In this week's episode we have on Richard from Prisma, we've been wanting him to come on the show for a couple of months now, as the LSD stablecoin protocol has been one of the fastest growing of Frax's partners last year. We spoke with him on a variety of topics that included bootstrapping Prisma, navigating its launch, its wild growth, and plans for the future.
What is Prisma Finance?
Prisma is a modified Liquity fork that uses LSDs as collateral. While most forks are second-tier and provide nothing new, Prisma is an evolution and an entirely new beast because of its integrations with Curve, Convex, and Frax. With a few major changes, Prisma has been able to reconfigure Liquity for the age of LSD enabled DeFi.
What is Liquity?
Liquity offers interest-free loans against ETH collateral to mint its native stablecoin, LUSD, which is pegged to the US dollar.
One of the main attractions of Liquity is its interest-free borrowing system. Unlike traditional loans, users can borrow LUSD without paying ongoing interest. Instead, they incur a one-time fee when taking out a loan. This fee is used to maintain the system's stability and solvency.
Liquity's liquidation process is an essential aspect of its stability. If a loan falls below the minimum collateral ratio, the protocol automatically liquidates the collateral to repay the debt and stabilize LUSD's value.
All liquidations are routed through the Stability Pool, which pools LUSD that is available to be swapped to close Troves and cover debts. Those uses with LUSD in the stability pool receive a portion of the liquidated ETH collateral.
On the flipside, if the price of LUSD declines below $1, any can buy up the discounted LUSD and redeem it for ETH collateral. The Troves that are redeemed do not pay any fees or penalties, so if they still have their LUSD, the can repurchase ETH at market rates and reclaim their value.
The problem though is that Liquity is broken.
Why is Liquity Broken?
You can thank the Fed for this. Liquity was deployed in a time of near zero interest rates. DeFi interest rates were also extremely low, with USDC and USDT borrowable for 1-3%. So it kinda made sense at the time to deploy a protocol with zero rates.
But that time is gone.
Currently the Fed's risk free rate is in the 4% and it is the baseline against all other risk and debt assets are priced against. Want to get a mortgage on a house? Well the rate is Fedrate + 2% (roughly). Want to issue bonds for Apple or Amazon? Then its Fedrate + 1%. Want to value any risk asset? Use a DCF model with the Fedrate as an input.
Looking at the rates in Fraxlend, almost all high demand assets have minimum rates of 5%. The cost of borrowing is high right now because people believe prices are going up, and so they want to borrow debt to get leverage or yield farm.
But what about an asset like LUSD which has zero interest? Well if you are a smart investor, you mint as much of it as possible to arbitrage yields. Mint LUSD, dump it for other stables, and then go deposit it into sFRAX or sDAI for a 4% near risk free yield.
The problem though is that when you dump your LUSD, you drive the price down below $1 and open up another arbitrage opportunity. Since the redemption price is hardcoded at $1, smarter arbitrageurs will buy the LUSD below peg and use it to redeem for ETH collateral.
When the LUSD is redeemed, the Troves with the lowest collateralization ratio are redeemed. Liquidation for Troves occurs at 110%, and the minimum CR for Trove creation is 150%. But right now the "safe" CR for Liquity Troves is 365%!
This means you need to post up nearly 3x the collateral in ETH to take a zero interest loan in LUSD. Compare that to Fraxlend which has a 75% LTV or 130% CR. When you take a loan of Fraxlend, you will never be liquidated unless you drop below this level. With Liquity, you have zero control over when you might get redeemed other than paying back your debt to increase your CR.
And so as a result of the ever higher pushing CR and decreasing capital efficiency of LUSD loans, the total supply of Liquity's stablecoin has been decreasing for several months.
In tandem, the number of open Troves has also been steadily decreasing.
If rates come back down to 1-3% again, we might see a resurgence of LUSD loans as their interest rate achieves market neutrality again, but for now, it's less advantageous to mint LUSD.
Liquity will survive, it's fully trustless, has zero dependencies other than oracles, uses ETH as collateral and also has widespread DeFi integrations, however, high rates have hamstrung its growth and growing LSD usage shuts it off from future growth opportunities.
How Prisma Innovates
Prisma's innovations are threefold, first accepts a variety of LSD's (sfrxETH, cbETH, stETH, and rETH) as collateral, second it enacted DAO governance to control key protocol parameters, and third it was designed for deep integration with Frax, Curve, and Convex.
LSD Collateral
Post-Shapella demand LSDs skyrocketed and the yield bearing assets are now the preferred collateral for DeFi. Liquity's non-usage of LSD as collateral is due to the protocol being deployed pre-Merge. Prisma allows any of these 4 assets to mint their stablecoin mkUSD.
