Parsec Weekly #43

The 2nd order effects of yield bearing stablecoins and the outperformance of onchain darlings

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LUSD - second-order effects of on-chain treasury yields

-chulie

I have written at length in previous weeklies about the “real-world asset” or as I prefer, “yield-bearing dollar” trend. Broadly, I believe it is a positive development as it allows for consistent, sustainable flows into crypto and perhaps gives stablecoin holders less reason to off-ramp. However, the introduction of non crypto-native yield on stablecoins has led to second-order effects on certain protocols such as Liquity:

LUSD Supply

LUSD supply has shed roughly $75m since July/August - the time at which when MakerDAO introduced their enhanced DAI Savings Rate and sDAI launched on Spark Protocol (read more here). By bringing off-chain yields on-chain, MakerDAO increased the base yield in DeFi.

Naturally, this led to an increase in stablecoin borrowing costs as the market adjusted to a new rates equilibrium. Yet on Liquity, borrow costs remained stable at a 0.5% initiation fee + variable base fee depending on activity. This created a positive carry trade (similar to the one we described for Aave’s GHO) whereby participants could mint LUSD, swap into sDAI (or another yield-bearing dollar) and collect the positive interest rate differential. Unsurprisingly, the proliferation of this strategy has caused significant pressure on the LUSD peg:

LUSD Price

Liquity’s redemption mechanism allows arbitrageurs to buy LUSD below peg and redeem it for $1 of collateral, a system which is designed to support the LUSD peg. The redemption mechanism allows the debt to be repaid and collateral redeemed for the most risky positions on the protocol (the positions with the lowest collateralisation ratio). With LUSD price trading consistently below peg, there has been a large uptick in redemptions and therefore an increase in the average collateralisation ratio at which positions are being redeemed at. This in itself is reducing LUSD supply but also driving users with open positions to close them in fear of redemption, further diminishing supply.

While one might imagine a severe contraction in LUSD supply would be bearish for LQTY, the ETH fees generated by increased redemptions have led to abundant yields for LQTY stakers. This has led to significant price outperformance:

LQTY Price

What is unclear is whether this outperformance can sustain given the severe underlying contraction in LUSD and a pick up in LQTY unstaking (including some extremely large withdrawals) over the last few days:

LQTY Unstaking Flows

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Onchain shenanigans

-kezfourtwez

Following on from last weeks 10% fake out candle BTC has not stopped, from the recent low prior to the fake ETF news the corn is up 27%. This has been the kind of price action that takes zero prisoners and gives no dips, putting partial sideliners everywhere in shambles, scrambling to allocate their remaining capital (it’s me, I’m partial sideliners).

It’s also lit a fuse reigniting on chain degeneracy and high leverage alts. The old onchain darlings from a few months ago have all caught a bid along with a slew of new memes in the making. The last few months have felt incredibly pvp onchain, you needed to be early to the right coin and you needed to take profits early. Very few had managed to break multi million dollar market caps and even less sustained them for longer than a few days. Just six months prior, random shitcoins were teleporting to $200m on the tailwind of Pepe because they were ‘created by an AI’ or managed to catch the attention of the newly rich degens, so it feels pretty nice to get a taste once again.

Prior to the market-wide rally, a few meme coins had been floating around the $2m mark, the jolt to the system managed to send them to 10, 20 and $30m valuations in a week. Considering the new market conditions we’ve been thrust into (that feel like a warm hug from an old friend), the aspiration of many in the trenches is to catch the next meme that can enthral the onchain populus and once again reach nine figure valuations and beyond.

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