How Chicken Bonds works

Before diving into Chicken Bonds, check out our Liquity risk assessment to understand how users earn yield on their LUSD stablecoins through the Stability Pool. The Stability Pool generates yield through two components: users buying ETH at a discount from liquidations and LQTY protocol rewards (to incentivize LUSD deposits to pay off debts of undercollateralized loans). With Chicken Bonds, users can leverage their LUSD yield by choosing to bond their LUSD (instead of depositing into the Stability Pool) to receive a boosted LUSD token (bLUSD). bLUSD is a derivative asset that offers a higher yield compared to the Stability Pool, auto-compounds rewards, and it can be used as collateral with a rising floor price (in LUSD). The primary way for users to acquire bLUSD is through bonding or through the Curve bLUSD-LUSD3Crv liquidity pool. Users first create a bond by depositing LUSD into Chicken Bonds. Once bonded, users will continuously accrue a virtual balance of bLUSD tokens. Every bond is unique and represented by an NFT that is transferrable and tradable. The bond has no maturity date and users can choose one of two options at any time: Chicken-in and Chicken-out. Users who "chicken-in" can claim their bond by exchanging their LUSD for the accrued bLUSD balance; once claimed, the deposited LUSD becomes protocol-owned liquidity (POL). Users can also "chicken-out" by canceling their bond to recoup the full amount of their initial LUSD deposit. In this sense, the user's principal is always protected and the user only forgoes the accrued yield. Users who chicken-in can further compound their yield by selling the bLUSD for LUSD and rebonding with a larger LUSD principal. A bank run is mitigated with Chicken Bonds as users can always recoup their LUSD principal by chickening-out.

How is the yield amplified?

The base yield is generated by deploying LUSD into the Stability Pool to earn LQTY as well as variable ETH liquidation premiums and to the Curve LUSD-3Crv pool to earn trading fees and CRV token incentives. Deposits into the Stability Pool are managed by the B.Protocol vault which handles the harvesting and compounding of ETH and LQTY rewards for LUSD. For the Curve pool, the Yearn Curve-LUSD vault is used to optimize the yields via Convex. The amplified yield is achieved through three separate sources: pending, reserve, and permanent buckets. The pending bucket holds the LUSD from all open bonds (users have not yet chickened in or out). The reserve bucket holds the acquired LUSD from users who chicken-in; this bucket backs the entire bLUSD supply (bLUSD is fully redeemable for the LUSD in the reserve). Lastly, the permanent bucket holds excess LUSD diverted from bonds that were chickened-in early; this LUSD is protocol-owned and can never be redeemed. Yield amplification comes from all three buckets (pending, reserve, permanent). Thus, the LUSD quantity in the reserve grows faster than the natural rate at which LUSD compounds. Over time, as all yields flow to the reserve, the redemption price increases. When a bonder chickens-out, they reclaim their initial LUSD deposit and effectively give up their accrued bLUSD yield to other bLUSD holders. When users chicken-in, some LUSD goes to the reserve and some to the permanent bucket. The earlier a user chickens in, the more of their bonded LUSD goes to the permanent bucket. The excess LUSD diverted on early chicken-ins increases the future yield which flows from the permanent bucket to the reserve. A rebonder that chickens in late spent longer bearing the opportunity cost of bonding. Thus, they are donating the yield from their underlying bonded LUSD to the system. The net effect is a transfer of value from rebonders who chicken in late to those who chicken in optimally.

How does Liquity benefit from Chicken Bonds?

The accrued POL will be used to provide liquidity for LUSD on Curve. The permanent bucket has a shifting function that allows it to shift the LUSD back and forth from Curve and the Stability Pool. This can be triggered by anyone as long as LUSD trades at a premium. By shifting LUSD from the permanent bucket to provide liquidity on Curve (single asset supply), it helps to rebalance the pool while also growing liquidity. This all works to better defend the LUSD peg and keep it closer to its value of 1 USD.