Lybra: The Growth Path and Real Challenges of LSDFi Newcomers

Author: Lawrence Lee, Mint Ventures

Introduction

Lybra Finance is a new project of LSDFi that was born in April this year. Since its inception, it has faced numerous controversies, including issues related to IDO funding sources, contract problems, and implications of its relationship with Lido on social media, which made Lybra Finance a focal point of debate. Additionally, its stablecoin design has been criticized for lacking anchoring capabilities, which has drawn ire from DeFi players.

Nevertheless, Lybra's TVL has already captured a significant share during the so-called LSDFi summer.

Source: https://dune.com/defimochi/LSDFi-summer

The price of its governance token LBR has also surged nearly 20 times in just over 20 days in May, and it currently has a fully diluted market cap of over $150 million.

Source: https://www.coingecko.com/en/coins/lybra-finance

In this article, we aim to clarify the following questions through an analysis of Lybra Finance's mechanisms:

• How did Lybra achieve the above results?
• What problems is Lybra currently facing?
• How will Lybra's V2 address these issues?

We hope this provides readers with a more comprehensive understanding of Lybra Finance and its stablecoin eUSD.

The content of this article reflects the author's views as of the time of publication and may contain factual inaccuracies, opinions, and biases. It is intended for discussion purposes only and should not be considered as investment advice. We also welcome corrections from other research professionals.

1. Basic Information and Business Data

Lybra Finance is a stablecoin protocol, with its stablecoin being eUSD and its governance token being LBR.

Lybra Finance has a relatively short history; it launched its testnet on April 11 and officially launched its product on April 24, making it just over three months old.

Lybra Finance is an anonymous team and has not conducted private fundraising. Its only funding came from a public IDO held on April 20, 2023, where it sold 5,000,000 LBR (5% of the total supply) at a valuation of 1 ETH = 20,000 LBR, resulting in an IDO valuation of 5,000 ETH. Based on an ETH price of $2000, Lybra Finance was valued at $10 million, raising a total of $500,000.

Since its launch, Lybra's TVL has surged rapidly, reaching $100 million within a month of its launch, and it currently approaches $400 million, ranking as the 18th protocol by TVL on the Ethereum network.

Source: https://defillama.com/protocol/lybra-finance

In terms of stablecoin issuance scale, eUSD, with a circulation of nearly $200 million, is already the 11th largest stablecoin. Particularly within the category of decentralized stablecoins, eUSD's circulation is only surpassed by DAI, FRAX, and LUSD, with established decentralized stablecoins like MIM and alUSD trailing behind. eUSD has become a new force in the stablecoin landscape that cannot be ignored.

Source: https://defillama.com/stablecoins

Currently, eUSD has a total liquidity of $25.5 million in Curve's liquidity pool, but the price of eUSD is unstable and has been in a state of persistent premium. On June 16, the price of eUSD surged to $1.36 due to a whale purchasing $900,000 worth of eUSD. Although arbitrageurs quickly brought the price back to the $1 line, the issue of eUSD's premium remains a significant problem, which we will elaborate on later.

Source: https://curve.fi/#/ethereum/pools/factory-crypto-246/deposit

However, the number of addresses holding eUSD is still relatively low, with only 829 holders. Moreover, apart from Curve's liquidity pool, the top ten addresses holding eUSD are all individual addresses, indicating a relatively dispersed overall holding. The use cases for eUSD on-chain are also scarce, with the vast majority of holders simply holding it in their accounts to earn interest, which is partly due to the current poor composability of eUSD (as will be detailed later).

Top ten eUSD holding addresses Source: etherscan

2. Core Mechanism of the Stablecoin

In the current V1 version, eUSD can only be generated through over-collateralization with stETH (Lybra also allows users to deposit ETH, but in practice, Lybra deposits users' ETH into Lido Finance to obtain stETH for subsequent business processes. After repaying all debts, users can only withdraw stETH, so we believe eUSD can only be generated through over-collateralization with stETH). The minimum collateralization ratio required by Lybra is 150%, meaning that for every 1 eUSD generated, there must be at least $1.5 worth of stETH as collateral.

