SWOT Analysis of Stablecoins Supported by LSD: Which Project Will Stand Out?
LSD-backed stablecoins are stablecoins based on the CDP model, requiring over-collateralization through liquid staking tokens and carrying liquidation risks.Written by: Caesar
Compiled by: Deep Tide TechFlow
2023 has been an extraordinary year for builders exploring the potential of new DeFi primitives. During this time, one of the most notable developments has been the rise of liquid staking derivatives (LSD) protocols, along with the subsequent establishment of protocols built on LSD projects, known as LSDfi.
These LSDfi projects can be divided into several different parts. In this article, I will primarily focus on stablecoins backed by LSD.
What is LSD? What is LSDfi?
Liquid staking derivatives (LSD) are financial instruments that represent ownership of staked tokens within DeFi protocols. These instruments allow users to stake their tokens while retaining the freedom to use these LSD in various applications. Some LSD protocols include Lido Finance and Rocket Pool. LSD provides numerous benefits to the ecosystem as they unlock previously locked capital while providing security to the network.
LSDfi refers to projects that utilize LSD protocols to build financial primitives, such as Pendle Finance and Unsheth. By offering additional yield-generating opportunities, LSDfi protocols allow LSD holders to leverage their assets and maximize returns.
However, as a subcategory, there are also some LSD-backed stablecoins, such as Raft, Gravita, Ethena, Prisma, and Lybra, which we will now evaluate.
LSD-backed stablecoins are stablecoins based on the CDP model that require over-collateralization through liquid staking tokens and carry liquidation risks. They allow holders to earn intrinsic yields while retaining the key properties of cryptocurrency-backed stablecoins.
It is evident that LSD-backed stablecoins do not differ significantly from established cryptocurrency-backed stablecoins (such as $LUSD, $FRAX, or $DAI). The main value proposition offered by LSD-backed stablecoins is the staking yield of $ETH while allowing users to continue accessing DeFi applications. However, new projects also offer some innovative features.
To better understand this category, let’s take a closer look at these protocols one by one.
Prisma Finance ($mkUSD)
Prisma is an LSD-backed stablecoin that is a fork of Liquity but with significant improvements. Prisma allows users to mint $mkUSD backed by multiple LSTs (such as $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH). $mkUSD will be incentivized on Curve and Convex Finance to create a capital-efficient flywheel, where users can earn trading fees, $CRV, $CVX, and $PRISMA, along with staking rewards from $ETH.
My thoughts on $mkUSD are as follows:
Competitive Value Proposition: Each LSD-backed stablecoin offers users $ETH yields; however, since the $mkUSD pool is deployed on Curve, users depositing $mkUSD can earn trading fees, $CRV, $CVX, and $PRISMA rewards, which may make $mkUSD more competitive among its peers.
Not a Medium of Exchange: $mkUSD is a yield-bearing stablecoin, and the protocol does not prioritize its use as a medium of exchange. Most users hold $mkUSD to earn the annual interest rate provided by holding $mkUSD.
Yield-bearing Asset: Since $mkUSD can generate yields for holders, some will certainly use it merely as a store of value. If users trust its peg stability, this can be a good way to earn $ETH yields.
Innovative Tokenomics: vePrisma holders will be able to incentivize specific pools, so LST providers may be interested in using their own LSTs to incentivize $mkUSD. This can create a positive feedback loop for the demand of $mkUSD. According to the whitepaper, voters can direct issuance towards minting with specific collateral to maintain active lending with that collateral and distribute rewards to any LP token holders. Given that deep liquidity is crucial for maintaining peg stability, this will be an important factor in distinguishing Prisma from its competitors.
Multiple LST Collaterals: Several LSTs can be used as collateral, such as $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH, with varying market capitalizations. Due to the unique tokenomics, these protocols can incentivize users to mint $mkUSD, thereby increasing exposure to Prisma.
Insufficient Capital Efficiency: The over-collateralization model means that $mkUSD has limited capital efficiency, as users need to put in more funds than they receive. Additionally, since the collateralization ratio must always be maintained above 120%, there is always a risk of liquidation.
Strong Backers: Compared to its competitors, although Prisma Finance entered the market later, the protocol is backed by several strong supporters, including Curve Finance, FRAX, and Convex.
Raft ($R)
Raft is a protocol for minting the R stablecoin, which is supported by LSTs through over-collateralization and carries liquidation risks. Users can earn sustainable yields by depositing savings rates.
My thoughts on $R are as follows:
Lack of Innovation: Raft is a fork of Liquity with only minor changes, so there is not much innovation in the product. Therefore, it may be easily surpassed after the launch of Liquity v2, which will utilize LSTs.
