SWOT Analysis of LSD-Supported Stablecoins: Which Project Will Stand Out?

2023.09.14

SWOT Analysis of LSD-Supported Stablecoins: Which Project Will Stand Out?

Stablecoins backed by LSD follow the CDP model, requiring over-collateralization with liquid staking tokens and carrying liquidation risk.

2023.09.14 - 06:24:57

LSD

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Stablecoins backed by LSD follow the CDP model, requiring over-collateralization with liquid staking tokens and carrying liquidation risk.

Author: Caesar

Translated by: 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 derivative (LSD) protocols and the subsequent emergence of protocols built on top of LSD projects, known as LSDfi.

These LSDfi projects can be divided into several distinct categories. In this article, I focus primarily on LSD-backed stablecoins.

What Is LSD? What Is LSDfi?

Liquid Staking Derivatives (LSD) are financial instruments representing ownership of staked tokens within DeFi protocols. These instruments allow users to stake their tokens while retaining the freedom to use these LSDs across various applications. Notable LSD protocols include Lido Finance and Rocket Pool. LSDs provide significant benefits to the ecosystem by unlocking previously locked capital while enhancing network security.

LSDfi refers to projects that leverage LSD protocols to build new financial primitives—examples include Pendle Finance and Unsheth. By offering additional yield-generating opportunities, LSDfi protocols enable LSD holders to utilize their assets and maximize returns.

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

LSD-backed stablecoins are CDP-model stablecoins requiring over-collateralization with liquid staking tokens and are subject to liquidation risk. They allow holders to retain key properties of crypto-backed stablecoins while generating intrinsic yield.

It's evident that LSD-backed stablecoins do not differ significantly from established crypto-backed stablecoins like $LUSD, $FRAX, or $DAI. The primary value proposition offered by LSD-backed stablecoins is earning $ETH staking yield while maintaining exposure to DeFi applications. However, newer projects have introduced some innovative features.

To better understand this category, let’s examine each protocol in turn.

Prisma Finance ($mkUSD)

Prisma is an LSD-backed stablecoin, a fork of Liquity but with significant improvements. Prisma enables users to mint $mkUSD, which is collateralized by multiple LSTs such as $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH. $mkUSD will be incentivized on Curve and Convex Finance, creating a capital-efficient flywheel where users earn trading fees, $CRV, $CVX, $PRISMA rewards, and $ETH staking yields.

My thoughts on $mkUSD:

Competitive Value Proposition: While every LSD-backed stablecoin offers $ETH yield, $mkUSD gains a competitive edge because its pool is deployed on Curve—users depositing $mkUSD can earn trading fees, $CRV, $CVX, and $PRISMA rewards, potentially making it more attractive than rivals.
Not a Medium of Exchange: $mkUSD is a yield-bearing stablecoin; the protocol does not prioritize its use as a medium of exchange. Most users hold $mkUSD for the APY it provides.
Yield-Bearing Asset: Since $mkUSD generates yield for holders, it will naturally attract users seeking a store of value. If users trust its peg stability, it serves as an effective way to earn $ETH yield.
Innovative Tokenomics: vePrisma holders can direct incentives toward specific pools, meaning LST providers may choose to incentivize $mkUSD using their own LSTs. This creates a positive feedback loop for $mkUSD demand. According to the whitepaper, voters can allocate emissions toward specific collateral types to maintain active borrowing and distribute rewards to LP token holders. Given that deep liquidity is crucial for maintaining peg stability, this could be a key differentiator for Prisma.
Multiple LST Collateral: Several LSTs—including $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH—can be used as collateral, varying in market cap. Thanks to its unique tokenomics, the protocol can incentivize users to mint $mkUSD, increasing exposure to Prisma.
Limited Capital Efficiency: The over-collateralized model restricts $mkUSD’s capital efficiency, as users must deposit more than they borrow. Additionally, with a minimum collateral ratio of 120%, liquidation risk always exists.
Strong Backing: Despite entering the market later than competitors, Prisma Finance enjoys support from major players such as Curve Finance, FRAX, and Convex.

