Dec 23, 2022
Chicken Bonds By Liquity [Initial Review Dec 2022]
Chicken Bonds by Liquidity in the bonding service of Liquidity. Users of Chicken Bond can deposit LUSD, the Liquity stablecoin, in exchange for a LUSD-denominated bond in the future.
Liquity is a purely decentralised system for the issuance of LUSD stablecoin. Users of Liquity needs to find a third-party front end, and collateralise ETH for minting LUSD at a minimum collateral rate of 110%. Liquity also includes a stability pool, pooling users’ LUSD to liquidate undercollateralised vaults.
The Strategy in this Article
Providing liquidity into bLUSD-LUSD3CRV in Curve Finance.
Current yield: 44.2% (23 Dec 2022)
Our risk assessment: High.
Our yield projection based on this week’s BenchMark Yield: Diminishing from 44% to BenchMark Yield
The Concept and How the Protocol Works
Chicken Bonds is an innovative way of risk classification and redistribution of yields from Liquity stability pool. First, users lock LUSD into Chicken Bond (bonding). Subsequently choose to:
- Chicken out: redeem the full amount of LUSD principal
- Chicken in: redeem bonded LUSD for bLUSD, which is interest-bearing LUSD that’s backed by a reserve pool. The amount to be redeemed starts from zero and gradually increases to a maxium 97% of the value bonded.
All yields in the entire Chicken Bond system is from the yield from LUSD stability pool, and based the LUSD bonded into the system. The redistribution goes this way:
- Chicken out bonders: no yield
- Chicken in bonders: up to 97% of the value of the LUSD they bond, and the stability pool yield from all the LUSD in the system
- Liquidity providers: 3% of the fees charged by Liquity for chicken in
The charts below from Crypto Risk’s Substack article summarises the above:
In a nut shell, Chicken Bond is a game theory play-out. If you believe that more people will join the Chicken Bond system, then you should bond and chicken in before them, in order to leverage your yield from the LUSD they have contributed before they chicken in. Similarly, as a liquidity provider, if you believe that more people will join the Chicken Bond system and there will be fees (3% on the bonded amount of LUSD chicken -n’ed), you should provide liquidity. For liquidity providers, the risk is also in the inflated bLUSD price at this moment.
To give a rough guide on the returns of chicken in, please check out DefiSaver’s Chicken Bond automation service. Based on today’s parameters (esp an inflated bLUSD price), bonding will break even in less than a month and in about 45 days (optimal time to sell bLUSD and re-do bonding), the ROI can be 3.54%, annualised to be 33.27%. We expect the bLUSD price to decline in the long-term, so this is for illustration and not our strategy.
Provide Liquidity for bLUSD
bLUSD is the token one receives when he chickens in. During the chicken in, his LUSD bonded earlier is split into 2 trenches: 97% goes to the reserve pool backing the redemption of bLUSD, and 3% as a fee charged goes to the bLUSD-LUSD3CRV Curve pool.
The reserve pool also receives the stability pool yield from almost all the LUSD in the chicken bond system. Its yield is therefore approximately:
bLUSD yield = Total LUSD in the system/total LUSD in the reserve pool X Stability pool yield
As one can only redeem up to 97% of his LUSD value bonded, for every $1 worth of LUSD added to the reserve pool, he only gets a maximum $0.97 worth of bLUSD. When he redeems bLUSD for LUSD, it’s based on the floor price (total LUSD in the reserve / total supply of bLUSD).
As the reserve pool is yield accruing and issues bLUSD at discount (redeems bLUSD at full price), the redemption price or the floor price is ever-increasing. At this moment, the floor price of bLUSD/LUSD is 1.0987; however the market price of bLUSD now is $1.218 now on Curve.
This strategy is about providing liquidity for bLUSD in Curve Finance, in the bLUSD-LUSD3CRV pool. Currently, the yield is 44%, mostly LUSD fee generated from people who chickened in during the past few days (we estimate it’s past seven days).
Therefore, the major economic risks of this strategy are:
- A potentially declining bLUSD price, as there are now 59m LUSD in the bonding pool, and they will be converted into bLUSD some time in the future. This will reduce the bLUSD price, if holders of bLUSD sell into this pool (as compared to redeeming at a lower floor price). This will cause the bLUSD price to approach the floor price, making it indifferent to redeem or sell.
- A potentially lower APY, as a result of more bLUSD being issued and joining the liquidity pool.
In the long run, other things being equal, we believe as the bLUSD circulation gets big, there’s little incentive for new users to bond and chicken in, as the yield amplifying impact of the Chicken Bond system will be very limited.
Therefore, the strategy is a short-term one, and should end before all of the 59m (to be safe, maybe half) of the bonded LUSD chickening in. One can track the outstanding amount of bonded LUSD (pending pool), or Dune Analytics, or Curve bLUSD-LUSD3CRV gauge for an estimate of the near term yield of this liquidity pool. Or for entertainment sake, just follow what one of the big Chicken Bond whale, Sifu.ETH for this.
Investment Risks and Yield Projection
Our assessment is purely based on the economic perspective of investing stablecoins into the protocol, and is not based on the smart contract or the other soft factors, such as company/project/investor quality. Our assessment of investing into the bLUSD-LUSD3CRV Curve pool is HIGH risk.
- Exposures to stablecoins: LUSD, USDC, USDT, DAI
- Exposures to protocols: Curve, Liquity and Liquity Chicken Bond
- Quality of the yields: The yield is largely LUSD token rewards from 3% chicken in fees, plus the Curve’s CRV rewards and trading fees income.
- Major risk points: expected declining bLUSD price and lowering yield.
Based on the economic risks, we project the equilibrium yield rate of this investment will gradually decline from the current 44% to Benchmark yield, i.e. 5.0% based on this week’s Benchmark Yield of 5.0%. Our Benchmark yield is the weekly average yields of the 10 selected stablcoin strategies, in protocols on Ethereum. This is published weekly on our Medium and Twitter, under the section “BenchMark: Other Stablecoin Platform”.
Disclaimer
The information provided on this document and the referenced sources do not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the content as such. The author of the document makes no representation or warranties as to the accuracy and or timelines of the information contained herein. A qualified professional should be consulted before making any financial decisions.