Not a Medium of Exchange: $R is a yield-bearing stablecoin, and the protocol does not prioritize its use as a medium of exchange. Most users hold $R to earn the annual interest rate provided by holding $R.
Peg Stability: $R is currently valued at around $0.98, and the team is working on finding solutions to restore the peg. The team proposed implementing interest fees instead of one-time fees to mint $R. By doing so, they aim to restore the peg through incentivizing buying pressure in the market. The reasons for the peg deviation can be attributed to the one-time fees for minting R, lack of liquidity, and absence of use cases to create organic demand.
Limited Value Proposition Compared to Competitors: At this point, users do not need to pay interest fees to borrow $R, allowing them to leverage their $ETH positions. This is the main value proposition of $R. However, if the team decides to change this model, Raft will have no value proposition.
Yield-bearing Asset: Since $R can generate yields for holders, some will certainly use it merely as a store of value. If users trust its peg stability, this can be a good way to earn $ETH yields.
Insufficient Capital Efficiency: As $R is a CDP model stablecoin that requires over-collateralization and carries liquidation risks, it is not a capital-efficient model for retail users. This will limit its growth potential, as scalability is constrained.
Gravita ($GRAI)
Gravita is a fork of Liquity that accepts different LSD products as collateral. It allows users to borrow without interest and does not take a cut from the yields generated from deposited LSTs. The redemption mechanism has not been activated in the initial phase but will be gradually released throughout the process. This may be the reason why $GRAI has maintained around $0.98 since its inception, which undoubtedly raises trust issues among users.
My thoughts on $GRAI are as follows:
Lack of Innovation: As mentioned, Gravita is a fork of Liquity, and there is not much innovation in the product. Therefore, it may be easily surpassed after the launch of Liquity v2, which will utilize LSTs.
Limited Value Proposition Compared to Competitors: Users can borrow $GRAU without paying interest fees, allowing them to leverage their $ETH positions. Additionally, allowing $bLUSD to be used as collateral without any liquidation risk and not taking any fees from staking yields is the value proposition offered by Gravita.
Not a Medium of Exchange: $GRAI is a yield-bearing stablecoin, and the protocol does not prioritize its use as a medium of exchange. Most users hold $GRAI to earn the annual interest rate provided by holding $GRAI.
Peg Stability: Since the launch of $GRAI, its price has fluctuated around $0.98. This may be due to the lack of redemption for $GRAI during the launch period and the gradual release thereafter, which may lead to oversupply and subsequently lower prices without arbitrage opportunities. Additionally, low liquidity and lack of use cases to create organic demand may limit the growth of demand for $GRAI, exacerbating the situation.
Yield-bearing Asset: Since $GRAI can generate income for holders, there will certainly be demand to use it as a store of value. If users trust its peg stability, this can be a good way to earn $ETH yields.
Multiple LST Collaterals: Several LSTs can be used as collateral, such as $WETH, $rETH, $wstETH, and $bLUSD. This can serve as an advantage, providing users with several opportunities.
Lack of Capital Efficiency: The over-collateralization model means that $GRAI is limited in capital efficiency, as users need to put in more funds than they receive. Additionally, there is always a risk of liquidation, which will limit growth.
Lybra ($eUSD)
$eUSD is a stablecoin backed by staked $ETH. Holding $eUSD will yield a stable income stream with an annual yield of around 8%. The protocol also has a governance token called $LBR, but its utility is limited. With the launch of Lybra v2, several new features have been introduced, expected to improve the protocol's shortcomings.
My thoughts on $eUSD are as follows:
Lack of Capital Efficiency: The over-collateralization model means that $eUSD is limited in capital efficiency, as users need to put in more funds than they receive. Additionally, there is always a risk of liquidation, as the collateralization ratio must always be above 150%.
Limited Value Proposition Compared to Competitors: For emerging LSD-backed stablecoins to have growth potential, they need to possess unique value propositions. However, despite $eUSD having an early advantage, it has not provided competitiveness in collateral requirements or any significant improvements.
Not a Medium of Exchange: $eUSD is a yield-bearing stablecoin, and the protocol does not prioritize its use as a medium of exchange. Most users hold $eUSD to earn the high annual yield provided by holding $eUSD.
Peg Stability: $eUSD holders are eligible for staking rewards from $ETH. Therefore, most users prefer to purchase $eUSD in the market, creating demand pressure. This leads to demand for $eUSD exceeding supply, pushing it above the $1 peg. Unless the system changes, $eUSD will struggle to find its peg, which could pose long-term issues for holders.
