SWOT Analysis of LSD Stablecoin Comprehensive Evaluation of 5 Projects

2023 is an extraordinary year for builders exploring the potential of new DeFi primitives. One of the most notable developments during this period is the rise of Liquidity Staking Derivatives (LSD) protocols and the protocols built on top of LSD projects, known as LSDfi.

These LSDfi projects can be divided into several different parts. In this article, I primarily focus on the stablecoins backed by LSD.

1. What is LSD? What is LSDfi?

Liquidity Staking Derivatives (LSD) are financial instruments that represent ownership of staked tokens in DeFi protocols. These instruments allow users to stake their tokens while retaining the freedom to use these LSDs in various applications. Some LSD protocols include Lido Finance and Rocket Pool. LSDs provide many benefits to the ecosystem as they release previously locked capital while providing security to the network.

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LSDfi refers to projects that build financial primitives using LSD protocols, such as Pendle Finance and Unsheth. By providing additional yield-generating opportunities, LSDfi protocols allow LSD holders to leverage their assets and maximize returns.

However, as a subcategory, there are also stablecoins backed by LSD, such as Raft, Gravita, Ethena, Prisma, and Lybra, which we will now evaluate.

LSD-backed stablecoins are stablecoins based on the CDP model, requiring overcollateralization through liquidity staked tokens and carrying liquidation risks. They allow holders to retain key attributes of cryptocurrency-backed stablecoins while earning intrinsic returns.

It can be seen that LSD-backed stablecoins do not differ much from established cryptocurrency-backed stablecoins like 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, the new projects also offer some innovative features.

To better understand this category, let’s take a look at these protocols one by one.

2. Prisma Finance ($mkUSD)

Prisma is an LSD-backed stablecoin that is a fork of Liquity but with significant improvements. Prisma enables users to mint mkUSD backed by various LSDs such as wstETH, cbETH, rETH, sfrxETH, and WBETH.

mkUSD will receive incentives on Curve and ConvexFinance to create a capital-efficient flywheel where users can earn trading fees, CRV, CVX, PRISMA, and staking rewards in $ETH.

Here are my thoughts on $mkUSD:

1. Competitive value proposition: Each LSD-backed stablecoin offers ETH yield to users. 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.

2. 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 provided by holding $mkUSD.

3. Yield-bearing asset: As mkUSD can generate returns for holders, some may use it as a store of value. This can be a good way to earn ETH returns if users trust its stability peg.

4. Innovative token economics: vePrisma holders will be able to incentivize specific pools, thus, LSD providers may be interested in incentivizing mkUSD with their own LSDs. This can create a positive feedback loop for mkUSD demand. According to the whitepaper, voters can direct issuance towards using specific collateral to maintain active borrowing with specific collateral and reward any LP token holders. Considering the importance of deep liquidity for maintaining stability peg, this will be a significant factor differentiating Prisma from competitors.

5. Multiple LSD collateral: Several LSDs can be used as collateral, such as wstETH, cbETH, rETH, sfrxETH, and WBETH, each with different market values. Due to the unique token economics, these protocols can incentivize users to mint mkUSD, increasing exposure to Prisma.

6. Capital efficiency limitations: The overcollateralization model means $mkUSD has limited capital efficiency as users need to deposit more funds than they can borrow. Additionally, due to the collateral ratio always needing to be above 120%, there is always liquidation risk.

7. Strong backing: Despite entering the market later than competitors, Prisma Finance has gained support from several strong backers such as Curve Finance, FRAX, and Convex.

3. Raft ($R)

Raft is a protocol for minting the stablecoin $R, which is backed by LST through over-collateralization and carries liquidation risks. Users can earn sustainable income by depositing at the savings rate.

My thoughts on $R are as follows:

1. Lack of innovation: Raft is a fork of Liquity with only minor changes, so there isn’t much innovation in the product. Therefore, it may be easily surpassed after the launch of Liquity v2, which will utilize LST.

2. Not a medium of exchange: R is a stablecoin with income, and the protocol does not prioritize using it as a medium of exchange. Most users hold R to earn the annual interest rate provided by holding $R.