In terms of eUSD's price stabilization mechanism, the main function is the Rigid Redemption mechanism. The Rigid Redemption mechanism allows any user to redeem 1 eUSD for stETH worth $1 in the system after paying a fee of 0.5% (which can be changed by the Lybra DAO). Since the protocol is over-collateralized, as long as the protocol mechanism functions correctly, the combination of over-collateralization and the Rigid Redemption mechanism can provide a price floor of $0.995 for eUSD. Stablecoin protocols that have previously adopted this design (such as Liquity) have generally been able to effectively guarantee this price floor, which constitutes the core of eUSD's current price stabilization mechanism.

However, regarding the price ceiling, the current V1 version of Lybra Finance lacks an effective mechanism to bring eUSD back to $1 when it is in a state of premium, which is a significant flaw in its current product design, and we will elaborate on this later.

The design of the liquidation module for over-collateralized stablecoins is a key factor in the protocol's security, and an effective price stabilization mechanism also requires a robust liquidation mechanism as a supplement.

In terms of liquidation, Lybra introduces two roles: Liquidator and Keeper. The Liquidator provides liquidation funds (eUSD), while the Keeper triggers the liquidation operation, with rewards of 9% and 1% respectively. To better protect the collateral of stakers, Lybra employs a forced partial liquidation mechanism: the maximum proportion that can be liquidated from a liquidated party is 50%.

Additionally, when the overall system's over-collateralization ratio falls below 150%, all users with an over-collateralization ratio below 125% can be fully liquidated to quickly increase the overall collateralization ratio of the system.

We can see that Lybra Finance has primarily referenced the stablecoin protocol Liquity in terms of the core mechanisms of the stablecoin (minting, redemption, liquidation, price stabilization), but it is not a mechanical copy of Liquity. They retained Liquity's redemption and recovery model, removed the stability pool (thus saving some token incentives), and instead relied on Liquidators to provide liquidation funds.

The core mechanism of Liquity has been validated over more than two years and has demonstrated good stability. We can see that several major stablecoin projects in LSDFi, such as Lybra, Raft, Gravita, and Prisma, have borrowed from Liquity to varying degrees. Based on Liquity, Lybra Finance has been operational for over three months and is functioning well. However, whether it can maintain this status remains to be seen.

3. Stablecoin Yield Mechanism

The ability to earn around 8% APR simply by holding the stablecoin eUSD is an important selling point for Lybra Finance to attract users, and it is also a rare innovation in stablecoin mechanisms recently. Let's take a closer look at the yield mechanism of eUSD.

Source: Lybra Finance Official Website

We know that the LSD stETH issued by Lido Finance aims to maintain a 1:1 peg with ETH, while the ETH staked by users continuously generates returns on the Ethereum consensus layer. This requires a Rebase mechanism to achieve, where Lido takes daily snapshots of all stETH holders and their holdings on the Ethereum mainnet and proportionally distributes the growth portion of stETH to all stETH holders. In terms of user experience, this means that the number of stETH held by users will increase daily, and their earnings will be reflected in the growing amount of stETH. Generally, users holding stETH can earn staking rewards from Lido. Most DeFi protocols that integrate stETH will also proportionally return the earnings generated from stETH rebase to users.

However, Lybra takes a completely different approach. After users deposit stETH into Lybra, all stETH generated from rebase will not be distributed to stETH holders; instead, the protocol will exchange stETH for its stablecoin eUSD through the secondary market, and then distribute the earnings from this portion of eUSD proportionally to all current eUSD holders. In this process, Lybra will extract an annualized 1.5% of eUSD based on the issuance scale of eUSD as protocol revenue, which will be distributed to holders of $esLBR (escrowed LBR, obtained through locking LBR or mining).

Through this process, Lybra Finance achieves "asset yield distributed according to liabilities." To better understand this process, consider the following example:

Assuming on Day 1, the current ETH price is 2000 eUSD, and the APR of stETH is 5%:

• Adam deposits 10 stETH into Lybra and mints 7000 eUSD, Adam's CR (collateralization ratio) is 285.7%;
• Bob deposits 10 stETH into Lybra and mints 10000 eUSD, Bob's CR is 200%;
• Charlie deposits 10 stETH into Lybra and mints 13000 eUSD, Charlie's CR is 153.8% (only 3.8% away from the liquidation threshold of 150%);
• Adam sells his 7000 eUSD to David in exchange for David's ETH, so David holds 7000 eUSD;
• Eric also holds 10 stETH but has not deposited it into Lybra;
• The entire Lybra system has 30 stETH, minting a total of 30,000 eUSD, resulting in an overall system CR of 200%.

