Note: The below proposal is in response to Yearn Finance’s Millennium Prize announcement. I am sharing this on my blog to include a reference to all links, corresponding to the governance forum post where it was shared.

Summary:

The intent of this proposal is to suggest a strategy to consistently and safely earn a 12% APY on $1B for a month or potentially longer, in reference to the Yearn Millennium Prize challenge.

Specifically, this strategy seeks to achieve its objective by utilizing Liquity Protocol's stability pool, whereby LQTY rewards are currently being issued to those that deposit LUSD. For added yield, LQTY earned in this manner can separately be staked to receive a portion of Liquity Protocol's revenue.

Additionally, I address the potential benefits of Yearn Finance running an independent frontend for Liquity Protocol, to further augment its long-term earnings potential from pursuing such a strategy if it were to choose to do so.

Background:

Liquity Protocol enables interest-free borrowing on Ethereum. The project launched in April of this year and has been stress-tested during multiple periods of market volatility since then; its whitepaper may be viewed here.

Liquity Protocol's stablecoin, LUSD, may be borrowed against ETH for as low as a 110% collateral ratio. There is a one-time borrowing fee, typically as low as 0.5%, and no further interest charges are due after the loan is initiated; loan positions are referred to as Troves.

As Liquity Protocol just launched this year, it continues to advance its collaborations with DeFi projects to expand the utility of LUSD. Recent collaborations include those with Bprotocol, Olympus DAO and Visor Finance.

In the meantime, a predominant number of LUSD holders choose to deposit their LUSD in Liquity Protocol's stability pool, whereby they receive liquidation gains as well as LQTY rewards in accordance to their proportion of the pool. The stability pool is the source of liquidity to repay debt from liquidated Troves.

LQTY is a secondary token that captures the protocol's revenue in the form of borrowing fees paid in LUSD and redemption fees paid in ETH; it is not a governance token, as Liquity Protocol is governance-free. The total LQTY supply is capped at 100M and just over 12.5M LQTY tokens are currently in circulation. For further details on the distribution schedule, one may refer to the project's launch post.

Currently, Liquity Protocol has over $2B in TVL and has generated over $24M in protocol revenue via borrowing fees and redemption fees. An overview of key data metrics for the protocol may be viewed here.

Motivation:

This strategy seeks to reliably earn a 12% APY on $1B for a month or possibly longer, per Yearn's Millennium Prize challenge; if it is selected, I will receive the prize outlined in the announcement tweet noted above. As I am not a developer, I am happy to collaborate to help see this strategy put into production to demonstrate that it can earn the APY to qualify for the prize, and to share the prize accordingly if it is rewarded.

In the context of potential DeFi opportunities, it is necessary to consider both the risks and rewards when evaluating various approaches to achieving a desired yield, especially on an amount of this magnitude. In the case of Liquity Protocol, it has been stress tested on numerous occasions since its debut and is immutable in its present version, thus mitigating associated risks.

Furthermore, Liquity Protocol is accessed by users via independent Frontend Operators, which are incentivized via a portion of the LQTY rewards allotted to those that deposit to the stability pool using their web interfaces (as defined by their respective kickback rates); this model further supports the decentralization of the protocol as a whole.

It is an opportune time to benefit from LQTY rewards as a stability pool depositor and frontend operator, as early adopters are incentivized at a higher rate since LQTY's issuance curve follows a yearly halving schedule, described by the following function: `32,000,000 * (1–0.5^year)`.

Additionally, LQTY was recently listed by Coinbase Custody, and the protocol's recognition in the broader DeFi space is expected to improve as adoption advances and it further matures. With the long-term vision of Liquity Protocol to offer additional collateral types as more assets are tokenized on the blockchain, staking its earned LQTY would offer Yearn Finance a continuous revenue stream moving forward.

Specification:

Although Liquity Protocol allows for loans to be originated for a minimimum collateral ratio of as low as 110%, it is suggested that a collateral ratio of 250% be employed with this strategy to be on the safe side. This is because when the total collateral ratio of all loans in Liquity Protocol falls below 150%, the system enters recovery mode, whereby Troves with a collateral ratio of less than 150% are at risk of liquidation.

Accordingly, $1B in ETH would be deposited to Liquity Protocol to draw a loan of about $400M LUSD, for a collateral ratio of 250%. The $400M LUSD would then be deposited to the stability pool. Note that a borrowing fee of at least 0.5% will be applied, as well as a $200 LUSD liquidation reserve charge; the $200 LUSD will be returned upon repayment of the debt, and the Trove may be left open indefinitely as long as the collateral ratio remains at least 110%. Also, the borrowing fee can be guaranteed even with a loan of this size if the loan is borrowed entirely at once and the fee is at 0.5% at the time.

LQTY rewards from the stability pool deposit will accumulate as they are earned, and may be separately withdrawn and staked within Liquity Protocol to concurrently earn a corresponding proportion of the protocol's revenue in the form of borrowing fees paid in LUSD and redemption fees paid in ETH. Note that the potential return from staking LQTY varies in accordance to the protocol’s usage.

If Yearn Finance seeks to automate the potential for compounding of gains from this strategy, it can refer to the integration offered by Bprotocol and Pickle Finance, as outlined here; this approach currently delivers a 38% APY by compounding both stability pool earnings and staking earnings, seemingly after accounting for Pickle Finance’s 20% fee charged to users seeking the convenience of this feature.

Note that the stability pool currently has just under $570M in LUSD and its LQTY APR is just over 23%, with nearly 21M LQTY in rewards remaining available for distribution to stability pool depositors. As it stands, if $400M LUSD is added to the stability pool via this strategy, the APR from LQTY rewards will notably drop. However, one must also consider the autocompounding of these rewards via staking to earn protocol revenue, as well as the potential of LQTY itself to appreciate in value, as outlined in my prior blog post.

Moreover, Yearn Finance could consider becoming a Frontend Operator for Liquity Protocol too, thereby enabling it to earn additional LQTY rewards from stability pool deposits made by its users, in accordance to the kickback rate it sets. Technical documentation on this may be viewed here. Yearn Finance can also consider integrating Bprotocol's autocompounding functionality for the stability pool in this manner, which other frontends have done. Yearn Finance may also consider offering its own autocompounding functionality for LQTY staking, similar to Pickle Finance; this could also be an added incentive for users to utilize it as a frontend, as a competitive fee may be charged for the benefit of enabling such a feature.

For:

The strategy enables a recurring and reliable yield, potentially even when scaled for $1B. Added consideration for running a frontend for Liquity Protocol and potential collaboration with Bprotocol to implement autocompounding capabilities requires input from the Yearn Finance team and the community at large.

Against:

The strategy maintains a higher collateral ratio than Liquity Protocol's minimum collateral ratio as a precautionary measure against liquidation; a lower collateral ratio than what is suggested may be considered more favorable depending on capital efficiency expectations. The Yearn Finance team may not be inclined to run a frontend for Liquity Protocol.

Poll:

To be determined.