3. Anchor stability: Currently, R is valued at around $0.98. The team is actively seeking solutions to restore the peg. They propose implementing interest fees instead of one-time fees for minting R. By doing so, they aim to restore the peg by incentivizing buying pressure in the market. The reasons for the deviation can be attributed to the one-time fee for minting R, lack of liquidity, and lack of organic demand-generating use cases.

4. Limited value proposition compared to competitors: At this point, users do not need to pay interest fees to borrow R, so they can leverage their ETH holdings. This is the primary value proposition of $R. However, if the team decides to change this model, Raft will have no value proposition.

5. Asset with income: Since R can generate income for holders, some people may simply use it as a store of value. This can be a good way to earn ETH returns if users trust its anchor stability.

6. Inefficient capital utilization: As $R is a stablecoin of the CDP model, it requires over-collateralization and carries liquidation risks. For retail users, it is not a capital-efficient model. This will limit its growth potential as scalability is limited.

4. 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 earnings generated by deposited LST. The redemption mechanism is not launched in the initial stage but gradually released throughout the process. This may be a reason why $GRAI has maintained around $0.98 from the beginning, which undoubtedly raises trust issues for users.

My thoughts on $GRAI are as follows:

1. Lack of innovation: As mentioned, Gravita is a fork of Liquity with not much innovation in the product, so it may be easily surpassed after the launch of Liquity v2 using LST.

2. Limited value proposition compared to competitors: Users can borrow GRAI without paying interest fees, so they can leverage their ETH positions. Additionally, allowing $bLUSD as collateral with no liquidation risk and no fees from the pledged earnings is the value proposition offered by Gravita.

3. Not a medium of exchange: GRAI is a stablecoin with income, and the protocol does not prioritize using it as a medium of exchange. Most users hold GRAI to earn the annual interest rate provided by holding $GRAI.

4. Anchor stability: Since the launch of GRAI, the price has been fluctuating around $0.98. This may be due to the restriction on redeeming GRAI during the launch and gradually releasing it, which may lead to oversupply, resulting in price decline without arbitrage opportunities. Additionally, low liquidity and lack of use cases to create organic demand may limit the demand growth for $GRAI, exacerbating the situation.

5. Asset with income: Since GRAI can generate income for holders, there will definitely be demand to use it as a store of value. If users trust the anchor stability, this can be a good way to earn ETH returns.

6. Multiple LST collaterals: There are several LSTs that can be used as collateral, such as WETH, rETH, wstETH, and bLUSD. This can be an advantage, providing users with multiple opportunities.

7. Lack of capital efficiency: The over-collateralization model means $GRAI is limited in terms of capital efficiency because users need to put in more funds than they receive. Additionally, there is always liquidation risk, which will limit growth.

5. Lybra ($eUSD)

eUSD is a stablecoin backed by staked ETH as reserves. Holding eUSD brings stable income flows, with an annualized yield of about 8LBR governance tokens, but its utility is limited. With the launch of Lybra v2, several new features have been introduced that are expected to address the protocol’s shortcomings.

Here are my thoughts on $eUSD:

1. Lack of capital efficiency: The overcollateralization model means that $eUSD is constrained in terms of capital efficiency, as users need to commit more funds than they receive. Additionally, there is always the risk of liquidation as the collateral ratio should always be above 150%.

2. Limited value proposition compared to competitors: In order to have potential for growth, emerging LSD-backed stablecoins need to have a unique value proposition. However, despite having early advantages, $eUSD does not offer competitiveness in terms of collateral requirements or any significant improvements.

3. 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 for the high annualized yield it provides.

4. Anchored stability: eUSD holders are eligible for ETH rewards from staking. As a result, most users prefer to buy eUSD on the market, creating demand pressure. This leads to a demand for eUSD that exceeds supply, causing it to deviate from its $1.00 anchor. This could pose long-term issues for holders.

5. Yield-bearing asset: Since eUSD can generate income for holders, there is certainly demand to use it as a store of value. This can be a good way to earn ETH returns if users trust the anchored stability.

6. Multiple LST collaterals: With the launch of Lybra v2, new LST collaterals such as rETH and WBETH can be used. This increases the potential for $eUSD minting, but we should not overestimate its impact.

