eIP 39 Promote LUSD to Cross Tier

[eIP] Euler Improvement Proposals Voted Proposals
1

Title: [RFC] Promote LUSD to Cross Tier
Author(s): TokenBrice, Yuliyan
Submission Date: 12/18/2022

Simple Summary

This proposal suggests the promotion of LUSD to cross tier: increasing borrow factor, decreasing the reserve factor, and adjusting the interest rate model accordingly.

Abstract

While Euler Finance is not relying as heavily on centralized stablecoins as other money markets, thanks to the very healthy ETH/stETH markets, centralized stablecoins still constitute a sizeable share of both sides of the market. Nurturing markets for resilient stablecoins like LUSD enable Euler to hedge against the centralization-related risks of other stablecoins.

LUSD is already supported as collateral on Angle Money (borrow agEUR) & Mimo (borrow PAR). A promotion of LUSD to cross on Euler will pave the way for its support as collateral once supply caps are implemented. It should prove to be a serious hedge facilitating the attraction of a critical mass of LUSD to the supply side of the Euler market, enabling further growth.

If Euler Finance can attract a decent supply of LUSD, then further integrations could be considered, such as the support of Chicken Bonds’ bLUSD to enable bLUSD holders to leverage their positions.

Motivation

Risk Assessment

LUSD is the stablecoin outputted by the Liquity Protocol, run entirely by immutable code, just like Uniswap. This characteristic dramatically reduces the scope of risk, as it eliminates any possibility of a governance attack. Since Liquity only accepts ETH for collateral, the risk scope on that front is also immensely reduced.

There are currently around 345K ETH in Liquity Troves, backing 182.5M LUSD of debt (=total supply).

What’s left are primarily technical and economic risks, which are addressed through all relevant means. The protocol was audited multiple times, and features the top DeFiSafety score, demonstrating very careful development practices.

Finally, the oracle risk for Euler is also reasonable since the LUSD market is already using a ChainLink-based price feed.

Market Data

image
image1808×791 80.9 KB

On mainnet, LUSD is mostly traded on Curve and Uniswap:

Volume-wise, LUSD sees some volatility depending on the ETH price movements, with an average of around ~$3M daily. Thanks to the available liquidity, 5M LUSD can be easily settled instantly to another stablecoin with minimal (<1%) slippage:

image
image1808×1077 134 KB

LUSD also has healthy markets on Optimism, with various stablecoin pairings (sUSD, USDC, MAI, USD+) and LUSD/wETH.

Background

LUSD has been added on Euler Finance as an isolated asset. With the addition of the EUL gauge votes, LUSD received a neat support ranking #9 on the latest round. The LUSD market now has a 1.23M LUSD supply with about 50% utilization rate.

Next to Euler, the main money market supporting LUSD is Aave, where LUSD can be borrowed. Aave has 1.6M LUSD supplied with 73% utilization rate.

References

Specification and Implementation

  1. Promote LUSD to Cross Tier
  2. Increase Borrow Factor from 0.28 to 0.70
  3. Decrease LUSD Reserve Factor from 0.23 to 0.10
  4. Adjust LUSD Interest Rate Model (same as USDC)
    1. Base IR unchanged (0.00)
    2. Lower Kink IR from 10.00 to 4.00
    3. Lower Max IR from 300.00 to 100.00

Voting

If the community response to this RFC is positive and this proposal moves to a vote, a Yes vote would entail support for raising LUSD to Cross tier and adjusting its parameter, while a No would keep the same as current (Isolated tier).

Additional Context on Liquity

Liquity is a decentralized borrowing protocol that allows you to draw 0% interest loans against ETH as collateral with only a 0.5% one-time initial fee. Loans are paid out in LUSD, a USD-pegged stablecoin.

Borrowing with Liquity is extremely capital-efficient, with a collateral ratio of only 110%. In addition to the collateral, the loans are secured by a Stability Pool containing LUSD and by other borrowers who collectively act as guarantees of last resort. Users borrowing against their ETH use decentralized 3rd party front ends.

LUSD has proved its impeccable resilience by flawlessly going through several severe market crashes. - 5/19/21 ETH Crash - How Liquity Handled its First Big Stress Test

image
image2456×999 143 KB

Liquity as a protocol is non-custodial, immutable, and governance-free. And LUSD is a stablecoin capable of resisting all kinds of censorship. No person or organization has any control over the protocol — it is “set in stone” in smart contract code and can never be altered in any way.