On Day 2, the 30 stETH generates 0.0041 stETH at a 5% APR. Lybra will exchange this 0.0041 stETH for 8.219 eUSD, which will be distributed to Bob, Charlie, and David according to their proportion of eUSD holdings:

• Adam, despite minting eUSD, currently holds no eUSD, so he does not receive new eUSD, and his APR on Day 1 is 0;
• Bob currently has 10000 eUSD and receives 2.74 eUSD according to a 1/3 ratio, so his APR on Day 1 = 2.74 * 365 / (10 * 2000) = 5%. If we consider the annualized 1.5% cut by Lybra, Bob's total earnings for holding for one year would be 3.5%;
• Charlie currently has 13000 eUSD and receives 3.56 eUSD according to a 13/30 ratio, so his APR on Day 1 = 3.56 * 365 / (10 * 2000) = 6.5%;
• David currently holds 7000 eUSD and receives 1.92 eUSD according to a 7/30 ratio, so his APR on Day 1 = 1.92 * 365 / 7000 = 10% (note that David's APR denominator is different from Bob's and Charlie's);
• Eric earns his stETH based on a 5% yield.

From the above example, we can see that:

• Ignoring Lybra's cut, the APR for users minting eUSD in eUSD terms = stETH APR / personal CR * system CR. If we assume that stETH APR and system CR remain constant in the short term, the way to increase personal APR is to lower personal CR; the lower the CR, the higher the yield, but this also means greater exposure to liquidation risks from price fluctuations. Of course, users minting eUSD can earn incentives based on the proportion of eUSD minted, and this portion of APR is currently around 20% (calculated based on the amount of eUSD minted), which is the main motivation for users to mint.
• The user with the highest yield, David, did not participate in minting eUSD (in fact, David can also apply the yield formula above, with a CR of 100%). The yield David receives (stETH APR * system CR) is the maximum possible yield for holding eUSD, which is also the yield listed on Lybra's official website (currently 8.54%). Moreover, unlike most stablecoin protocols, to obtain this yield, users need to mint as little as possible and hold more eUSD. Any user who participates in minting eUSD cannot have a personal CR lower than 150%, so their theoretical yield ceiling = stETH APR * system CR / 150%.
• From the comparison between Bob and Eric, we can see that if an individual's CR is consistent with the system CR, due to Lybra's cut and potential liquidation risks, the strategy of minting eUSD and holding it is not as advantageous as simply holding stETH.

The benefits of Lybra adopting this design are evident: it provides a strong use case for their stablecoin eUSD—yield-bearing stablecoin. Currently, in the DeFi world, decentralized stablecoins primarily serve as "yield-generating mining tools" rather than the value metric and medium of exchange they should be. Even MakerDAO, which has a significant first-mover advantage and network effect, has proposed offering high-yield stablecoin sDAI to recover its declining TVL and stablecoin scale. The approximately 7.5% to 8% annualized yield offered by eUSD fulfills its role as a yield-generating mining tool well.

In fact, generating returns from the collateral deposited by users in the protocol and redistributing them is not uncommon in over-collateralized stablecoin protocols. From the protocol's perspective, over-collateralization is primarily to ensure the overall security of the protocol. However, having such a large amount of quality collateral tied up in the protocol is also a significant waste of resources. If the collateral can generate returns through a safe and reasonable method, it benefits users by allowing them to earn additional returns while obtaining stablecoins, which users naturally welcome. On the other hand, the protocol extracting a portion of the "commission" as protocol revenue is also relatively reasonable.

For example, Alchemix Finance, supported by the then DeFi "father" Andre Cronje, launched in early 2021, issuing alUSD with the so-called "automatic loan repayment" feature. Its core logic is to deposit the stablecoins users provide into Yearn, using the returns generated by Yearn to repay users' debts, with Alchemix taking 10% of the earnings as protocol revenue. Its subsequent alETH product logic is similar, relying on the yield of collateral to automatically repay debts while meeting the liquidity needs of holders of these yield-bearing assets (DAI, wstETH).

