Is the 90% APR of the LSDFi protocol 0xAcid a real yield?

Author: Cabin Crew, Cabin VC

After the Ethereum Shanghai upgrade, the staking yield of ETH can be seen as the risk-free government bond rate of Ethereum. Based on this rate, various LSDFi protocols have emerged, recently gaining significant exposure, including: the interest rate swap market Pendle; LSD yield aggregators Yearn, unshETH; LSD liquidity solutions Aura, LSDx Finance, etc. Among the many LSDfi protocols, 0xAcid offers the highest yield, with the current staking APR for wETH being around 90%, far exceeding the 5%-20% APR provided by other protocols. This article will detail how 0xAcid achieves the highest yield and the risks involved.

I. 0xAcid Mechanism

0xAcid is a protocol designed to maximize returns on LSD assets (stETH, rETH, fraxETH, etc.), currently deployed on Arbitrum and Ethereum. The treasury strategy invests LSD assets in other DeFi protocols to pursue the highest yield, categorizing users based on different yield targets, providing returns far higher than other LSD protocols.

The mechanism of 0xAcid is relatively complex. In summary, locking ACID can accumulate a larger share of ETH claims in the treasury, while staking ACID can yield a higher real return from LSD assets. The complete mechanism is illustrated in the figure below:

(Source: Twitter @0xEvix)

1. ACID & esACID

ACID represents a claim on treasury assets. When ETH reaches $10k, the treasury will convert all LSD assets into wETH and distribute them proportionally to all ACID holders, thus the value of ACID is entirely supported by the ETH in the treasury.

There are two ways to obtain ACID: purchasing Bonds and esACID allocation.

The Bond mechanism allows users to purchase ACID at a discount of around 5%. Currently, there are four types of Bonds: wETH, wstETH, ankrETH, and the ACID-ETH pool LP on Camelot. After purchasing Bonds, they will be allocated as ACID within 1-2 days. The cumulative sales of Bonds currently amount to approximately 1192 ETH. 90% of the ETH and LSD assets obtained from Bond sales will enter the treasury revenue strategy, with 10% distributed to ACID stakers.

(Source: 0xAcid Official Website)

esACID is the ACID that is in allocation or pending allocation, produced only through Locked ACID, and cannot be transferred or traded. To allocate esACID as ACID, at least twice the amount of ACID must be locked, which will linearly convert to ACID over 60 days.

2. Locked ACID & Staked ACID

ACID holders can choose to stake or lock to obtain different types of returns:

Locking ACID as Locked ACID can earn esACID emission rewards, with the current esACID output being 500 per day, which can be modified through community proposals. The longer the locking period, the more esACID emission rewards are obtained. Currently, the APR for locking between 1-12 months is around 220%-2400%. In the future, as esACID emissions decrease and the amount of Locked ACID increases, the locking APR will gradually decline;

Staking ACID as Staked ACID will yield two types of returns: all returns obtained from LSD assets through the treasury strategy and 10% of the Bonds sales revenue, both distributed in wETH. Currently, the staking APR for ACID is around 90%. Staked ACID can be unstaked at any time for circulation.

Currently, the total supply of ACID is 12861, with 13.8% in circulation, 14.8% staked, and 71.3% locked.

(Source: 0xAcid Official Website)

3. Treasury

The ETH and wstETH raised through Bond sales will pursue high returns in DeFi protocols while prioritizing safety through treasury strategies. 90% will be invested in lower-risk projects with relatively stable returns (Aura, Frax, Curve, Convex, Balancer, etc.), while 10% will be invested in slightly higher-risk stable return projects (AAVE, Pendle, etc.).

Currently, the treasury has accumulated a total of 5184 ETH, including 4000 ETH obtained through the Launch and 1184 ETH accumulated through Bond sales. The percentage of strategy allocation can be modified through proposals, with the initial allocation ratio as follows:

(Source: 0xAcid Docs)

The revenue obtained from the treasury strategy will be 100% distributed to Staked ACID.

4. Lending

Users can borrow wstETH by collateralizing ACID, obtaining leveraged returns through a circular lending mechanism similar to AAVE. The maximum borrowable value of wstETH is 40% of the collateralized ACID value, with a liquidation threshold of 50%. Upon triggering liquidation, the protocol will directly destroy the ACID used as collateral, which will not create selling pressure but will instead benefit the price of ACID due to the reduced circulation.