The Liquity protocol was launched on the 5th of April, 2021. As the code is immutable, there has been no update since then. The Liquity team has recently launched Chicken Bonds. It offers an amplified yield-earning and trading opportunity for LUSD holders while helping to reduce the stablecoin premium and improve its liquidity.

5 Likes
2

Welcome TokenBrice and Yuliyan! It’s so great to have LQTY contributors posting such thoughtful and timely proposals in the DAO. As ever, my primary concern with something like this is liquidity and indeed LUSD liquidity is relatively good at ~10M. This will help people deal with liquidations should something arise.

Nevertheless, I’ve been following LUSD for quite some time now and it has not suffered a significant depeg event in it’s history. Yes, it trades slightly above $1.00 but as @Millie points out there’s a strong demand for censorship resistant dollars. Thanks to the stability pool, there are good measures in place against a depeg event.

As for CF I agree with 0.7. For RF, I’d vote to keep it the same until a reasonable reserve is built up to backstop unlikely events. As unlikely as they are in this instance, I think it’s good to have something in the tank.

All in all, I support this and look forward to hearing what others propose. Thank you again for suggesting it.

4 Likes
3

Hello @river0x, and thanks for the constructive feedback!

It makes sense to keep the Reserve Factor a bit higher to build up a base surplus. Still, to grow the market sustainably, we need to consider lowering it too eventually, which could be in a few months with another proposal raising LUSD to collateral status (with supply cap) if this one is successful.

The Reserve Factor is essentially most of the spread between the APY paid by borrowers and the APY earned by lenders, so it’s important to aim for the most reasonable value possible here to keep the lending/borrowing rates on Euler/LUSD as competitive as possible.

On Aave, LUSD’s reserve factor is already 10% although LUSD is borrow-only so far there, and this is the reference I used to argue lowering Euler LUSD-RF from the current 0.23 to 0.10.

Do you have any reference/figures / other examples to estimate better what a “reasonable reserve” means in terms of the amount of LUSD?

4

Hey @TokenBrice thanks for the proposal! Tbh I particularly like your step by step approach, paving the way for making LUSD a collateral asset.
A the same time I tend to agree with @river0x that some reserves should be accumulated before moving forward. In this regard, I think we could consider cbETH market for which the RF was recently decreased in accordance with the eIP 26: Promote cbETH to Collateral tier. I did not follow closely the changes but maybe the team could help me here to identify what amount of reserves were accumulated at the moment the RF was changed ? (atm it is $135k). So my suggestion here is that we implement a gradual reduction of the RF starting with 0,2 when Reserves reach at least 10 k. On the other hand, the agEUR market for example, having a cross tier and $23k reserves still has 0.23 RF.

1 Like
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Perhaps the 0.23 RF on angle gaining just $23k in reserves is a sign that we shouldn’t use it, I might be misinterpreting it though. Maybe this is down to relatively low demand for agEUR → utilisation sits at just 1.21%. Maybe this is something we want to avoid moving forwards?

There is no denying it though, the reserve on LUSD is low at 400$~. I’d be warm to the idea of perhaps following TokenBrice’s original suggestion for the duration of the cross tier phase and then we can re-evaluate how we’re proceeding once we feel like the time has come for a collateral stage? It’s important to remember that this is just the first step down this path (correct me if I am wrong, Brice).

After thinking and discussing it, I feel good about the existing proposal. Thanks for clarifying a few things @TokenBrice !

3 Likes
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Reserve factors are a double-edged sword. On the one hand, the higher they are, the more reserves grow. But on the other, they effectively increase the interest rate spread and the cost of borrowing, which inhibits borrowing, and might then lead to less lending. So it’s not trivial to figure out what is optimal.

2 Likes
7

Thanks to y’all for the clear and constructive feedback.

We’re open to revising the Reserve Factor suggested in the proposal, maybe down to 0.15-0.20, to make sure the market becomes a bit more competitive - helping to attract new borrowers and lenders as LUSD is raised to cross tier.

We could revise it again to the downside when/if we follow up in a few months with the collateral tier proposal.

