Hey folks, if you’ve been following me for some time, you’ll know that I’ve been a long term fan of two things in crypto — Liquity and Stablecoins, or more specifically in Liquity’s case, $LUSD. I’ve written several articles about Liquity’s mechanics in the past, but as a bit of a refresher, Liquity is a decentralized interest-free lending platform where users can open up a “trove” and borrow $LUSD using $ETH collateral. The beauty of Liquity is not only that it’s decentralized, but also because immutably 1 $LUSD can always be redeemed for 1 dollar’s worth of $ETH, meaning that as long as the price of $ETH has inherent value, by proxy so should $LUSD. This redemption mechanism has always prevented $LUSD from dropping below its peg, as arbitragers are incentivized to scoop up as much $LUSD as they can in order redeem it for $LUSD.
OK, that’s a very short and abridged version of how Liquity works, but let’s talk more specifically about what’s been going on for the past few months…
The Stress-Test
There are 3 different metrics that have been raising a lot of eyebrows around Liquity over the past few months, and more intensely over the past few weeks. These include:
- Over the past 90 days, $LUSD’s total market cap has been on a steady decline, dropping from around $300 million to about $212 million which is where it’s sitting now:
2. Approximately over this same period of time, $LUSD’s peg has also been sitting below peg, ranging roughly between $0.991-$0.999. This wouldn’t be unusual for a lot of other stablecoins, but it is for $LUSD because typically speaking, $LUSD trades at slight premium:
3. And lastly, there’s a lot of troves being redeemed at more than 240%, which is 2x’s more than the normal liquidation rate of 110%:
To clarify, these trovesare not getting liquidated, but instead they are getting redeemed, or in other words the trove’s debt is paid almost in full.
So why is this happening?
So before you go around screaming that the sky is falling, there’s some key catalysts that have occurred which are causing all of this to happen, all of which I would say are normal market events. Because there’s so much juice in the markets right now, there’s several major opportunities to stake stablecoins out there that offer pretty solid rates. These include:
Staked $DAI ($sDAI): Although it’s been brought back to 5% now (or even 6.2% on Gnosis), last August, with the incorproation of real world assets (RWAs), the $DAI Savings Rate (DSR) was hiked up to 8%, meaning that if you staked your $DAI for $sDAI, you could earn an easy 8% yield.
Staked $FRAX ($sFRAX): Similar to $DAI, $FRAX holders can now stake their $FRAX for $sFRAX and get in return a 5.40% APY. With the induction of Frax V3, Frax Finance also utilizes RWAs, including US Treasury bills and money market mutual funds.
$USDC on Coinbase: A couple of months ago, Coinbase started offering yield on $USDC held on their platform from 2% to 5%. We always knew that Circle ($USDC’s founder) was making interest from US Treasury bills on all the deposits backing $USDC, but after acquiring a minority stake in Circle last August, Coinbase is now passing along that yield to attract more customers.
So to sum it all up — in the past few months you have 3 top-10-marketcap stablecoins that are now offering relatively safe +5% yields from RWAs. Naturally if relatively risk-free ways to earn significant yields are available, then as 0xdeif points out, the market will jump on to the the more profitable (and albeit still safe) ship:
The only thing that 0xdeif is now outdated on is that today you have multiple places to get a better store of value, not just $DAI.
So what happens now?
There’s a couple of ways this can go, but here are some considerations I’m making as I look at this situation continue to play out…
Arbitragers will continue to keep arb as long as $LUSD is below peg: As long as you can continue to get $ETH for free, then it makes complete sense for them to continue to do so. In other words, no matter how many people are selling off their $LUSD to more RWA-yield-bearing stablecoins, there will always be someone (or at least a bot) behind them willing to scoop it up for a discounted price.
Troves will continue to be redeemed, but that’s not as bad as it sounds: As long as people continue to jump to more yield-bearing assets, there’s going to be continued sell pressure leading to more people redeeming $ETH at a discount. This is fundamentally different than getting liquidated for the only losses that Trove holders should have are the initial 0.5% minting which they paid up front when they initially opened up the Trove, and also their exposure to $ETH itself. To note there is a redemption fee that also is kicked in when $LUSD gets below peg (as it is now) in order to discourage redemption, but this leads me to my next point…
$LQTY stakers will make out: If redemptions continue as they have been, the rewards for $LQTY stakers will continue to pay out significantly. And as you can see from the graphic below, this has already begun to play out as so:
Every time a trove is redeemed (or issued), redemption fees are paid out via $LUSD and $ETH. In other words, the more troves that are opened or closed, $LQTY stakers will inevitably profit.
Real World Assets aren’t immutable, Liquity is: The main reason why some of these rates for other stablecoins having high interest rates is because of macro-factors tied with the U.S. Government. As long as short-term Treasury Bills are giving high yields, so will the assets that they’re tied into with. However, as history will tell us, this (shouldn’t) be sustained:
Conclusion
Am I worried about Liquity? Liquity is immutable and still offers an excellent cheap way to get collateral off your $ETH. It makes perfect sense to me that due to native yields on US Treasury-backed assets that right now, assets like $DAI and $FRAX might be be more attractive options, but I can’t imagine that they’ll be so lucrative in the long-term. Above all else, what I do know for certain is that this wasn’t the first time Liquity was stress-tested and came out alive, and it probably won’t be the last.
And as always, thanks for taking the time to read this and be sure to follow me on twitter (https://twitter.com/CryptosWith) to get all my latest updates. If you want to get access to all my draft links or get an idea about what’s next on my docket before I publish, find me on Friend.tech, where I share all that information in my chatroom. Also, looking for a gift for your Crypto-loving/hating friend? Give them a REKT journal to cheer them up!
Disclaimer: And as a final reminder, this is not financial advice and this is for educational and entertainment purposes only. Please as always, do your own research and find what investments are best for you. Cheers everyone!