Raft ($R)

Raft is a protocol for minting the $R stablecoin, which is over-collateralized by LSTs and subject to liquidation risk. Users can earn sustainable yield through savings rate deposits.

My thoughts on $R:

Lack of Innovation: Raft is a fork of Liquity with only minor modifications, offering little product innovation. Once Liquity v2 launches utilizing LSTs, Raft may easily be overtaken.
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 solely for its APY.
Peg Stability: $R currently trades around $0.98, and the team is actively working on solutions to restore the peg. They propose replacing the one-time minting fee with an interest-based borrowing cost, aiming to restore the peg by incentivizing market buy pressure. Causes of the depeg include the upfront minting fee, lack of liquidity, and insufficient use cases driving organic demand.
Limited Value Proposition vs Competitors: Currently, users borrow $R without paying interest, allowing them to leverage their $ETH positions—this is $R’s main value proposition. However, if the team changes this model, Raft loses its core appeal.
Yield-Bearing Asset: As $R generates yield, it will attract users seeking a store of value. Provided users trust its peg stability, it remains a viable path to $ETH yield.
Limited Capital Efficiency: As a CDP-model stablecoin requiring over-collateralization and facing liquidation risk, $R is not capital-efficient for retail users. This limits scalability and growth potential.

Gravita ($GRAI)

Gravita is a fork of Liquity that accepts various LSD products as collateral. It allows interest-free borrowing and takes no cut from staking yields generated by deposited LSTs. The redemption mechanism was not enabled at launch but gradually released over time. This may explain why $GRAI has consistently traded around $0.98 since inception, raising concerns about user trust.

My thoughts on $GRAI:

Lack of Innovation: As noted, Gravita is a Liquity fork with minimal innovation, making it vulnerable to being overtaken once Liquity v2 launches with LST support.
Limited Value Proposition vs Competitors: Users borrow $GRAI without paying interest, enabling leverage on $ETH positions. Additionally, accepting $bLUSD as collateral with zero liquidation risk and no fee on staking yields constitutes Gravita’s value proposition.
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 for its APY.
Peg Stability: Since launch, $GRAI has fluctuated around $0.98. This may stem from the delayed release of the redemption mechanism, potentially causing oversupply without arbitrage opportunities. Low liquidity and lack of use cases further limit organic demand, exacerbating the issue.
Yield-Bearing Asset: As $GRAI generates income, it will attract users seeking a store of value. If users trust its peg, it becomes a solid option for earning $ETH yield.
Multiple LST Collateral: Several LSTs—including $WETH, $rETH, $wstETH, and $bLUSD—can be used as collateral, offering users flexibility.
Lack of Capital Efficiency: The over-collateralized model limits $GRAI’s capital efficiency, requiring users to deposit more than they borrow. Persistent liquidation risk further constrains growth.

Lybra ($eUSD)

$eUSD is a stablecoin backed by staked $ETH. Holding $eUSD provides a steady income stream with an estimated ~8% APY. The protocol also has a governance token, $LBR, though its utility is limited. With the launch of Lybra v2, several new features were introduced, expected to address existing shortcomings.

My thoughts on $eUSD:

Lack of Capital Efficiency: The over-collateralized model restricts $eUSD’s capital efficiency, as users must deposit more than they receive. Liquidation risk persists due to a required collateral ratio above 150%.
Limited Value Proposition vs Competitors: To grow sustainably, emerging LSD-backed stablecoins need unique value propositions. However, despite early-mover advantage, $eUSD offers no competitive edge in collateral requirements or meaningful 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 for its high APY.
Peg Stability: $eUSD holders are eligible for staking rewards. Consequently, most users prefer buying $eUSD on the market, creating strong demand pressure. This causes $eUSD to trade above $1.00, breaking its peg. Unless structural changes occur, $eUSD may struggle to re-peg, posing long-term issues for holders.
Yield-Bearing Asset: As $eUSD generates income, it attracts users seeking a store of value. If users trust its peg stability, it remains an appealing way to earn $ETH yield.
Multiple LST Collateral: With Lybra v2, new LSTs such as $rETH and $WBETH are now accepted as collateral. This increases minting possibilities for $eUSD, though we should not overestimate its impact.
Poor Tokenomics: $LBR is the protocol’s governance token, but nearly all LSD-generated yield flows to $eUSD rather than $LBR, leaving $LBR with minimal utility. Poor tokenomics perpetuate $eUSD’s premium, as users are incentivized to hold $eUSD—a yield-bearing stablecoin—leading to far greater holding demand than minting demand.