Another example is MakerDAO, which uses the USDC accumulated by the PSM (Peg Stability Module) to purchase various RWA products. The returns from this portion will be used as MakerDAO's protocol funds for daily expenses, distribution to sDAI holders, and providing liquidity for MKR (essentially repurchasing half of the funds).

Lybra Finance's approach differs from both Alchemix and MakerDAO. Lybra targets the yield-bearing assets held by users themselves, redistributing the interest generated from the original yield-bearing assets. Critics may argue that all the returns obtained by eUSD come from the original earnings of stETH depositors, and that depositing stETH into Lybra does not yield any additional returns, but rather incurs a 1.5% fee extracted by Lybra, resulting in a zero-sum game among all minters. While this is indeed the case without considering other incentive factors, as we can see in the current decentralized stablecoin market, the circulation of any stablecoin is essentially maintained by various yield mining opportunities, and the mined rewards ultimately stem from the governance tokens of the stablecoin projects themselves (of course, leading stablecoins like DAI may also mine other tokens rewarded by other projects for promotional purposes). With the addition of protocol token incentives, the entire system can achieve a certain degree of good operation, as evidenced by Lybra's current status.

For stablecoin holders (pure stablecoin holders, not those who mint and hold stablecoins), this design clearly allows them to earn returns more "organically": the returns are directly from the stablecoin itself, and there are no locking terms or various complex tokens to manage; they simply need to hold eUSD daily, and the returns will be automatically credited.

Lybra's thinking might be: by providing stablecoin holders with a better-yielding stablecoin, they can stimulate the demand side of stablecoins through mechanisms rather than incentives, and on this basis, early incentives can be combined to stimulate stETH holders to mint and form a closed loop.

Of course, this design also brings a series of problems, such as the rebase characteristics of eUSD, which make it difficult to integrate with other DeFi protocols and inconvenient for cross-chain use, significantly affecting the composability of eUSD.

Moreover, to some extent, Lybra places all users minting eUSD in a "prisoner's dilemma."

Since each person's APR = stETH APR / personal CR * system CR, and stETH APR is an external input parameter that cannot be adjusted, individuals aiming to improve their APR mainly focus on: 1) lowering personal CR, and 2) increasing system CR.

In the example above, Charlie, with a 200% collateralization ratio, earns the average system yield (i.e., the basic stETH yield without considering Lybra's cut). Given that Lybra's liquidation CR is 150%, this means that Charlie can only bear a maximum stETH price drop risk of 25%. If the stETH price drops more than 25%, Charlie risks losing his stETH.

If the entire system's CR is currently 300%, then Charlie only needs to set his CR to 300% to earn the basic stETH yield, allowing him to bear a price drop of 50%. Both methods can yield the basic stETH returns, but the latter can bear more risk, clearly making it superior.

From a macro perspective, if all minters can maintain a high CR, their yields can be consistent, and they can bear more risk. From a micro perspective, each minter has the incentive to lower their CR to increase their yield. This game theory scenario would lead minters to collectively lower their CR, reducing the overall risk tolerance of all participants while keeping total yields unchanged.

Of course, compared to the above two issues, the problem of eUSD's premium may appear more severe in the short term. In the current design of Lybra V1, the daily stETH earnings from all collateral are purchased by the protocol in the secondary market to become eUSD and then distributed to all eUSD holders. This means there is a fixed amount of buying pressure on eUSD every day. The forced redemption mechanism primarily addresses the issue of eUSD de-pegging downwards, but the protocol has no means to encourage the price of eUSD to return to $1 when it is de-pegged upwards, which has resulted in eUSD being in a state of slight upward de-pegging for an extended period. Although the degree of de-pegging is not very high, purchasing at a 3% premium for a target annualized yield of 7.5% presents a poor risk-reward ratio, which also limits the development of eUSD from a mechanistic perspective.

eUSD Historical Price Source: Geckoterminal

4. Token Model

The governance token of Lybra Finance is LBR, with a total supply of 100 million tokens. Among them:

• 60% of the tokens are allocated for mining, used for incentives across the protocol, including incentives for eUSD minting, eUSD - USDC LP incentives, and LBR - ETH LP incentives.