This is different from most lending protocols because, in 0xAcid, the counterparty for user borrowing is the protocol itself, and all wstETH in the protocol treasury is accumulated through Bond sales. Therefore, liquidation effectively destroys Bonds and reduces the circulation of ACID. The interest paid by users for borrowing will be 100% distributed to Staked ACID.

5. PCV

One cleverly designed aspect of the 0xAcid mechanism is the protocol's own liquidity (PCV), where Bond sales support payments in the form of ACID-ETH LP. After receiving these LPs, the protocol will lock them into liquidity pools, continuously accumulating its own liquidity through Bonds. Additionally, a small portion of funds can be allocated through proposals to inject into the ACID-ETH liquidity pool, enhancing ACID's liquidity.

Through the PCV mechanism, the 0xAcid protocol has become the largest liquidity provider, able to capture most of the fees and liquidity incentives, and by locking liquidity, it reduces the risk of panic selling during price downturns.

II. Analysis

0xAcid accumulates ETH from users through Bond sales, using this ETH to participate in LSDFi for real returns. The ACID returned to users is divided into Locked and Staked categories. Locked users effectively forfeit the real yield rights of LSD assets, accumulating ACID through a mechanism similar to locked mining to gain a larger share of treasury funds; Staked users receive 100% of the treasury strategy returns and 10% of the Bonds sales revenue while also being passively diluted in their ETH principal share. The expected returns and risks of both can be analyzed through simple estimates:

1) Staked ACID returns = Total treasury ETH * Average strategy yield + Subsequent Bonds amount * 10%

Based on the current staking ratio of 14.8% and an average treasury strategy APR of 8%, if the goal is to recover 100% of the initial ETH investment within a year, the daily Bonds sales need to reach 50 ETH, totaling about 18,000 ETH over a year (currently, around 1200 ETH has been accumulated in about a month since 0xAcid's launch, averaging 40 ETH per day). In this scenario, about 1/3 of the ETH returns come from the treasury strategy, while about 2/3 come from Bonds dividends. The remaining ACID is net returns; theoretically, the FDV of ACID = total value of treasury ETH, and as esACID is released, the holdings of Staked users will be diluted. The expected final coin-based APR for Staked users is around 19%, still higher than most LSDFi protocols' returns, with the premise that 50 ETH is added to the treasury daily.

Considering the worst-case scenario, if no new ETH enters the treasury, based on the current staking ratio and treasury yield, it would take about 2 years to recover the entire initial ETH investment. In this case, the final coin-based APR for Staked users would be about 1.5%, significantly lower than the returns offered by other LSDFi protocols.

2) Locked ACID returns = (Initial ACID amount + esACID accumulated emission rewards) / Total ACID supply * Total treasury ETH * 2 - Initial ETH investment

Based on the current 71.3% Locked ACID ratio and the daily 500 esACID emission rewards, assuming the treasury adds 50 ETH daily for a year, the coin-based APR for Locked users would be around 17%; considering the worst-case scenario with no new funds entering, Locked users could even lose 3% of their principal in ETH after a year.

Note: The above calculations are based on the premise that the total market value of ACID equals the total value of treasury ETH. In the early stages of the project, due to expected returns, the FDV of ACID may be slightly higher than the value of treasury ETH, and as the ETH price approaches the treasury liquidation value of $10k, this price difference will gradually disappear.

III. Conclusion

0xAcid is a relatively alternative LSDFi protocol with a very clever mechanism design, first establishing a major premise: Ethereum will reach $10k, at which point all ETH in the treasury will be distributed to ACID holders to attract long-term ETH holders. For users expecting to gain more ETH shares, they can forgo the staking yield of ETH to participate in locked mining; for users expecting higher staking yields, they need to bear the risk of dilution of their principal ETH.

Although 0xAcid offers the highest LSD yield in the market, the returns are real, but the principal will become "unreal." Both yields are based on the amount of new incoming funds, thus carrying Ponzi attributes. Participants effectively bet on both 0xAcid's ability to attract more ETH and that ETH will reach $10k in the future, making it suitable for high-risk tolerant long-termists.