Demystifying alAsset Transmuting and Liquidity Provisioning
How to evaluate alAsset risk, using alETH as a case study.
Introduction
If you are familiar with Alchemix, you are likely familiar with self-repaying loans: Deposit collateral, take a loan in the form of a synthetic like-kind asset (called alAssets), and spend it freely. The standout feature? The loan repays itself over time.
On the other side of this equation is that someone needs to purchase this alAsset from you. They would do that for a few reasons, but it typically boils down to being paid to buy and hold the alAsset.
You may be interested in being paid to hold alAssets. There are two primary ways to earn yield with alAssets: using the Transmuter and providing liquidity.
The purpose of this post is to help you estimate the risks and rewards of these strategies so you can determine if alAsset exposure fits into your investment portfolio.
alAssets — The Transmuter
Transmuter — The Basics
The purpose of the Transmuter is to gradually convert alAssets to their underlying assets. In the case of alETH, the process involves converting alETH into wETH. From this point forward, this article will focus on alETH.
When users earn yield in Alchemix, they do not directly receive their yield — instead, they receive a credit to mint more alETH. The actual yield is sent to the Transmuter, which is credited to users that have deposited alETH. This presents a potential yield-earning opportunity in that you may wish to purchase alETH at some value less than 1 ETH:alETH, which you can then transmute and earn a profit. To estimate the profit, you must know at what price you can purchase alETH, as well as an estimate of the conversion rate of alETH in the Transmuter.
If you calculate an attractive rate, and if you determine that you wish to transmute, then it is as simple as depositing alETH into the Transmuter and waiting.
Transmuter — How to Estimate Yield
To estimate the yield, you must know the price of alETH and the time it will take to convert it to wETH, or the transmutation time.
The transmutation time is determined by how much yield flows to the Transmuter, and how much alETH is already in the Transmuter. To determine the yield that flows to the Transmuter, you must estimate the yield of the entire system by determining a weighted average of the TVL and yield of each vault. Multiplying this by the TVL of all alETH vaults will result in the total estimated wETH expected to flow into the Transmuter in one year, or the expected one-year flow.
Next, you must look at the total alETH deposited by other addresses in the Transmuter — this is the amount of alETH between which the yield must be split. The estimated time to transmute can be calculated with the equation below, where the result is in years:
Lastly, you can determine the projected yield rate of transmuting by using the equation:
Note that in some cases the Transmuter will not convert all of the wETH it receives due to the available flow, but as long as the alETH supply is not growing rapidly, this is not expected to be a limiting factor and can be ignored.
Transmuter — Example Calculation
When using numbers as of May 12th, 2024, the above calculation looks like the following:
- First, determine the average yield. The TVL and yield of each vault can be found at https://app.alchemix.fi/vaults. From below, this average is currently 5.0%.
- Next multiply by the TVL for the expected 1-year flow, which is currently 639.5 ETH.
- From etherscan, it can be seen there is a balance of 701 alETH in the Transmuter contract. Therefore, the expected time to transmute is 701 / 639.5, or 1.1 years.
- The current price of alETH is ~0.91, as quoted by Curve.
- Therefore, the current expected transmutation yield is [1 / 0.91–1] x [100 / 1.1] = 9%.
Transmuter — Additional Variables
The variables above are just that — variable! If more people were to deposit alETH in the Transmuter (including you, dear reader), the rate of transmutation would decrease. If more people were to deposit into the Alchemix vaults, then there would be more yield, and thus the transmutation rate would increase. However, depositors are also likely to mint new alETH for loans, which could potentially result in more alETH in the Transmuter.
Additionally, if anyone closes their loan using self-liquidation or repays their loan with ETH (or wETH), these funds will also flow to the Transmuter, thus speeding up transmutation time.
alAssets — Providing Liquidity
Providing Liquidity — The Basics
You can provide alETH liquidity on Curve.fi on Mainnet, among other locations across Ethereum, Optimism, and Arbitrum — with more Layer 2 chains coming soon. Curve pools are different from typical liquidity pools, as they allow the assets within the pool to be imbalanced (i.e., unequal), while also keeping the tradable asset prices within the liquidity pool close to 1:1 relative to each other. Currently, the alETH pool is 87.7% alETH and 12.2% frxETH.
Providing liquidity is subject to slightly more risk compared to holding or transmuting alETH, as users are exposed to both alETH and frxETH, rather than just alETH. However, liquidity can be staked in various locations to earn yield to offset risk. As a liquidity provider, you lock in an “entry” price of alETH when you enter the pool. You earn yield while in the pool, and then you lock in an “exit” price of alETH when you exit the pool. Therefore, if alETH goes up (relative to ETH and frxETH) while in the pool, you earn an additional profit, and you lose some profit if alETH goes down.
So how can you determine if the yield is worth the risk?
Providing Liquidity — Where to Earn Yield
First, you need to determine the yield rate you are paid for providing liquidity. On Mainnet, Curve will quote yields directly; however, without a veCRV stack of your own, you will only get the low end of the yield. Some aggregators, such as FraxConvex and Yearn, will boost yield for you — both are quoting closer to the high end of the range at ~30% APR.
If you want to explore further, https://alchemix-stats.com/earn lists most places where you can earn interest by providing liquidity.