Yield-bearing Asset: Since $eUSD can generate income for holders, there will certainly be demand to use it as a store of value. If users trust its peg stability, this can be a good way to earn $ETH yields.
Multiple LST Collaterals: With the launch of Lybra v2, new LST collaterals such as $rETH and $WBETH can be used. This will increase the likelihood of $eUSD being minted, but we should not overestimate its impact.
Poor Tokenomics: $LBR is the governance token of the protocol; however, due to almost all yields from LSD flowing to $eUSD rather than $LBR, the token has very little utility. Poor tokenomics also sustain a premium for $eUSD, causing it to always exceed its peg, as users are incentivized to hold $eUSD due to it being a yield-bearing stablecoin, with demand for holding $eUSD greatly exceeding the demand for minting $eUSD.
Ethena ($USDe)
Ethena Labs is a new project that has not yet launched. The project differentiates itself from competitors by offering a funding-neutral support model that is different from the CDP model. Through this model, the project will use LSD as collateral to create a spot long and 1x short position on exchanges, thereby preventing volatility in the collateral. $USDe will be more efficient as it will offer a 1:1 collateralization ratio, providing funding fee income in addition to LSD yields. However, users will not be affected by $ETH price fluctuations.
My thoughts on $USDe are as follows:
Innovation: Among all existing projects, Ethena is the only one offering an innovative solution. I believe the funding-neutral model can successfully address some of the major issues faced by LSD-backed stablecoins, such as capital efficiency, lack of scalability, and peg stability.
Capital Efficiency: Due to the funding-neutral model, the protocol does not require over-collateralization to maintain the peg, allowing it to offer a 1:1 collateralization ratio. Therefore, in terms of capital efficiency, $USDe performs best among its competitors.
Peg Stability: $USDe will use funding-neutral positions to maintain peg stability. Theoretically, "creating a spot long and 1x short position on exchanges" will always protect the value of the collateral. However, it is important to see practical results.
Medium of Exchange: Since $USDe offers a 1:1 collateralization ratio, it can address the scalability issues of existing cryptocurrency-based stablecoins. Therefore, $USDe can serve as a medium of exchange between platforms with deep liquidity.
Strong Value Proposition Compared to Competitors: $USDe has two main unique advantages in the market that can differentiate the product from competitors. First, it can offer a 1:1 collateralization ratio, which is more attractive to users. Additionally, in addition to LSD yields, $USDe will also provide funding fee income, making it more competitive than existing projects.
User Adoption: As every innovative project faces the same challenges, $USDe will also encounter some skepticism from the community, as the Delta-Neutral approach is not widely known. Therefore, Ethena will need some time to educate users and encourage them to try this approach.
Not Affected by ETH Volatility: Since the deposited collateral is used to establish hedged positions, users will not face the risk of $ETH price fluctuations. Risk-averse users may see this as a benefit, while $ETH maxis may view it as a drawback.
Overall Thoughts on the Landscape of LSD-backed Stablecoins
So far, I have shared my thoughts on individual LSD-backed stablecoins to better understand the dynamics of these stablecoins while analyzing their opportunities and limitations. I believe this analysis helps to understand the competitive landscape of LSD-backed stablecoins and illustrates the trade-offs of each individual stablecoin.
Now, I will share my overall overview of the landscape of LSD-backed stablecoins so that we can predict how this category may evolve. To do this, I will implement a SWOT analysis:
Note: It should be emphasized that conducting a general SWOT model analysis for each LSD-backed stablecoin does not provide a good overview, as each has different values/characteristics. This is especially true for Ethena Labs, as their Delta-Neutral mechanism is entirely different from the CDP model. For example, in the weaknesses section, capital efficiency, medium of exchange, and limited use cases do not apply to Ethena's stablecoin $eUSD.
Strengths
Value Storage: LSD-backed stablecoins are excellent value storage tools, as most of them have achieved price stability while providing users with $ETH yields. Therefore, they can serve as low-risk yield opportunities and value storage, increasing market share in the near future. As people realize that LSD-backed stablecoins empower users by sharing inherent yields, adoption rates will grow.
Yield Opportunities: While a 5-8% annual yield on stablecoins may not be attractive to retail traders, it presents a great opportunity for large holders and leveraged traders, considering the limited high-yield opportunities in the DeFi ecosystem, especially during prolonged bear markets.
Unlocking Liquidity: LSD is a great way to unlock the liquidity of staked $ETH, and LSDfi, especially LSD-backed stablecoins, further improves this situation by creating new use cases for LSD, which will undoubtedly increase opportunities within the ecosystem.
