Recently, Ethena, the algorithmic stablecoin launched by Binance, has once again triggered heated discussions in the market. In every previous bull market, there was always a wave of algorithmic stablecoin craze, such as Basis, Luna, etc. So, what innovations does Ethena have this time? Will Ethena hope to become the largest algorithmic stablecoin? What potential crises and risks will Ethena face?
Ethena is the developer of the Ethereum-based stablecoin USDe, which hopes to provide a scalable form of crypto-native currency to enable a truly decentralized financial system while providing a globally accessible U.S. dollar Denominated savings instruments – “Internet bonds”.
The idea for this product comes from an idea by BitMEX founder Arthur Hayes. In March 2023, Arthur wrote the article "Dust on Crust", proposing the idea of creating a new stablecoin "Satoshi Dollar" that would be backed by an equal number of BTC spot longs and futures shorts. Ethena Labs was inspired by this idea, but they chose to use ETH instead of BTC as the main asset target. That is, USDe's collateral assets are composed of equal amounts of long spot ETH and short futures ETH. In Ethena, there are three main key parts, namely USDe, sUSDe, and Internet Bonds.
USDe: is an Ethereum-based stablecoin backed by derivatives. Ethena allows users to create USDe using USD, ETH or liquid pledged tokens as collateral.
sUSDe: Rewards earned by staking Liquid tokens and funding rates. Initially 1 sUSDe is exchanged for 1 USDe, and over time, 1 sUSDe is greater than 1 USDe
Internet Bonds: Built on USDe, combined with yields from Ethereum, and from perpetual swaps and futures The market’s funding and underlying price differentials create the first on-chain crypto-native “bond” that can serve as a USD-denominated savings instrument for users in permitted jurisdictions
Currently, the annualized rate of sUSDe is as high as 35.4%. Many people exchange their USDT, USDC and other stable coins for USDe issued by this platform. So, where does this amazing staking income come from?
Ethena also supports staking spot ETH through liquid pledge derivative protocols such as Lido, thereby earning an annualized return of 3% to 5%, plus the short order yield of ETH (the funding rate is positive The time is usually much longer than the time when the funding rate is negative, which means that longs will pay fees to shorts). Therefore, the superposition of these two yields creates a considerable high yield for USDe. In this process, the core mechanism of Ethena products - delta neutrality, plays a very critical role.
Delta: In finance, it is an indicator used to measure the impact of changes in underlying asset prices on changes in investment portfolios, with a value ranging from -1 to 1. Delta neutrality means that if a portfolio consists of related financial products and its value is not affected by small price changes in the underlying assets, such a portfolio is delta neutral. For example: assuming the price of ETH is 1 US dollar, when creating 1USDe, 1 ETH will be used as a margin to short 1 ETH in derivatives trading. Regardless of whether the price of ETH drops to 0.1 US dollars or rises to 100 US dollars, through the hedging mechanism of the short contract, the value of 1 ETH in the contract can always remain at 1 US dollar, thereby achieving a balance of funds. This creates a native decentralized and equally mortgaged synthetic U.S. dollar, ensuring that 1USDe is always equivalent to 1 U.S. dollar, embodying the core value of stablecoins.
As Ethena Labs is promoting this vision of Arthur, Arthur himself is directly involved in the minting of a large amount of USDe. It publicly stated on the What potential risks and crises does it face?
Risk of mortgage decoupling: If Ethena’s LST collateral is decoupled from ETH, ETH shorts will be unable to effectively capture market fluctuations, which may cause losses to the protocol. There have been examples of LST decoupling in history, such as stETH’s discount reaching nearly 8% in some events.
Funding rate risk: Although Ethena’s backtesting shows that the number of days of negative returns can be reduced by using ETH as collateral, the funding rate may turn negative, and past protocols have failed due to yield inversions.
Counterparty Risk: While the risk of deploying user collateral to a centralized exchange is mitigated through the use of OES escrow accounts, losses may still result from exchange bankruptcy. Ethena needs to take measures to reduce exchange capital risks, such as settling profits and losses at least daily.
General Cryptocurrency Risks: Depositors of Ethena face risks from possible misappropriation of funds by the protocol team, as well as risks related to potential vulnerabilities in smart contracts. However, Ethena reduces the latter risk by using OES escrow accounts without relying on complex smart contract logic.
Trader’s strategy error: The trader’s strategy error involves the risk of loss when opening a perpetual contract position on CEX, as well as misjudgment of the stablecoin supply and demand trend, making money by going long but the stablecoin supply business has stagnated. Risks etc.
Crypto V Haotian tweeted that Ethena’s entry point anchored by reverse hedging positions in the contract market needs to be continuously observed, because the platform’s expansion of stablecoin issuance is destined to become a “big short” in the market to a greater extent. . In a market trend that continues to be bullish, it would be good if the issuance of stablecoins is the main motivation, but if the platform becomes more profit-oriented and wants to make money on the already stretched Ethereum DeFi protocol, it must also rely on Maximizing the benefits of trading strategies will be very challenging in the current unstable trading market.
The encryption market has a native demand for algorithmic stablecoins. Every bull market will always have a wave of enthusiasm; however, algorithmic stablecoins always attract a big wave after a period of hype. The collapse of , especially after the Luna thunderstorm, caused great panic in the market. Ethena is innovative in terms of design mechanism, but its potential risks are also very high. During the bull market, Ethena may still be able to thrive driven by funds; however, Ethena's extremely high yield is essentially difficult to maintain during the bear market, and it may still be difficult to escape the downward spiral cycle in the end.
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