Since it seems to be the main contention point on this proposal, with valid arguments from both sides, I’m taking the liberty of starting a quick signaling poll to get a better sense of the community’s sentiment on the topic. The three answers stem from the current (0.23), what was initially suggested (0.10), and a middle ground (0.15) to address @euler_mab point, trying to find a sweet spot between growing the reserve and being as competitive as possible on supply/borrow rate.

What Reserve Factor would be most comfortable with for LUSD as a cross asset on Euler?

  • Keep the current (0.23)
  • Lower to 0.15
  • Lower to 0.10

0 voters

1 Like
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0.15 is good for me. I think it’s a good place to start, and this can be revised at the time when we start discussing collateral LUSD. Thanks for the amendment. I’d say this one is ready to put to a vote with the 0.15 figure!

1 Like
9

Gm, everyone hopes this is still timely.

I’m dropping the DAOplomats risk analysis for LUSD; We have committed to do this for all new collateral tier RFCs. Even though this RFC promotes LUSD as Cross Tier asset, I took the liberty to run LUSD through our gage. Read more on our Risk metrics in our general delegation thread

1. Smart Contract Risk

  1. Quality of smart contract audits
  2. Days of operation with/without a hack.
  3. Nature of the source code: the ability to inspect, modify, and enhance

The open source code of Liquidity and the LUSD token is audited two times, and the last code audit was done by Coininspect, who have also audited Ledger and Zcash. And have experienced any hacks or exploits. The protocol also scores points for being truly immutable without any admin key.

Score 1.2

2. Centralisation

  1. Distribution of the token across the stakeholders
  2. Ability to mint/burn arbitrary amounts of tokens
  3. Role of a DAO, if any

The LUSD token is a stablecoin with 5,607 total holders, according to Etherscan on 21.12, which is a fair number considering its 180M market cap. The ability to mint new tokens is immutable and controlled by a smart contract which ensures a 110% collateralisation of LUSD tokens with ETH. The absence of a DAO that can freeze or seize LUSD tokens makes this 100% censorship-resistant.

DAOstewards score: 1.9

Reduced score due to a low number of token holders

3. Volatility

  1. Price fluctuations over 70 days
  2. 30 Moving average
  3. EMA200
  4. TTV; total trading volume over 30 days and 50 days.

The above metrics are not applicable here since LUSD is a stablecoin. The USD peg is only dropped a couple of times, and the token tries to hold around the 0.99 -1.10 range.

ATL - $0.896722 Jan 27, 2022,

ATH - $1.16 Apr 05, 2021

Score: 1.7

4. Liquidity

  1. Relative Circulating Supply = Circulating Supply/total supply
  2. Total market depth.
  3. Relative market depth (token depth /depth of WETH/USDC)
  4. Distribution of volume across chains and pools

no Extra comments are required as the RFC covers liquidity risk in detail

Liquidity score 2.1

5. Oracle Risk

  1. Stable chainlink price feed
  2. Cost of moving Uni v3 TWAP.

Not graded since Euler will be using Chainlink oracle.

This aspect arguably qualifies to be a collateral asset. Still, it has relatively low utility to use LUSD as collateral to borrow other collateral-tier assets. The low number of holders makes it an ideal candidate for cross-tier assets.

Disclaimer
The information mentioned above is from publically available information. The sores given By @0xBaer is just for informational purposes only.
Bankless DAO, which has commissioned DAOstewards, has an active project building on top Liquity Protocol and is Running Liquity Protocol frontend in test net.[link to the project]

1 Like
10

Hi @0xBaer ! Thanks for your analysis! Just to understand better the meaning of the score attributed, what range do u use? I mean, for example, Liquidity score 2.1is it good or bad? What is the range 0-10, 0-5 etc?

11

Quoting from the original post

1 Like
12

With the results of the poll quite clear (15% Reserve Factor consensus), we can now finalize this proposal into an eIP:

Title: eIP 39: Promote LUSD to Cross Tier
Author(s): TokenBrice, Yuliyan
Submission Date: 12/26/2022

Simple Summary

This proposal suggests the promotion of LUSD to cross tier: increasing borrow factor, decreasing the reserve factor, and adjusting the interest rate model accordingly.

Abstract

While Euler Finance is not relying as heavily on centralized stablecoins as other money markets, thanks to the very healthy ETH/stETH markets, centralized stablecoins still constitute a sizeable share of both sides of the market. Nurturing markets for resilient stablecoins like LUSD enable Euler to hedge against the centralization-related risks of other stablecoins.