7. Poor token economics: LBR is the governance token of the protocol, however, due to almost all revenue from LSD flowing to eUSD instead of LBR, the token has little utility. The poor token economics also perpetuate the premium of eUSD, causing it to consistently deviate from its anchor, as there is an incentive for users to hold eUSD as it is an interest-bearing stablecoin, resulting in a significantly higher demand for holding eUSD compared to minting $eUSD.

6. Ethena ($USDe)

Ethena Labs is a new project that has not been released yet. The project differs from competitors by offering an incrementally 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 the exchange, thus mitigating the volatility of the collateral. USDe will be more efficient as it will offer a 1:1 collateral ratio and, in addition to LSD returns, will provide funding fee returns from the incrementally neutral model. However, users will not be affected by ETH price fluctuations.

Here is my view on $USDe:

1. Innovation: Among all existing projects, Ethena is the only one that provides innovative solutions. I believe the incremental-neutral model can successfully address some key issues of LSD-supported stablecoins, such as capital efficiency, lack of scalability, and stable anchoring.

2. Capital efficiency: Due to the incremental-neutral model, this protocol does not require over-collateralization to maintain stability, thus offering a 1:1 collateral ratio. Therefore, in terms of capital efficiency, $USDe performs the best among competitors.

3. Stable anchoring: $USDe will use incremental-neutral positions to maintain stable anchoring. In theory, “creating a spot long position and 1x short position on an exchange” will always protect the value of collateral. However, it is important to see the results in practice.

4. Medium of exchange: With a 1:1 collateral ratio, $USDe can address the scalability issues of existing cryptocurrency-based stablecoins. Therefore, $USDe can serve as a medium of exchange between platforms with deep liquidity.

5. Strong value proposition compared to competitors: $USDe has two major unique advantages in the market that differentiate it from competitors. Firstly, it offers a 1:1 collateral ratio, which is more attractive to users. Additionally, besides LST returns, $USDe will also offer funding rate returns, which is more competitive among existing projects.

6. User adoption: Like any innovative project, $USDe will also face some skepticism from the community. Since the Delta-Neutral approach is not widely known, Ethena will need some time to educate users and try out this method.

7. Not affected by ETH volatility: Due to the collateral used for hedging positions, users will not face the risk of ETH price fluctuations. Risk-averse users might see this as a benefit, however, ETH maxis might see it as a drawback.

7. Thoughts on the overall landscape of LSD-supported stablecoins

So far, I have shared my views on individual LSD-supported stablecoins to better understand the dynamics and analyze their opportunities and limitations. I believe this analysis helps in understanding the competitive landscape of LSD-supported stablecoins and demonstrates the trade-offs for each individual stablecoin.

Now, I will share an overview of the overall landscape of LSD-supported stablecoins to predict how this category might develop. For this, I will conduct a SWOT analysis:

Note: It should be emphasized that conducting a general SWOT analysis for each LSD-supported stablecoin cannot provide a comprehensive overview as they each have different values/features. This is especially true for Ethena Labs, as their Delta-Neutral mechanism is completely 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.

Advantages

1. Store of value: The stablecoins supported by LSD are excellent value storage tools, as most of them have achieved price stability while providing users with $ETH returns. Therefore, they can serve as low-risk investment opportunities and value stores, increasing market share in the near future. As people realize that LSD-supported stablecoins empower users by sharing inherent returns with them, adoption rates will grow.

2. Investment opportunities: The 5-8% annualized returns of stablecoins may not be attractive to retail traders, but they present a good opportunity for large-scale and leverage traders, given the limited high-yield opportunities in the DeFi ecosystem, especially during bear markets.

3. Liquidity release: LSD is a good method for unlocking the liquidity of collateralized $ETH, and LSDfi, especially LSD-supported stablecoins, further improve this situation, creating new use cases for LSD and undoubtedly increasing opportunities in the ecosystem.

4. Increased ETH exposure: LSD-supported stablecoins are good tools for expanding the Ethereum ecosystem because they improve the way users are exposed to ETH and create new use cases, thereby increasing more organic demand.

Disadvantages

1. Growth depends on LSDfi adoption: LSDfi is a new category that needs further exploration. As pioneers in this category, LSD-supported stablecoins will depend heavily on the overall growth of the market, which is somewhat independent of their influence.

