Flexible premium? Analyzing the reasons for the formation of premium in LUSD and its impact

Analyzing reasons for premium formation in LUSD and its impact on flexibility.

For most of its existence, LUSD has consistently traded at a premium compared to other centralized and auditable stablecoins. Why is there a premium? Token Brice, a strategic consultant for the Liquity Protocol, analyzes LUSD’s peg and liquidity strategies, dissecting the three factors that contribute to the premium and the impact it has.

Why is there a premium? There are three main factors: 1) Protocol specification – achieving a truly decentralized stablecoin with an absolute peg is a challenging task. When using volatile collateral such as $ETH, volatility on the stablecoin can help the system better absorb market trends. 2) Imbalance between LUSD minters and users – LUSD is currently the most flexible stablecoin, leading to high demand sometimes not matched by the number of users willing to borrow stablecoins using $ETH as collateral. 3) Stability Pool (SP) – liquidity is immutable and the SP’s incentivization budget has been determined. Due to the existence of liquidation bonuses, even without considering the incentive factor of $LQTY, the SP is already in an attractive position.

Impact of premium: 1) For $LUSD buyers (not borrowers), this is a problem of the premium difference between entering and exiting. Small ratios of change are tolerable. 2) For borrowers, it depends on what they do. 3) For liquidity miners, the issue is: are you staying in LUSD (e.g. holding it in the stability pool)? Then the premium does not affect you; it only affects those who swap in/out. If you like $LUSD, a clever way to completely avoid the premium is to borrow it + use it to mine. 4) For ETH leveragers, the premium is a booster to increase efficiency.

Reference: https://twitter.com/TokenBrice/status/1660652372169838595