Distribution of LBR incentives Source: https://lybra.finance/earn

• 8.5% of the tokens are allocated to the team, which will be released linearly over two years after a 6-month lock-up period post-TGE.
• 5% of the tokens are allocated to advisors, which will be released linearly over one year after a one-month lock-up period post-TGE.
• 10% of the tokens are reserved for ecosystem incentives, with 2% unlocked at TGE and the remaining portion released linearly over two years.
• 10% of the tokens are retained for the protocol treasury, released linearly over two years.
• 5% of the tokens were used for IDO, raising a total of $500,000.
• 0.5% of the tokens were allocated for IDO whitelist rewards.

According to Coingecko data, the current circulating supply of LBR is 11.78 million tokens, with a circulation ratio of 11.78%.

Source: https://www.coingecko.com/en/coins/lybra-finance

The use case of LBR primarily revolves around esLBR (escrowed LBR), with protocol mining rewards also distributed in the form of esLBR.

esLBR cannot be traded or transferred but can share in protocol revenues (i.e., the annualized 1.5% cut from eUSD issuance). Users can unlock esLBR into LBR through a 30-day linear release, or they can lock LBR to obtain esLBR for enhanced mining speed and to share in protocol revenues. Additionally, esLBR also has governance participation functionality.

In V2, there will be significant adjustments to the reward distribution module for Lybra, which we will detail next.

5. Lybra V2

Lybra V2 has already launched its testnet, and documentation has been released. It is currently undergoing an audit by Halborn, with an expected launch date no earlier than the end of August.

Regarding the scope of V2, Lybra has provided a detailed description in a diagram.

In summary, the changes in V2 include the following points:

First, Lybra V2 will issue a new stablecoin, peUSD, and will also support more LSTs (Liquid Staking Tokens).

Currently, there are two types of LSTs in the market: one is stETH and sETH issued by Stakewise, which are rebase LSTs, and their characteristics have been introduced earlier. Lybra can support this type of LST well. The other type includes "value accumulation" LSTs such as rETH from Rocket Pool, cbETH from Coinbase, wBETH from Binance, swETH from Swell, and wstETH from Lido. The characteristic of these LSTs is that their value appreciation is reflected in the increase of their exchange rate relative to ETH. For example, after a user holds rETH, the quantity of rETH does not change, but the amount of ETH each rETH can be exchanged for continues to increase; hence we refer to them as value accumulation LSTs. Currently, the entire yield mechanism of eUSD can only apply to rebase LSTs and is not applicable to value accumulation LSTs. To address this issue, Lybra is introducing a new stablecoin, p eUSD (pegged eUSD), which can be minted directly from value accumulation LSTs. p eUSD and eUSD are quite similar in terms of price stabilization, liquidation, and fee mechanisms, with the main difference being that p eUSD generated from value accumulation LSTs is not a yield-bearing stablecoin, and holding p eUSD will not automatically yield returns (since the accumulated value of the collateral still belongs to the user). Of course, p eUSD can also be wrapped from eUSD, and p eUSD wrapped from eUSD can earn the returns generated from eUSD's rebase.

The introduction of p eUSD significantly enhances Lybra's composability: on one hand, Lybra can obtain a more stable stablecoin, p eUSD, which is beneficial for its multi-chain expansion and integration with other DeFi protocols; on the other hand, through the design of p eUSD, Lybra can extend its protocol collateral to previously unsupported value accumulation LSTs, achieving full coverage of LSTs. Additionally, the eUSD stored in p eUSD, according to Lybra's plan, can also provide flash loan services externally, allowing eUSD holders to earn more income. However, issuing two stablecoins is relatively rare in stablecoin protocols, which may increase the cognitive threshold for users. Moreover, despite their connection, the mechanisms of p eUSD and eUSD are quite different, which may affect overall expansion on the consumer side. Furthermore, if Lybra's composability is achieved through p eUSD rather than eUSD, it may render eUSD's positioning somewhat awkward: the only purpose for users holding eUSD would be to obtain the 7.5% stablecoin yield (other uses, such as leveraging, would need to be achieved through holding p eUSD), and the source of this yield would ultimately only be the governance token LBR's incentives, potentially turning eUSD into a typical Ponzi scheme sustained solely by governance token incentives.

Secondly, Lybra V2 has made significant adjustments to the acquisition of esLBR token rewards, introducing two bounty programs—Advanced Vesting Bounty and DLP Bounty. These two adjustments are primarily inspired by the V2 version of the lending project Radiant, which was born on Arbitrum.