2. Capital efficiency: Since most of the LSD-supported stablecoins implement the CDP model, they require over-collateralization and face liquidation risks. Therefore, capital efficiency becomes a core challenge for users.

3. Exchange medium: LSD-supported stablecoins are essentially used for investment opportunities and rely on the CDP model. Therefore, they cannot be treated as exchange media, which limits the scalability of these products.

4. Limited use cases: Despite being good value propositions as sustainable income assets, the fragmentation of liquidity and lack of liquidity restrict the use cases of LSD-supported stablecoins. Apart from holding them, there are hardly any other ways to utilize these stablecoins.

Opportunities

1. ETH staking adoption: With continued trust in the security of the Ethereum ecosystem and ETH staking rewards, ETH staking is one of the areas where we will see further growth. With potentially increased ETH staking rates in the future, it can be predicted that LSD-supported stablecoins will benefit from this.

2. Value storage against inflation: Due to inflation, there will always be strong demand for income assets. As we can see from the attempts to build inflation-resistant stablecoins/steadycoins, there is a huge demand for them. Although LSD-supported stablecoins do not inherently exist for the purpose of combating inflation or as a value store against inflation, they prove to be powerful tools in this regard.

Threats

1. Lack of innovation: I believe that the stablecoins supported by LSD are mainly forks of Liquity with little differentiation. Therefore, they do not offer much value proposition compared to Liquity, except for the use of LST as collateral. Will investors continue to use them when Liquity v2 is implemented?

2. Possible decrease in returns: As the yield from ETH staking may decrease at any time, the returns of the stablecoins supported by LSD may also decrease. This may make users unwilling to choose these stablecoins. Considering that there will be more ETH staking in the future, this is an inevitable result for stablecoins supported by LSD.

3. Low demand and liquidity: So far, most of the stablecoins supported by LSD have not been able to maintain an anchor around $1. Although there are specific reasons for this situation, a common problem is that these stablecoins lack strong demand and liquidity.

4. Fragmentation of liquidity due to competition: Currently, several teams are trying to build stablecoins supported by LSD, and there is no clear winner in this competition. This means that liquidity is spread among competitors, limiting the ability to grow and hindering the effectiveness or revenue generation of the product. All of these may have long-term impacts on the success of stablecoins supported by LSD.

5. The end of the bear market: Most investors choose stablecoins supported by LSD as income assets because there are no better solutions/substitutes in bear markets. However, when the bull market begins, funds can flow to more profitable projects because 5%-8% annualized returns may not be attractive in a bull market. However, it is worth noting that the end of the bear market will definitely help these protocols grow, as the overall market capitalization will further increase.

Future Impact: Making LSD-supported stablecoins more efficient

It is evident that with the rise of LSDfi products, there is increasing interest in LSD-supported stablecoins. I believe this trend will continue to grow. However, I think that currently, most LSD-supported stablecoin models are either not suitable for the product market or lack competitive advantages compared to competitors.

Some LSD-supported stablecoins, such as R, GRAI, and eUSD, do not have a clear value proposition compared to existing projects like crvUSD and $LUSD. These protocols may be able to reduce the market share of the aforementioned projects.

Prisma Finance is an interesting case, as they are developing a unique token economic model to increase the returns for stablecoin holders and create value for governance token holders. Although the current CDP model of this stablecoin is not unique and does not offer new value propositions, the protocol may have an opportunity because its token economic model creates organic demand for users, deepens liquidity, and makes it easier to maintain the peg.

Ethena Labs is a unique model that challenges existing models. The protocol is more efficient and can generate more income through funding costs due to the open risk position of the protocol. This is very important because this model creates organic income on top of existing LST revenue and makes the protocol more competitive. However, it is worth noting that in the CDP model, borrowers profit when collateral prices rise. However, in the case of Ethena, users give up the potential profits from the volatility of $ETH due to the maintenance of anchoring through risk-free positions. Overall, I believe Ethena can address some of the key issues with LSD-backed stablecoins, such as capital efficiency, lack of scalability, and anchoring stability.

Overall, the future of LSD-backed stablecoins will depend on:

1. New models that improve capital efficiency;

2. New sources of revenue;

3. Scaling up ETH collateral adoption;

4. Adoption of LSDfi.

Let’s wait and see.

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