Each collateral type has a maximum mkUSD debt cap, mint fee of .5% and an adjustable interest rate. While the interest rates were set at 1% when the protocol first launched, the DAO has now raised them two times to 4%, which is just a hair lower than the Fed's risk free rate.
Frax's debt cap is currently 50m mkUSD, and borrowers have already taken 44m as loans.
Currently, sfrxETH borrowers earn 8-16% on the value of their mkUSD loan. So without adding the mkUSD to the stability pool or Curve LP, the current yield is net 4-12% for mkUSD loans.
A minimum of 1800 mkUSD is necessary to open a Trove.
DAO Governance
The Prisma DAO was created for two purposes, first it handles all admin parameter changes for the underlying contracts, and second it directs protocol emissions.
Prisma Finance DAO, despite being an immutable and fully on-chain protocol, maintains a set of minimal administrative functions that are controlled through governance. The admin changes require a DAO vote and affect the following controls on the contracts.
The first of these admin functions is Emergency Pausing. This feature is critical for halting all operations except for those allowing users to recover their collateral, thereby maximizing safety and mitigating the risks of collateral being stuck due to unforeseen bugs. It also serves to reassure users that their capital cannot be unduly locked by Governance or Guardians.
In scenarios involving protocol-wide catastrophic issues, certain functions can be paused. These include the ability to open new vaults, increase collateral or debt for existing vaults, and deposit mkUSD into the Stability Pool.
Moreover, the protocol allows for the setting and changing of the Guardians multi-sig. This is a group that holds responsibility for certain emergency functions, and its composition can be altered via governance voting.
There is also a provision for Collateral Pausing. If there are urgent issues with a specific type of collateral, the Guardian multi-sig, has the authority to pause related functions, including the opening of new vaults and adjustments to collateral and debt in existing vaults.
The process of Unpausing is strictly governed. Any pause, be it protocol-wide or collateral-specific, can only be lifted through a governance vote, ensuring that these decisions are made collectively rather than unilaterally.
Another key function is the changing of the Fee Receiver. All protocol fees are directed to a designated address, and governance has the authority to change this address. This function includes the ability to transfer tokens from the initial fee receiver contract.
Governance also has the power to change the Price Feed, ensuring the protocol is receiving oracle provided pricing data from correct sources at all times.
In terms of collateral management, governance votes can decide on a Collateral Sunset, phasing out specific types of collateral, and on Adding New Collateral, allowing the protocol to expand and diversify its asset base.
Finally, the protocol includes a function for Replacing Default Account Manager and Sorted Account Implementations. This is particularly relevant when new collateral types are added, as it requires deploying clones of these contracts.
The Prisma Finance DAO also allows users who have locked vePRISMA to vote and determine the distribution of PRISMA emissions within the protocol. This system is akin to Curve's gauge weight voting, where users can influence the allocation of rewards by voting.
Users direct the flow of weekly PRISMA emissions to various parts of the protocol by allocating their lock weight towards one or more emission receivers. This allocation is expressed in percentages, with each user having a maximum of 100% to distribute. These votes can be adjusted at any time but are tallied at the start of each Thursday for the following week's emissions.
Votes persist week-to-week unless users actively change or clear them. This mechanism is designed to save on transaction costs and ensure continuous participation.
When voting on weekly emissions, users can focus their votes on four different protocol actions: depositing to the Stability Pool, minting new mkUSD with specific collateral, maintaining an active mkUSD debt with specific collateral, and staking Curve LP tokens.
Curve/Convex Integration
Prisma was designed from the ground up for deep integrations with Curve and Convex. Prisma is a core part of crvUSD liquidity and also is one of the 4 protocol integrated with Convex's liquid locker system.
The integration between Convex and Prisma Finance started at launch with the distribution of Prisma Finance’s PRISMA token. All PRISMA rewards when received have a 1 year vesting period, where they are locked, but may be used to vote for governance proposals.
The Convex partnership allows all earn PRISMA rewards to be swapped to cvxPRISMA, a unidirectional conversion, mirroring the relationship between CRV and cvxCRV. Once converted, the original PRISMA tokens are permanently locked and inaccessible. However, users can trade between PRISMA and cvxPRISMA using liquidity pools on Curve Finance.
Once added to Curve, you can then stake the LP in Convex for a boosted APR of 200%.
As with all Convex supported liquid wrappers, vlCVX users determine the allocation of vePRISMA vote weighting in Prisma Finance’s governance system. Additionally, users staking cvxPRISMA on Convex Finance earn a share of fees from staking vePRISMA tokens, and may also receive native CVX rewards.
As of writing this article, cvxPRISMA is earning 81% APR in PRISMA rewards.
Convex enables boosted yield farming of Prisma's LP pools. The FRAX/mkUSD pool currently has $13.3m TVL and is earning 49% boosted APR.
