A Quick Overview of LSD-Based Stablecoins: Advantages, Current Status, and Competitive Landscape

Source: medium

Translator: Nick

Today, we will explore the topic of LSD-backed stablecoins, which provide holders with the opportunity to avoid loss and earn yield while preserving key stablecoin properties.

Stablecoins

Stablecoins are cryptocurrencies whose value is pegged to an external reference asset, such as another currency, commodity, or financial instrument. As a non-volatile asset, stablecoins can be used as a medium of exchange because their value fluctuates the least relative to the reference asset.

Some well-known stablecoin examples include:

  • US dollar: Tether ($USDT), USD Coin ($USDC), Dai ($DAI), LUSD ($LUSD), Frax ($FRAX)
  • Euro: Euro Tether ($EURT), Euro Coin ($EUROC), Angle EUR ($AGEUR)
  • Gold: Blockingx Gold ($BlockingXG), Tether Gold ($XAUT)

Given the US dollar’s status as the world’s reserve currency, it is natural to see US dollar stablecoins dominating the stablecoin market.

Stablecoin Market Overview

Stablecoins can roughly be divided into three types: 1) fiat-collateralized stablecoins, 2) crypto-collateralized stablecoins, and 3) algorithmic stablecoins. These stablecoins differ in their issuance mechanism, collateralization ratio, underlying asset supporting the stablecoin, and price stabilization mechanism.

Source: Ben Wee

How Do Stablecoin Issuers Handle Collateral?

When users mint collateralized stablecoins by depositing fiat or crypto with the issuer, the issuer can use these collateral assets to generate yield. Here are the ways in which some of the largest stablecoin issuers handle collateral.

Circle / $USDC: $27 billion in reserves

Circle publishes monthly attestations of its reserve collateral and is audited by Deloitte. According to the May 2023 attestation, we can see that the majority of the reserves are held in US Treasuries and repurchase agreements collateralized by US Treasuries with maturities of less than 3 months.

Tether / $USDT: $83 billion in reserve

Tether publishes its reserve proof every quarter, which is audited by BDO. From the proof for Q1 2023, we can see that the reserves are primarily allocated to US treasuries and some other low-liquidity assets, such as money market funds, corporate bonds, precious metals, bitcoin, other investments, and secured loans.

Maker / $DAI: $4.5 billion in reserve

As part of Maker’s “Endgame” plan, Maker hopes to allocate its $4.5 billion in reserves to various yield-generating strategies, with advice provided by external asset management firm Monetalis. They have taken a few strategies:

Purchasing up to $1.2 billion in US treasuries

Depositing $1.6 billion of $USDC into Coinbase Prime, generating a 1.5% return

Advantages of LSD-backed stablecoins

One commonality observed from the above examples is that the yield generated from these yield-generating strategies is recorded as income for the issuer, benefiting the issuer’s equity or governance token holders.

However, stablecoin holders have no right to the yield, meaning that holding stablecoins incurs opportunity costs, as they could have put the funds into their own yield-generating tools.

With the upgrade of Ethereum to Ethereum 2.0 and the shift from PoW to PoS, we see an increasing interest in liquidity mining derivatives such as LSD, where LSD holders can earn yield paid in ETH and can redeem their LSD for ETH at any time.

The launch of LSD-backed stablecoins provides holders with an opportunity to earn yield while avoiding the cost of loss, while also preserving the key attributes of stablecoins.

Competition in LSD-backed stablecoins

Below is an overview of several major projects in the LSD stablecoin space. It should be noted that most of the LSD-backed stablecoins currently are collateralized by cryptocurrencies.

Lybra Finance ($LBR/$eUSD) – Launched

Lybra is building $eUSD, which is an interest-bearing stablecoin backed by $stETH. Currently, the circulating supply of $eUSD is $176 million.

Minting: Minting is done using $ETH or $stETH collateral with a collateralization ratio of over 150%. Lybra will convert any $ETH collateral into $stETH.

Revenue Source: Holding collateral in the form of $stETH generates approximately 6% in collateral yield per year.

Price Stability: The redemption mechanism forms a “price floor,” while a minimum collateralization ratio of 150% forms a “price ceiling.”

Other Observations: The trading price of $eUSD remains at a premium of approximately $1.05, which means that $eUSD holders would not redeem $eUSD even if there were arbitrage opportunities.

Raft (n.a. / $R) – Live

Raft is building $R, a yield-stablecoin backed by $stETH and $rETH. Currently, the circulating supply of $R is $30 million.

Minting: Mint with $stETH or $rETH collateralization ratios greater than 120%.

Revenue Source: Holding collateral in $stETH or $rETH generates approximately 6% in staking yield per year.

Price Stability: The redemption mechanism forms a “price floor,” while a minimum collateralization ratio of 120% forms a “price ceiling.”

Ethena – Testnet

Ethena is implementing a risk-free stablecoin envisioned by Arthur Hayes in his March 2023 blog post, “Dust on Crust.”

Ethena’s collateral assets are held in the form of Ethereum LSD, similar to spot positions. Delta-neutralized by shorting $ETH perpetual contracts on a CEX.

Minting: Mint with any Ethereum LSD with a 1:1 collateralization ratio.

Revenue Source: Holding collateral in the form of Ethereum LSD generates approximately 6% in collateral yield per year. Shorting 1x $ETH perpetual contracts on a centralized exchange will also generate yield via funding rates.

Price Stability: Ensured by holding Ethereum LSD spot and shorting $ETH perpetual contracts.

Prisma Finance – Testnet

Prisma Finance is building $acUSD, a yield-stablecoin backed by Ethereum LSD. The contract is based on Liquity and is immutable and un-upgradable.

Minting: Over-collateralize minting with any of the five Ethereum LSDs authorized by the white-list: $stETH, $cbETH, $rETH, $frxETH, $bETH.

Revenue source: Holding collateral in the form of Ethereum LSD generates a staking yield of approximately 6% per year.

Price stability: The redemption mechanism forms a “price floor,” while the minimum collateralization ratio for each asset forms a “price ceiling.”

Other observations: It has veTokenomics functionality, which allows users to lock $PRISMA to obtain $vePRISMA. The LSD issuer can incentivize users to use their LSD to mint $acUSD. In the end, the vision is to build a protocol similar to Convex on top of Prisma.

Summary

The LSD field of liquid staking derivatives is developing rapidly, especially in the LSD stablecoin field where new innovations are emerging. We believe that with the positive impact of the Ethereum London upgrade in the second half of the year, LSD stablecoins will also usher in a wave of hype. Let us wait and see.

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