Ethena ($USDe)

Ethena Labs is a new project yet to launch. It differentiates itself from competitors by introducing a delta-neutral backing model instead of the traditional CDP model. Under this model, the protocol uses LSD as collateral to create a spot long and 1x short position on exchanges, hedging against collateral volatility. $USDe will be more efficient, offering a 1:1 collateral ratio and generating yield not only from LSD rewards but also from funding fees earned via the delta-neutral position. Users are shielded from $ETH price fluctuations.

My thoughts on $USDe:

Innovation: Among all existing projects, Ethena is the only one offering a truly innovative solution. I believe the delta-neutral model can successfully address major issues faced by LSD-backed stablecoins—capital inefficiency, poor scalability, and peg instability.
Capital Efficiency: Due to the delta-neutral model, the protocol doesn’t require over-collateralization to maintain the peg, enabling a 1:1 collateral ratio. Thus, $USDe leads competitors in capital efficiency.
Peg Stability: $USDe will use delta-neutral positions to maintain peg stability. Theoretically, “creating a spot long and 1x short position on exchanges” ensures collateral value is preserved. However, real-world performance remains to be seen.
Medium of Exchange: With a 1:1 collateral ratio, $USDe can overcome scalability limitations of existing crypto-backed stablecoins. Hence, $USDe could serve as a medium of exchange across platforms with deep liquidity.
Strong Value Proposition vs Competitors: $USDe holds two key advantages distinguishing it from rivals. First, the 1:1 collateral ratio is highly user-friendly. Second, beyond LST yield, $USDe also earns funding fee revenue—making it more competitive than existing projects.
User Adoption: Like any innovative project, $USDe will face community skepticism, as the delta-neutral approach is not widely understood. Ethena will need time to educate users and demonstrate the model’s viability.
Immune to ETH Volatility: Since deposited collateral is used to establish hedged positions, users are insulated from $ETH price swings. Risk-averse users may view this positively, though $ETH maxis might see it as a drawback.

Overall Outlook on the LSD-Backed Stablecoin Landscape

So far, I’ve shared my views on individual LSD-backed stablecoins to better understand their dynamics, opportunities, and constraints. I believe this analysis helps clarify the competitive landscape and highlights the trade-offs of each stablecoin.

Now, I’ll share my overall perspective on the LSD-backed stablecoin ecosystem to forecast how this category might evolve. For this, I’ll conduct a SWOT analysis:

Note: Applying a general SWOT framework to all LSD-backed stablecoins may not offer accurate insights, as each possesses distinct characteristics. This is especially true for Ethena Labs, whose delta-neutral mechanism differs fundamentally from the CDP model. For instance, weaknesses like capital inefficiency, lack of medium-of-exchange functionality, and limited use cases do not apply to Ethena’s $USDe.

Strengths

Store of Value: LSD-backed stablecoins serve as excellent stores of value, having achieved price stability while delivering $ETH yield. They represent low-risk yield opportunities and can grow market share in the near term. As users recognize that LSD-backed stablecoins empower them by sharing intrinsic yield, adoption will increase.

Yield Opportunities: While 5–8% APY may not attract retail traders, it presents a compelling opportunity for large holders and leveraged traders, especially given the scarcity of high-yield options in DeFi during prolonged bear markets.