LUSD is already supported as collateral on Angle Money (borrow agEUR) & Mimo (borrow PAR). A promotion of LUSD to cross on Euler will pave the way for its support as collateral once supply caps are implemented. It should prove to be a serious hedge facilitating the attraction of a critical mass of LUSD to the supply side of the Euler market, enabling further growth.

If Euler Finance can attract a decent supply of LUSD, then further integrations could be considered, such as the support of Chicken Bonds’ bLUSD to enable bLUSD holders to leverage their positions.

Motivation

Risk Assessment

LUSD is the stablecoin outputted by the Liquity Protocol, run entirely by immutable code, just like Uniswap. This characteristic dramatically reduces the scope of risk, as it eliminates any possibility of a governance attack. Since Liquity only accepts ETH for collateral, the risk scope on that front is also immensely reduced.

There are currently around 345K ETH in Liquity Troves, backing 182.5M LUSD of debt (=total supply).

What’s left are primarily technical and economic risks, which are addressed through all relevant means. The protocol was audited multiple times, and features the top DeFiSafety score, demonstrating very careful development practices.

Finally, the oracle risk for Euler is also reasonable since the LUSD market is already using a ChainLink-based price feed.

Market Data

image
image1808×791 80.9 KB

On mainnet, LUSD is mostly traded on Curve and Uniswap:

Volume-wise, LUSD sees some volatility depending on the ETH price movements, with an average of around ~$3M daily. Thanks to the available liquidity, 5M LUSD can be easily settled instantly to another stablecoin with minimal (<1%) slippage:

image
image1808×1077 134 KB

LUSD also has healthy markets on Optimism, with various stablecoin pairings (sUSD, USDC, MAI, USD+) and LUSD/wETH.

Background

LUSD has been added on Euler Finance as an isolated asset. With the addition of the EUL gauge votes, LUSD received a neat support ranking #9 on the latest round. The LUSD market now has a 1.23M LUSD supply with about 50% utilization rate.

Next to Euler, the main money market supporting LUSD is Aave, where LUSD can be borrowed. Aave has 1.6M LUSD supplied with 73% utilization rate.

References

Specification and Implementation

  1. Promote LUSD to Cross Tier
  2. Increase Borrow Factor from 0.28 to 0.70
  3. Decrease LUSD Reserve Factor from 0.23 to 0.15
  4. Adjust LUSD Interest Rate Model (same as USDC)
    1. Base IR unchanged (0.00)
    2. Lower Kink IR from 10.00 to 4.00
    3. Lower Max IR from 300.00 to 100.00

Voting

If the community response to this RFC is positive and this proposal moves to a vote, a Yes vote would entail support for raising LUSD to Cross tier and adjusting its parameter, while a No would keep the same as current (Isolated tier).

Additional Context on Liquity

Liquity is a decentralized borrowing protocol that allows you to draw 0% interest loans against ETH as collateral with only a 0.5% one-time initial fee. Loans are paid out in LUSD, a USD-pegged stablecoin.

Borrowing with Liquity is extremely capital-efficient, with a collateral ratio of only 110%. In addition to the collateral, the loans are secured by a Stability Pool containing LUSD and by other borrowers who collectively act as guarantees of last resort. Users borrowing against their ETH use decentralized 3rd party front ends.

LUSD has proved its impeccable resilience by flawlessly going through several severe market crashes. - 5/19/21 ETH Crash - How Liquity Handled its First Big Stress Test

image
image2456×999 143 KB

Liquity as a protocol is non-custodial, immutable, and governance-free. And LUSD is a stablecoin capable of resisting all kinds of censorship. No person or organization has any control over the protocol — it is “set in stone” in smart contract code and can never be altered in any way.

The Liquity protocol was launched on the 5th of April, 2021. As the code is immutable, there has been no update since then. The Liquity team has recently launched Chicken Bonds. It offers an amplified yield-earning and trading opportunity for LUSD holders while helping to reduce the stablecoin premium and improve its liquidity.

3 Likes
13

Voting is live: Snapshot

14

LUSD has proven its reliability and it also has enough liquidity to be promoted to cross-tier assets.
Fully support this proposal.

1 Like
15

Yes, supportive, with caution though. Euler is really showing its stuff in the current market conditions and am wary of being brash with collateral listings. But let’s give it a go :slightly_smiling_face: