Ethena Labs, the developer of the Ethereum stablecoin USDe, recently announced the launch of a public mainnet and launched a "Shard activity" to incentivize users. The current annual interest rate of the stablecoin USDe is 27%. How sustainable is Ethena? This article provides an in-depth interpretation of Ethena.
What is Ethena ?
Ethena is a synthetic dollar protocol based on Ethereum that will provide a crypto-native solution for currencies that do not rely on traditional banking.
Ethena’s synthetic USD, USDe, offers the first censorship-resistant, scalable and stable crypto-native solution by delta hedging Ethereum as collateral.
The “Internet Bond”will combine proceeds from staking Ethereum with funding and basis from perpetual and futures markets.
Why are stablecoins so important?
All major trading pairs in spot and futures markets in centralized and decentralized venues are priced in stablecoin pairs, and more than 90% of order transactions and more than 70% of on-chain settlements are priced in stablecoins.
More than $12 trillion of stablecoins have been settled on the chain this year, accounting for more than 40% of TVL in DeFi and by far the most used asset in the decentralized currency market.
AllianceBernstein, a global asset management company with $7,250 in assets under management, predicts that the market value of stablecoins will reach $3 trillion by 2028. Today, the market value of stablecoins is US$138 billion, with a peak value of US$187 billion. There is still 20 times potential growth space.
USDe aims to fill this need by being censorship-resistant, scalable, and (hopefully) stable.
How does Ethena work?
Suppose the user deposits 1 ETH = 3000 USD in stETH and automatically receives approximately 3000 USD in USDe
Ethena established a corresponding short perpetual position on the derivatives exchange at approximately the same value.
The assets received are transferred to an "over-the-counter settlement" provider. Assets are supported to remain on-chain and on off-exchange servers to minimize counterparty risk.
Ethena generates two sustainable revenue streams from deposited assets. The revenue returned to users comes from:
Consensus and execution layer rewards obtained by staking Ethereum (annual interest rate 3.5%)
Funding and basis for delta hedging derivatives positions (0-20% annual interest rate). The annual interest rate changes and may be negative (more on this below).
5 Risks of Ethena
1. Funding risk: related to the possibility that the funding rate will continue to be negative
Ethena can earn profits from funds, but it can also lose money (=lower protocol profits).
Ethena’s insurance fund operates in a similar manner to the Anchor Protocol yield reserve.
2.Liquidation risk
Ethena uses pledged Ethereum assets (such as Lido's stETH) to guarantee short ETHUSD and ETHUSDT perpetual positions on CeFi exchanges.
Ethena uses a different asset than the underlying asset ETH of the derivatives position: stETH.
The price difference between ETH and stETH must deviate to 65%, but this has never happened before, with the highest in history being 8% (LUNA unanchoring event in May 2022).
3. Custody risk
Given that Ethena Labs relies on an "over-the-counter settlement" provider to host the protocol-backed assets, it is dependent on the provider's operational capabilities.
Ethena’s ability to deposit, withdraw, and place orders from exchanges. The unavailability or delay of any of these features will hinder the ability to trade and exchange USDe.
4. Risks of centralized exchanges
Ethena Labs utilizes derivatives positions to offset the delta of digital asset collateral. These derivatives positions are traded on CeFi exchanges such as Binance, Bybit, Bitget, Deribit and Okx. There is a risk of centralization in these exchanges (refer to the FTX incident).
5. Collateral risk
Perhaps due to the discovery of critical smart contract errors in LST, users will lose confidence in LST. In this case, users may try to unstake or swap from LST to alternative collateral as quickly as possible.
A run could lead to long validator exit queues for protocols like Lido, and liquidity drying up on DeFi and CeFi exchanges.