Providing Liquidity — alAsset Price
Given that the price of alETH and the yield rates are market-driven and variable, it is important to understand what may drive the price of alETH up or down. The price of alETH can go down for many reasons, such as users not wanting to wait to transmute choosing to cash out, taking alETH loans and selling, or simply that the yield is too low and therefore no one is providing liquidity. All of these reasons boil down to the fundamental issue that the supply of alETH is too high — there is more alETH in the market than the market wants to hold onto. So how is this resolved?
Firstly, when the alETH price is below a certain point, users are unlikely to take new loans. Historically this is around 0.95–0.98 alETH/ETH. At that point, the market is not creating any new supply but is instead seeking to shrink the existing supply.
Shrinking the existing supply can happen in three ways. The first is that users with loans may purchase alETH off of the market to repay their loans — however, this is not an option for LPers that do not have loans. Additionally, this historically requires a lower alETH price than what is typically attractive for LPers and transmuter users.
The second is with the Transmuter, which, as discussed above, will convert alETH back into wETH. In doing so, the transmuted alETH is burned, meaning it is no longer part of the circulating supply.
The third way is the Elixir AMO: The Elixir is a pool of excess ETH that the protocol accumulated when the alETH supply expanded. If alETH is worth 1:1, the protocol does not want people to transmute. Therefore, it holds onto the wETH sent to the Transmuter for later, in the form of liquidity in the Curve pool. Therefore, the Elixir is essentially a pool of wETH earmarked to eventually be redeemed for alETH, similar to the Transmuter. To achieve this mechanism, the Elixir periodically withdraws alETH from the liquidity pool, thus removing it from circulation. During the time the Elixir does hold funds in the liquidity pool, it stakes them to earn yield. In this manner, the Elixir can earn yield for the protocol while it waits to shrink the supply. The Elixir is also mandated to withdraw alETH from the pools when the price is below a certain target, thus ensuring it is always shrinking the alETH supply in some manner, when necessary.
Providing Liquidity — How Low Can alETH Go?
The system cannot force users to repay their loans any faster than the rate of transmutation; however, a low alETH price will disincentivize new loans. Therefore, at the current price of 0.91 alETH, it is unlikely that the supply will increase.
One benefit of the Elixir is that the Elixir can shrink the supply by removing liquidity. The current value of the Elixir is ~1898 alETH. Thus, the supply of alETH can be shrunk by 1898 alETH.
Alchemix uses ALCX to incentivize liquidity for alAssets. However, the DAO also has a sizable sdCRV position, as is viewable on Alchemix-stats. Conservatively (i.e., ignoring the boost), the Alchemix-owned sdCRV position is equivalent to 5.5m veCRV. Alchemix has an additional 1.9m veCRV it controls through the treasury’s vlCVX position. In total, Alchemix controls 1% of the veCRV voting power. The current rate of emissions is 163,406,144 CRV per year, which means Alchemix controls 1.63 million CRV of emissions this year, or approximately 230 ETH worth (at current CRV/ETH prices).
If the Elixir were to fully withdraw from the sfrxETH/alETH pool, then the total remaining liquidity provided by 3rd party LPers in both pools (sfrxETH/alETH and alETH/wETH) would have a total value of ~1460 alETH. This means the DAO’s sdCRV and vlCVX stack alone could contribute 230/1460 = 15.7% yield to LPers if it were fully allocated to alETH liquidity. Therefore, the baseline yield to LPers is 15.7%, which is only ever that low if all 3rd party liquidity remains, ALCX incentives stop, no one buys alETH to repay loans, and the treasury does not step in to help shrink the supply more quickly, and no more alETH enters the Transmuter. The only other way the yield would go that low is if there is a significant increase in 3rd party LPers — at which case the alETH price likely would have increased.
WIth that in mind — an LPer must determine what they believe the lowest price alETH could reasonably go to is, and they can LP with that in mind.
Providing Liquidity — The Risk, and the Reward
As noted above, if you provide liquidity, then you need to understand the entry point, the yield you earn, and the exit point.
If you are LPing, you may decide that alETH cannot reasonably go below 0.8 for any extended period of time. You may also determine that if alETH gets to 0.98, you will terminate your liquidity position. Lastly, you may decide that you are willing to hold the position for at least one year, even if the price were to drop.
Currently, alETH is at 0.91 alETH/ETH. If you were to provide 10 ETH worth of liquidity (~11 alETH) and stake with Yearn, you would have earned 30% APR at current rates. Even if after 1 year, the price of alETH decreased to 0.8 ETH and you were to choose to exit, you would have earned 3 ETH from yield while losing 1.2 ETH from the price drop. Therefore, you would have still netted 18% APR, or 1.8 ETH.
If alETH were to increase to 0.98 after one year, you would have earned 4 ETH from yield while also gaining 0.77 ETH from the price change — thus netting a total APR of 48%.
Conclusion
This guide aims to provide you with a clear understanding of the potential risks and rewards associated with alETH transmutation and liquidity provisioning. The calculation specifically for the transmuter is laborious, so it will be worked into the UI in the future.
For further questions or discussions, hop in our Discord server (link below). We’re here to help and look forward to welcoming you.
