EIV x Lemma: The Basis Trading DeFi Protocol

Superior, sustainable, market-neutral yield

e^{i} Ventures
6 min readDec 9, 2021

By Ariana Fariab, e^{i} Ventures

One of our earliest portfolio projects, Lemma, launched their much-anticipated mainnet last week. An early EIV incubator project, Lemma’s co-founders Matthieu Gavaudan and Yash Shah effectively served as Entrepreneurs-in-Residence at EIV during the ideation and inception stages of building what would become the Lemma protocol.

Today, Lemma is the first basis trading protocol on Arbitrum mainnet, supported by a strong community and an array of talented investors including Dragonfly Capital, Standard Crypto, Nascent, Multicoin Capital, Coinbase Ventures, Wintermute, and more. EIV is proud to be a part of Lemma’s mission to democratize access to DeFi investment strategies.

What is Lemma?

Lemma is a decentralized basis trading protocol that provides superior, sustainable, low-risk yield. The protocol has two products:

  1. A decentralized, 100% capital efficient, USD pegged stablecoin
  2. A “leveraged” basis trading vault

Lemma utilizes basis trading–a strategy popular among large crypto hedge funds–to generate considerable yield on user-deposited assets. This is achieved by collateralizing the assets (ETH) to short ETH-USD inverse perpetual contracts on a decentralized derivatives exchange. For anyone unfamiliar with them, perpetual contracts are similar to futures, but have no expiration date. Also unlike futures, perpetual prices are closely tethered to their underlying spot price. Derivatives DEXs, like Monte Carlo DEX (currently integrated with Lemma), ensure perpetuals remain in line with spot markets through a funding rate mechanism that requires long traders to pay shorts a recurring fee when the funding rate is positive, and vice versa when it is negative. The past five years have seen an ongoing trend of positive funding rates (for various reasons), creating an opportunity for short sellers.

Basis trading results in a market-neutral position, eliminating directional risk and exposure to price action of the underlying asset, while generating consistent yield via funding payments. This yield-generating delta neutral position is responsible for the low-risk, superior returns Lemma achieves. In a recent backtest we conducted using the Monte Carlo DEX (period: August 15, 2021 — December 1, 2021), Lemma’s basis trading strategy produced an APY of 50.32% (USDC-ETH pair).

USDL Stablecoin

For every $1 a user deposits, they receive 1 USDL (Lemma’s decentralized stablecoin). USDL is pegged to the U.S. Dollar and backed by the yield-generating short position explained above. The stablecoin is 100% capital efficient, meaning 1 USDL is always redeemable for $1 of ETH and mintable for $1 of ETH, USDC, or USDT; a rare, if not entirely unique, feat for a decentralized stablecoin. USDL minting is fully permissionless and non-custodial; its smart contracts interact directly with those of the derivatives DEX.

“Leveraged” Basis Trading Vault

To access the yield generated from basis trading, users must deposit assets into Lemma’s basis trading vault. Upon deposit, USDL is minted and automatically staked. In return, users receive a proportional amount of xUSDL (the staked version of USDL), which will increase in value as yield is produced. Only holders of xUSDL can access basis trading yield; this is where the “leveraged” aspect comes into play. In addition to their own pro rata share, xUSDL holders receive the yield for all unstaked USDL, creating a leveraged effect (but with virtually no liquidation risk). According to backtesting results, without this “leverage”, basis trading may produce a lower return, but with significantly less drawdown, than simply holding the underlying asset. However, when “leverage” is applied, basis trading can significantly outperform holding, while still only posing a fraction of the risk and volatility.

EIV & Lemma

Matthieu and Yash joined EIV as Entrepreneurs-in-Residence in early 2021. Matthieu coming from a product and quant trading background and Yash having a strong technical background (and both being brilliant, promising entrepreneurs), the co-founders formed a strong partnership. EIV ideated with the co-founders to create the initial core ideas of a DeFi prime brokerage and a perpetual swap aggregator; ideas which would become stepping stones for Lemma’s derivative-backed stablecoin.

As a venture studio focused on building, funding, and supporting the future of DeFi and cryptocurrency applications, we often take a high-touch approach to working with portfolio projects; particularly those we incubate. We’ll work with founders to determine the level of support that best fits their project’s needs at the time, which can range from providing capital to co-building alongside them. With Lemma, our initial approach was more hands-on. Alongside co-founders Matthieu and Yash, EIV conducted quantitative research for Lemma’s AMM pools and backtested the basis trading strategy. As Lemma has progressively grown and scaled, our involvement has, appropriately, shifted to the less hands-on role of an investor.

We couldn’t be more excited for what lies ahead for Lemma and their team. The project is a major breakthrough in decentralized finance, giving retail investors easier access to high-yield strategies that were previously only really feasible for institutional investors.

Basis trading is a massively popular trading/yield generation strategy in crypto, however, historically, it has not been easily usable or accessible to the average DeFi user. As Lemma put it:

A good part of this is due to complexity. Basis trading is traditionally a multi-step process that is far from “user-friendly”. Lemma solves this by automating the process and condensing it all down into a fairly simple “one-click” trade.

In line with their mission to democratize access to DeFi investment strategies, Lemma is bringing basis trading to everyday DeFi users. This is great since one of the pillars in the ethos of DeFi is, as Alok Vasudev put it, making institutional financial processes accessible to anyone. Another pillar of DeFi is making these processes permissionless and transparent, which Lemma also achieves.

Lemma’s initial mainnet launch was on the MonteCarlo DEX (MCDEX), a derivatives DEX built on top of Arbitrum (an Ethereum L2). Lemma plans to launch on Perpetual Protocol next month and expand to more Arbitrum derivatives DEXs soon after.

We’re excited to see what the future holds for our friends at Lemma; this is only the beginning.

Brought to you by the team at e^{i} Ventures
Written by: Ariana Fariab
Special thanks to: Nas, Srikar, Bowen

Website: https://www.eiventures.io
Twitter: https://twitter.com/eiventurestudio
Email: hello@eiventures.io


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