ELI5 Alchemix: How does it actually work and how can you benefit from it?

What is alchemix exactly?

Well alchemix is a defi protocol that allows you to earn interest on deposits and borrow assets. There are many like this already such as aave, compound, cream and many others.

So let's say you've made your first ethereum and you want to earn interest on it so you decide to deposit it on a defi platform that allows you to earn interest on your ethereum and also borrow on it by using it as collateral.  

Once you deposit it you can borrow on it and you can do whatever you want with what you borrowed, you usually can borrow up to 50% and once you've done what you wanted to do with it you can repay your loan and get your initial deposit back with extra interests earned on it while it was in the vault.

So this is very nice but there is one risk associated with this, that is if the value of ethereum drops by a lot, say more than 50%, then the value of your deposit is lower than the loan that you got and therefore it will be liquidated by the defi protocol so this means that you will lose your initial deposit and you won't be able to get it back.

Alchemix works pretty much the same way except that at least for now although this will soon change you can only deposit DAI so for example you can deposit a thousand DAI and you will be able to earn interest on it and also borrow. So you can borrow up to 50% out of your 1000 DAI and the thing is that instead of giving you 500 DAI it will only give you 500 alUSD which is a synthetic asset that is equal to one DAI and the thing is there is no risk of getting liquidated and there is no need to repay a loan.

That's it, you can just use what you borrowed and then you will get your initial deposit back like magic. But how is it possible?

Well actually alchemix deposits your money on yearn.finance where it is put to work and earns interest thanks to yearn strategies. And then it uses the yield from the yearn vault to repay your loan automatically. After a while you are able to get your DAI back and keep whatever you borrowed with no need to repay. You can also do so manually if you wish to. You can repay your loan either in alUSD or in DAI. Now you may be asking yourself what can i do exactly with alUSD? is it worth anything? If you think about it you deposited a thousand DAI and you're getting 500 alUSD and supposedly your whole deposit is now in a yearn vault to earn yields! So where do this 500 alUSD come from? is it made out of thin air?

If it's alUSD synthetic asset. How is it worth anything?

It is indeed minted out of thin air by the alchemix contract but here is how it has some value and how it can be used. So first of all you can easily exchange those 500 alUSD you just received by going to a decentralized exchange such as sushi or crv.to and use the liquidity providers there that will exchange your alUSD for DAI and ethereum. Now you may be wondering why would any liquidity provider risk losing their precious DAI and ethereum for alUSD?

Well as you may know when you provide liquidity you get a percentage every time there is an exchange, so every time the user exchange alUSD for DAI or DAI for alUSD you get 0.3% of that and then every time you provide liquidity, you get a liquidity token in exchange, which represents your proportion of liquidity provided. Alchemix then allows you to deposit this liquidity token inside the alchemix farm which rewards you with alchemics token. But what if you don't trust those liquidity providers to provide enough liquidity so that you can exchange your alUSD? Well there is something called the transmuter and what it does is actually that you can deposit your alUSD in the transmuter and in exchange you will get your DAI with time. Well remember the yearn vault where your DAI were deposited by alchemix? Well some of the interest that are yield by the vault are deposited in the transmuter. So day by day you will get some DAI for your alUSD until all of your alUSD have been converted into DAI. Another thing that the yearn vault does is send 10 percent of interest to the treasury.

What  does the treasury do? Well it allows the DAO to use funds for developer pay, infrastructure costs, developer grants, and community discretion. But the DAO is led by a governance that is allowed to vote on what goes on with the treasury, the yearn vault and the alchemix farms. So let's recap. First the user is able to deposit a thousand DAI in the alchemix vault. Then they can borrow up to 500 alUSD.

Then alchemix deposits the DAI in yearn vault which repays the loan day by day. The user can also repay the loan manually if they want or wait for the loan to be repaid. Once the user has their 500 alUSD, they can exchange them for ethereum or DAI using an exchange such as sushi or crv.to. Why would the liquidity providers help with liquidity here? Well first they get their 0.3% every time someone exchanges alUSD for DAI or ethereum or vice versa. Then they also get liquidity tokens for providing liquidity that they can farm in alchemix in order to get ALCX rewards.

Those rewards can be used in the governance as the DAO in order to vote on what goes on in the yearn vault. the treasury and the alchemix farm.
And if the user does not want to exchange the alUSD in a dex such as sushi they can also use the transmuter. So they deposit their alUSD in the transmuter which receives some of the yield from the yearn vault and it uses this to provide DAI to the depositor day by day until they get the whole DAI amount that they had in alUSD and that's it for alchemix.

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