Prisma finance is an LSD project that launched on November 1, 2023. What sets it apart from other LSD projects is the variety of protocols it supports. LSD, short for Liquid Staking, essentially allows tokens used for staking or borrowing to be staked or borrowed again. LSD effectively adds leverage to staking and borrowing.

Understanding the Value of LSD in Three Minutes

The most significant difference between cryptocurrencies and traditional fiat currencies is that, due to their decentralized nature, once the rules are set, the supply of tokens in the entire cryptocurrency network cannot be arbitrarily increased or decreased. In contrast, fiat currencies, due to the presence of central banks, can increase the money supply by printing more notes to stimulate economic growth. In the current bear market where funding is scarce, the LSD protocol can amplify capital to provide more liquidity to certain cryptocurrency projects.

For example, using the LSD protocol for circular borrowing and lending between Lido and AAVE:

Assuming a user holds 1 ETH and stakes it in Lido, using the LSD protocol, they exchange it for 1 stETH.

The user takes the 1 stETH to AAVE for lending, but since AAVE requires 60% collateral for stETH, they can only borrow a maximum of 0.6 ETH.

The user then takes the 0.6 ETH back to Lido for staking and repeats the process for lending on AAVE.

The user stops when they believe that the total transaction fees and gas fees for this process exceed the borrowed ETH. So they stop the cycle.

The user started with 1 ETH and borrowed 2.2 ETH. This means Asset: 3.2 ETH and Debt: 2.2 ETH. They use 3.2 ETH for staking, and the 2.2 ETH needs to be repaid with interest.

As long as the staking rewards exceed the borrowing interest, the user's gains are amplified. The estimated actual gain for the user is 2x.

This requires many protocols directly supporting LSD. Currently, Prisma Finance supports the most protocols among LSD projects, including AAVE, Lido, and other DeFi protocols like Curve.

Risks of LSD

The most significant risk of LSD protocols is that circular staking and borrowing increase leverage. The stability of LSD depends on users who borrow for project development and short-term lending. In bear markets, platforms offering subsidies to encourage users to participate in circular borrowing and lending are common. The duration of these subsidies depends on how much money the platform has.

LSD involves a multitude of financial figures, and the more DeFi protocols it supports, the more staking and borrowing interest rates need to be considered to calculate the optimal circular staking and borrowing strategy. Moreover, different DeFi platforms have varying lock-up periods and staking APRs. Balancing these variables is more challenging than Yield Farming. Users tend to prefer platforms they are familiar with and may not immediately invest in new platforms. Users engaging in circular borrowing and lending are relatively few, but they increase the platform's trading volume.