Today I’m going to review some of the mechanics behind how Alchemix works and why this is one of the most bullish Defi projects for the entire Ethereum ecosystem. If you own ETH, this post should make you happy.
So most people are familiar with the concept that Alchemix gives you a loan that you repay with future revenue. If you aren’t, this is for you.
Imagine a bank. You can deposit money, and the bank pays you 10-15% interest. There’s a credit card attached to the account, with a credit limit of 50% of the amount you have deposited. There’s no interest on the card. There are no monthly payments to make. Instead, the interest you earn on your balance pays off any debt you have, automatically.
There are ways to use this responsibly. And then of course there’s me. What went over my head about this at first was what happens to the funds that are actually earned. My initial impression was this worked similar to a self-repaying Maker loan. They’d harvest funds from Yearn, swap it to alUSD, and then repay your loan with the proceeds just like if you repaid your loan yourself. Nope. What actually happens is the funds (interest on your deposit) go to the transmuter and the alUSD you owe is just reduced as a matter of bookkeeping. To be clear, alUSD is not bought or destroyed by this process. All that happens is your alUSD debt is lowered pro-rata according to your deposit balance.
Now the transmuter first uses these funds to enforce the alUSD peg as best it can. In the worst case more alUSD is being made and sold than the transmuter can keep up with. In this case alUSD becomes a bond that takes all the interest on the deposits and buys back alUSD at a 1:1 rate until the alUSD deposited for transmutation is exhausted. Once there are no more alUSD to transmute the excess DAI is reinvested in Yearn. Due to the fact that there is no differentiation between what funds belong to users and what funds belong to the transmuter when interest is earned all the profit from the DAI in the transmuter is socialized amongst all depositers. This has the net effect of increasing the APR of deposits in Alchemix. Compare:
yearn.finance yDAI APY: 13.48
alchemix DAI APR: 24.701
That’s a big difference and it’s because the transmuter is sitting on 245,493,552 DAI which is a majority of all DAI in the system. That’s a lot of DAI, far too much to have come from purely the interest payments so far which is about 100k a day. So where did the rest come from? Well its a useful byproduct of their liquidity mining program. People wanted to farm the alUSD3CRV pool. I mean why not, it pays 42.01% APR right now plus trading fees from curve which is pretty good on cash equivalents. But if the Curve pool was small how do you get the curve LP? Buying alUSD would cause too much slippage and minting it was capital inefficient. So instead some whales did an interesting thing:
1) Deposit 100% DAI.
2) Mint 50% of DAI balance as alUSD.
3) Liquidate 50% DAI clearing your loan.
4) Withdraw 50% DAI.
This leaves you with 50% DAI and 50% alUSD while incurring 0 slippage. Brilliant. From there you can mint your curve LP and farm at 42% APR. A byproduct of step 3 though is our industrious whales sent 50% of their DAI balance to the transmuter where it is effectively locked forever. So now there is 245M DAI locked there forever socializing its’ interest to depositors.
A consequence of this socialized profit system is new entrants to the system get a better yield than they would by depositing directly into yearn. This in turn incentivizes protocol growth; exponential protocol growth without end. If people withdraw their balance it just increases the APR of the people who remain. As the transmuter balance grows rates grow until new DAI is deposited to dilute the rewards. The only way of getting money out of the transmuter is to burn alUSD for it on instant transmutations (which comes at a penalty). Basically Alchemix used their liquidity mining program to bootstrap a god damn rocket to the base of their platform which will push their TVL upwards forever.
This same system should exist for alETH when it launches too. Which will make Alchemix a perpetual, exponential ETH sink. Bullish.