Increased $ETH Exposure: LSD-backed stablecoins are excellent tools for expanding the Ethereum ecosystem, as they improve users' $ETH exposure and create new use cases, leading to more organic demand.
Weaknesses
Growth Depends on LSDfi Adoption: LSDfi is a new category that requires further exploration. As pioneers in this category, LSD-backed stablecoins will heavily rely on the overall growth of the market, which is somewhat independent of their influence.
Capital Efficiency: Since most LSD-backed stablecoins implement the CDP model, they require over-collateralization and face liquidation risks. Therefore, capital efficiency becomes a core challenge faced by users.
Medium of Exchange: LSD-backed stablecoins are primarily used for yield opportunities, and they all rely on the CDP model, making it impossible to treat LSD-backed stablecoins as mediums of exchange, which will limit the scalability of these products.
Limited Use Cases: While being a sustainable yield asset is a good value proposition, liquidity fragmentation and lack of liquidity limit the use cases of LSD-backed stablecoins. Aside from holding, there are almost no other ways to utilize these stablecoins.
Opportunities
ETH Staking Adoption: With ongoing trust in the security of the Ethereum ecosystem and $ETH staking yields, ETH staking is one of the areas where we will see further growth. As the staking rate of $ETH may increase in the future, it can be predicted that LSD-backed stablecoins will benefit from this.
Value Storage Against Inflation: Due to inflation, there will always be strong demand for yield assets. As we can see from attempts to build anti-inflation stablecoins/stable assets, there is huge demand for them. Although LSD-backed stablecoins do not inherently exist to combat inflation or serve as value storage against inflation, they have proven to be powerful tools in this regard.
Threats
Lack of Innovation: I believe that LSD-backed stablecoins are primarily forks of Liquity with little differentiation. Therefore, they do not offer much value proposition compared to Liquity, except for allowing the use of LSTs as collateral. Liquity v2 will achieve this goal; will investors continue to use them?
Yield May Decrease: As $ETH staking yields may decrease at any time, the yields of LSD-backed stablecoins will also decline. This may deter users from choosing these stablecoins. Given that more $ETH will be staked in the future, this is an inevitable outcome faced by LSD-backed stablecoins.
Low Demand and Liquidity: So far, most LSD-backed stablecoins have struggled to maintain a peg around $1. While there are specific reasons for this situation, a common issue is the lack of strong demand and liquidity for these stablecoins.
Liquidity Fragmentation Due to Competition: Currently, several teams are attempting to build LSD-backed stablecoins, and there is no clear winner in this race. This means that liquidity is dispersed among competitors, limiting growth potential and hindering the effectiveness or revenue generation of the products. All of this could have long-term implications for the success of LSD-backed stablecoins.
End of the Bear Market: Most investors choose LSD-backed stablecoins as yield assets because there are no better solutions/alternatives during a bear market. However, when a bull market begins, funds may flow into more profitable projects, as a 5%-8% annual yield may not be attractive in a bull market. However, it is worth noting that the end of the bear market will certainly help these protocols grow, as the overall market capitalization will further increase.
Future Implications: Making LSD-backed Stablecoins More Efficient
It is clear that with the rise of LSDfi products, interest in LSD-backed stablecoins is growing. I believe this trend will continue. However, I think that most of the current models of LSD-backed stablecoins are either unsuitable for the product market or lack competitive advantages against their competitors.
Some LSD-backed stablecoins, like $R, $GRAI, and $eUSD, do not have a clear value proposition compared to existing projects like $crvUSD and $LUSD. These protocols have the potential to reduce the market share of the aforementioned projects.
Prisma Finance is an interesting case, as they are developing a unique tokenomics model to enhance yields for stablecoin holders and create value for governance token holders. Although the current CDP model of the stablecoin is not unique and does not provide new value propositions, the protocol may have an opportunity because its tokenomics creates organic demand for users, deepening liquidity and making it easier to maintain the peg.
Ethena Labs presents a unique model that challenges existing models. The protocol is more efficient and can generate more income through funding fees due to the open risk-free positions of the protocol. This is crucial, as this model creates organic yields on top of existing LST yields, making the protocol more competitive. However, it is worth noting that in the CDP model, when the price of collateral rises, borrowers profit. In Ethena's case, however, users forgo potential profits from $ETH price volatility due to maintaining the peg through risk-free positions. Overall, I believe Ethena can address some of the major issues faced by LSD-backed stablecoins, such as capital efficiency, lack of scalability, and peg stability.
In summary, the future of LSD-backed stablecoins will depend on:
New models that improve capital efficiency;
New sources of yield;
Scaling up ETH staking adoption;
Adoption of LSDfi.
Let’s wait and see.
