why I asked a question on Twitter last week: Is there a greater probability of eUSD unpegging upwards or downwards? How big is the possibility? In my personal opinion, the design of eUSD makes it face a counterintuitive feature—an inherent tendency to unpeg upwards.

Just a few hours after completing this part of the draft (July 16), eUSD had already risen to 1.03 USDC. Of course, as the price of eUSD rises, arbitrage opportunities will be significantly reduced, and the upward unpegging of eUSD is not without limitations.

4. How does the Upward Unpegging of eUSD Occur?

Next, let’s analyze why the upward unpegging of eUSD is inevitable from the perspective of eUSD’s supply and demand in practical operation:

(1) Arbitrage behavior leads to net buying

Detailed theoretical derivations on this point were provided in the previous section. In practice, arbitrage behavior includes directly using USDC to buy eUSD, earning 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 returns may not even cover impermanent losses. The actions of these arbitrageurs will bring net buying to eUSD, driving an increase in demand for eUSD.

(2) Flaws in the rebase mechanism leads to net buying

This issue was analyzed in the first section of this article; approximately $35,000 to $40,000 worth of stETH is exchanged for eUSD every day. Since eUSD does not have a liquidity pool with stETH, the routing path must be stETH-USDC-eUSD, similarly bringing net buying to eUSD.

In fact, this is an inherent flaw in the eUSD rebase mechanism. Although theoretically, users could sell the additional eUSD they receive, which exceeds their actual debt, to offset the net buying of eUSD, it is not happening at this stage. Reasons include: 1) Some users are not familiar with the rebase mechanism. 2) eUSD can earn interest, and users are more inclined to hold it compared to USDC. 3) Users do not want to repay debts and exit Lybra in the short term. 4) Transactions incur fees, and users prefer to accumulate before selling.

(3) Design Flaws in Lybra

Firstly, there is a lack of mechanisms to mitigate upward unpegging (this is being addressed in V2). A more significant issue is that eUSD is deployed in the Curve v2 pool rather than the stablecoin pool. The v2 pool is oriented towards assets with higher volatility. As mentioned in the previous analysis, the willingness of Lybra users to participate in Curve mining is not strong, so the depth of Curve is relatively limited.

Examining the Curve data, the current pool has approximately $13 million in eUSD and $20.6 million in USDC, roughly a 40% : 60% ratio. In other words, just a few million dollars in net buying results in a 3% unpegging. In fact, pools like crvUSD-USDT, Frax-USDC also maintain a 40% : 60% ratio, but their prices have not deviated.

Regarding this point, I genuinely do not agree with Lybra’s approach. All the factors mentioned above take effect very slowly, and the team has ample time to address these flaws. However, choosing the v2 Pool makes this happen quickly. In a sense, the current unpegging, with the choice of the Curve v2 Pool, is the decisive factor.

5. Lybra V2: What Happens Next?

In the past few months, Lybra has seen significant growth in TVL and circulating supply, but risks still exist. The good news is that in Lybra V2, I see many meaningful solutions:

(1) eUSD Price Stabilization Mechanism

V2 introduces a series of mechanisms to address eUSD’s pegging issues, including the introduction of the stablecoin pool 3pool to replace the current non-stablecoin pool, a premium protection mechanism (using USDC as a substitute reward when there is a premium to reduce net buying caused by rebase), and the dLP mechanism, which will play a role in avoiding eUSD’s negative premium.

(2) Bubble Reductions

This mainly includes:

dLP mechanism: Minting requires holding LBR-ETH LP simultaneously, or else rewards decrease, effectively forcing holding of LBR.

Extension of Vesting Period: Extended from 30 days to 90 days, with penalties for early redemption.

Boost: The lock-up period affects mining profitability.

These measures essentially add friction to mining. While reducing the selling pressure from mining inflation, they may also lead to fund outflows. Objectively speaking, these are not groundbreaking innovations and cannot fundamentally solve the characteristic of LBR as a “mining coin.”

(3) peUSD: New Growth Possibilities

In my view, peUSD is the most important feature in V2 because it addresses the contradiction of eUSD, specifically the contradiction between eUSD as an interest-bearing asset and its circulation attributes.

The eUSD price stabilization mechanism in V2 aims to limit the value of eUSD between 0.995 and 1.005. However, this does not fundamentally solve the volatility issue of eUSD. Anytime the price of 1 USDC is greater than or equal to 1 eUSD, exchanging USDC for eUSD is profitable as it exploits stETH’s staking returns. Conversely, eUSD holders have a strong incentive to hold eUSD rather than putting it into circulation or trading since 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 idle in the LBR mining reward system.

peUSD can address this issue. According to the plan in V2, users can mint interest-bearing asset eUSD using rebase LST and zero-interest asset peUSD using non-rebase LST. eUSD can be exchanged 1:1 with peUSD. This exchange essentially separates the circulation attributes of eUSD and transfers them to peUSD for trading and circulation. Meanwhile, the interest-bearing attributes remain with eUSD holders, avoiding the plunder of LST income for eUSD holders. (I’m always willing to exchange 1 USD for 1 eUSD, but I’ll never exchange 0.995 USDC for 1 peUSD).

Apart from solving the problem of LST income plundering, the peUSD mechanism can create new growth potentials. After the establishment of the peUSD mechanism, collateral is not limited to stETH; it also includes all non-rebase LST. There is potential for growth in TVL and governance value for LBR. peUSD can be used in trading and circulation (e.g., LP pairs, collateral, margin, etc.), bringing real demand beyond arbitrage and mining, driving real growth. (Lybra’s 1.5% funding cost is also lower than the maker’s 3.49%). Additionally, eUSD can create its own scenarios based on its interest-bearing attributes, such as DAO treasuries, VC idle fund management, trust scenarios, etc.

Disclaimer：

1. This article is reprinted from [极客 Web3], Forward the Original Title‘Lybra Finance机制拆解：风险、收益与生息资产的正溢价属性’,All copyrights belong to the original author [Loki，新火科技]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
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