In this section, we go over how Lemma creates a “synthetic USD” that backs each USDL. The "synthetic USD" is created without ever holding USD or other USD-pegged stablecoins, and instead uses coin-margined perpetual contracts.
Creating a market neutral position
Being market neutral implies creating a derivatives position that does not have any directional risk with regards to more volatile crypto assets (eg. BTC, ETH...).
An example flow to create a market neutral position is described below:
User deposits 1 ETH on Lemma
Lemma will move that 1 ETH to a decentralized derivatives exchange
Lemma will use it as collateral to short the ETH-USD inverse perpetual contract with no leverage.
Assume the price of ETH is 1000 USD:
If the price of ETH increases to 1100 USD, then our short will have lost 100 USD, but our collateral will have gained 100 USD in value, meaning our portfolio’s overall value will have stayed at exactly 1000 USD.
If the price of ETH decreases to 900 USD, then our short will have gained 100 USD, but our collateral will have lost 100 USD in value, meaning our portfolio’s overall value will have stayed at exactly 1000 USD.
In this example, when a user deposits 1 ETH at a price of 1000 USD, Lemma will create a portfolio of 1000 “synthetic USD” on their behalf. Lemma will then mint 1000 USDL to represent the user’s stake in the overall Lemma “synthetic USD” portfolio.
Synthetic USD's intrinsic value
The “synthetic USD” intrinsic value is equal to the index price (spot price of ETH) divided by the mark price (perpetual contract price of ETH). Traders on derivatives platforms are incentivized via funding rates  to arbitrage this value so that it is always as close to 1 as possible. As a point of reference, on Bitmex, the standard deviation over the last few years for the difference between the mark and index price has been ~0.14%.
Lemma creates this "synthetic USD" in a permissionless and non custodial way as its smart contracts interact directly with the decentralized derivative exchanges’ smart contracts.
Shorts on inverse perpetual contracts with no leverage are almost impossible to liquidate since the portfolio’s value is stable. The main risks involve a derivative dex exploit and an extremely long period of negative funding payments - which we will cover later on.
This means we avoid the biggest liquidation risk (our margin ratio falling below the maintenance ratio) when creating “synthetic USD”, at any scale.