In V2, the unlocking time for esLBR will be extended from 30 days to 90 days, but users will be allowed to unlock early, incurring a fee of 25%-95% based on how far they are from the full unlocking time. The fees paid for early unlocking of esLBR will become the Advanced Vesting Bounty.

The DLP (Dynamic Liquidity Provisioning) bounty requires users minting eUSD to maintain at least 5% of their minting ratio in LBR/ETH liquidity to normally receive their esLBR rewards. If minting users cannot maintain over 5% LBR/ETH liquidity, their esLBR will convert into DLP bounty.

The esLBR from the Advanced Vesting Bounty and DLP Bounty allows users to purchase LBR/eUSD at a discounted price. All LBR received by the protocol will be burned, while the eUSD received will enter the stability fund (which will be detailed later).

Through the Advanced Vesting Bounty and DLP Bounty, Lybra V2 aims to bind the acquisition of protocol incentives more closely to the long-term development of the protocol. Of course, from another perspective, such high friction may also affect users' willingness to enter the Lybra ecosystem for mining.

Another series of important improvements in Lybra V2 focuses on stabilizing the price of eUSD. As analyzed earlier, the current yield mechanism of eUSD involves purchasing eUSD in the secondary market with daily stETH earnings and distributing them to all eUSD holders, creating continuous buying pressure for eUSD. In V2, Lybra has introduced the following two measures to address the issue of eUSD's premium:

• First, a premium suppression mechanism has been designed: when the eUSD/USDC exchange rate exceeds 1.005 (i.e., a premium exceeding 0.5%), the protocol will change the daily stETH earnings to purchase USDC in the secondary market and distribute it to eUSD holders, thus transferring the continuous buying pressure for eUSD to USDC, addressing the long-term root cause of eUSD's premium;
• Secondly, a stability fund. The stability fund is accumulated from users purchasing esLBR at a discount using eUSD. The eUSD reserves in the stability fund can also be used to control the price of eUSD when it is excessively premium. Through the premium suppression mechanism and the eUSD stored in the stability fund, the issue of eUSD's premium should be effectively resolved, combined with the price floor provided by the Rigid Redemption mechanism, potentially stabilizing eUSD's price peg.

Overall, Lybra V2 addresses the issues exposed during the operation of V1, such as poor composability of eUSD, the inability to extend the product model to value accumulation LSTs, and the difficulty in restoring eUSD's price premium. It is targeted and also attempts to more closely link the protocol incentives of the LBR token with the long-term development of the protocol.

Of course, these changes will significantly increase the complexity of the protocol, and the existence of two stablecoins with vastly different designs may also affect user-side expansion. Additionally, the composability advantage of p eUSD may make eUSD's positioning appear somewhat awkward.

Conclusion

Among the new LSDFi projects launched concurrently, Lybra's investment background is relatively weak (with no institutional investments), and its fundraising amount of $500,000 is the least. There has also been continuous FUD surrounding Lybra. However, in the current LSDFi projects, Lybra is the one with the highest TVL and token market cap, and its business development speed is also the fastest. Not only has V1 been successfully launched and operational, but V2 has also entered the testnet phase. This reflects both the operational and business development capabilities of the Lybra team and the inherent strength of the product.

Compared to other LSD Fi stablecoin protocols that make minor adjustments to existing stablecoin protocols, Lybra has truly innovated the way LSD returns are distributed. By providing users with a stablecoin yielding around 8% APR, it has built a relatively robust demand scenario, while appropriately controlling token incentives on the supply side, allowing the protocol to develop rapidly. From the perspective of stablecoin holders, this APR is more sustainable than the APR of stablecoins reliant on protocol token incentives, forming the cornerstone of Lybra's long-term development.

However, for a stablecoin that has already reached a scale of $200 million and seeks further breakthroughs, the above is far from sufficient. Use case expansion is currently the top priority for all decentralized stablecoins, and compared to FRAX, LUSD, and even smaller-scale alUSD and MIM, eUSD's use cases are clearly much fewer. If, in future developments, p eUSD cannot build a richer set of use cases, then Lybra will still be a mining game—albeit a more intricately designed one, with the game theory further complicated in V2.

Nonetheless, Lybra Finance has already become a backbone of the current LSDFi landscape, and we look forward to its future development.