Liquidity Unlocking: LSDs are an effective way to unlock liquidity from staked $ETH, and LSDfi—particularly LSD-backed stablecoins—further enhances this by creating new use cases for LSDs, expanding ecosystem opportunities.

Increased $ETH Exposure: LSD-backed stablecoins are powerful tools for expanding the Ethereum ecosystem, improving how users gain $ETH exposure and creating new use cases, thereby driving organic demand.

Weaknesses

Growth Dependent on LSDfi Adoption: LSDfi is a nascent category requiring further exploration. As pioneers, LSD-backed stablecoins will heavily depend on broader market growth, which lies partly outside their control.

Capital Inefficiency: Most LSD-backed stablecoins employ the CDP model, requiring over-collateralization and exposing users to liquidation risk. This makes capital efficiency a core challenge.

Medium of Exchange: LSD-backed stablecoins are inherently designed for yield generation and rely on the CDP model, preventing their use as mediums of exchange—limiting scalability.

Limited Use Cases: While serving as sustainable yield assets is a solid value proposition, fragmented liquidity and shallow pools restrict utility. Beyond holding, there are few ways to actively use these stablecoins.

Opportunities

ETH Staking Adoption: Continued confidence in Ethereum’s security and $ETH staking yields will drive further growth in ETH staking. As staking rates rise, LSD-backed stablecoins stand to benefit significantly.

Inflation-Resistant Store of Value: Persistent demand for yield assets amid inflation is evident. As seen in attempts to build anti-inflation or "stable yield" coins, there’s strong market appetite. Though not explicitly designed for inflation resistance, LSD-backed stablecoins prove effective as inflation-hedging tools.

Threats

Lack of Innovation: I believe most LSD-backed stablecoins are mere forks of Liquity with minimal differentiation. Compared to Liquity, they offer little added value beyond accepting LSTs as collateral. Once Liquity v2 supports LSTs, will investors still favor these alternatives?

Declining Yields: $ETH staking yields may decrease at any time, reducing returns for LSD-backed stablecoins. This could deter users. With increasing amounts of staked $ETH, declining yields are an inevitable outcome.

Low Demand and Liquidity: Most LSD-backed stablecoins have struggled to maintain a $1 peg. While specific reasons vary, a common thread is weak demand and insufficient liquidity.

Liquidity Fragmentation Due to Competition: Multiple teams are racing to build LSD-backed stablecoins, with no clear winner yet. This fragments liquidity across competitors, limiting growth, effectiveness, and revenue potential—posing long-term risks to the category’s success.

End of Bear Market: Most investors choose LSD-backed stablecoins for yield during bear markets when alternatives are scarce. However, during bull runs, capital may shift to higher-return projects, as 5–8% APY becomes less attractive. That said, the end of a bear market will likely benefit these protocols through overall market expansion.

Future Impact: Making LSD-Backed Stablecoins More Efficient

Clearly, rising interest in LSD-backed stablecoins accompanies the emergence of LSDfi products. I believe this trend will continue. However, I think most current LSD-backed stablecoin models are either unsuitable for product-market fit or lack competitive advantages.

Stablecoins like $R, $GRAI, and $eUSD lack clear differentiation from established projects like $crvUSD and $LUSD. These protocols may struggle to capture significant market share.

Prisma Finance is an interesting case, developing a unique tokenomic model to boost stablecoin holder yields and create value for governance token holders. While its current CDP model isn’t novel, its tokenomics may foster organic demand, deepen liquidity, and stabilize the peg more effectively.

Ethena Labs introduces a fundamentally different model challenging the status quo. The protocol is more efficient and generates additional revenue via funding fees from risk-free positions. This is significant—it creates organic yield atop existing LST returns, enhancing competitiveness. However, note that in CDP models, borrowers profit when collateral appreciates. In Ethena’s case, users forgo potential upside from $ETH price appreciation due to the hedged, peg-preserving mechanism. Overall, I believe Ethena can resolve key challenges faced by LSD-backed stablecoins—capital inefficiency, poor scalability, and peg instability.

Ultimately, the future of LSD-backed stablecoins depends on: