Ethena: A Tool to Maximize Investor Returns or a "Black Swan" Generator?

Ethena drew inspiration from BitMEX's founder, Arthur Hayes. In his “Dust on Crust” piece, he mentioned the idea of creating a stablecoin backed by an equal amount of BTC spot longs and futures shorts. Ethena subsequently turned Arthur's concept into reality but opted for ETH as the primary asset target for both spot and futures positions. In other words, the collateral assets for USDe consist of an equal amount of ETH spot longs and ETH futures shorts.

In the crypto industry, stablecoins are considered one of the most crucial tools, with most trades being priced in stablecoins. For crypto users, USDe offers dual value. Firstly, the foundational value that any crypto stablecoin asset possesses — the ability to reduce reliance on traditional fiat banking systems. Secondly, the scalability of capturing profits by leveraging derivatives to increase capital efficiency.

Following the collapse of algorithmic stablecoin UST, there are varying opinions within the market and among industry experts regarding Ethena. Ethena has garnered support from multiple institutions and investors, including Dragonfly, OKX Ventures, Binance Labs, GSR, and Arthur Hayes, among others. However, many experts hold opposing views, believing that Ethena has not been market-tested and carries foreseeable risks. Despite differing opinions, USDe has now become a stablecoin with a market capitalization of $2 billion, ranking fifth among stablecoins in terms of market value.

Introduction to Ethena

Ethena Labs' primary product at present is the “Delta Neutral” stablecoin, USDe. The term “Delta” in finance is an indicator used to measure the impact of price changes in the underlying asset on the portfolio, with values ranging from “-1 to 1”. The definition of “Delta Neutral” is that if a portfolio consists of correlated financial products and its value is not affected by minor price changes in the underlying asset, such a portfolio possesses “Delta Neutral” characteristics. Considering the nature of USDe's product, as the collateral for this stablecoin consists of an equal amount of ETH spot longs and ETH futures shorts, the Delta value of the spot position is “1”, and the Delta value of the futures short exposure is “-1”. After hedging the two, the Delta value becomes “0”, achieving “Delta Neutral”.

Why does Ethena Labs adopt such a complex design？ How does USDe compete for market share against established stablecoins？

The answer lies in the yield. USDe collateral users can share dual profits from the collateral assets.

• Firstly, stable earnings from spot long collateral. Ethena Labs supports the pledging of spot ETH through liquidity staking derivatives protocols like Lido, earning an annualized yield of 3% - 5%.

• Secondly, unstable earnings from futures short funding rates. Users familiar with contracts understand the concept of funding rates. Although funding rates are an unstable factor, for short positions, the majority of the time, the funding rate is positive in the long run. This implies that overall returns tend to be positive.

Industry Experts' Views on Ethena

Founder of Aavechan, Marc

Previously, Rune Christensen, the founder of MakerDAO (@RuneKek), deposited 5.66 million USDT into Ethena and minted 5.655 million USDe. Furthermore, MakerDAO is considering allocating 600 million DAI to USDe and pledging USDe (sUSDe) through the DeFi lending protocol, Morpho Labs.

Marc, the founder of Aavechan (@lemiscate), posted a tweet criticizing reckless practices in certain DeFi practices. Specifically, he pointed out the imprudent action of allocating 100 million USD worth of DAI, which accounts for 20% of its total supply, to an “untested in battle” protocol (Ethena) without adopting any risk mitigation measures, especially after the recent issue with weak oracles. Marc believes that such handling of assets that are highly susceptible to market conditions is extremely reckless. He announced his intention to propose reducing the loan-to-value ratio for DAI on Aave.

AC's Perspective

Andre Cronje posted a lengthy article on his personal account. While he did not explicitly mention Ethena Labs and USDe, he raised strong concerns about the project's design from a mechanistic perspective, even directly likening it to the next UST.

Austin Campbell's Perspective

Austin Campbell, a professor at Columbia Business School and the founder and managing partner of Zero Knowledge Consulting, once dissected the design structure of USDe in an article.

In the article, Austin pointed out that he prefers to refer to USDe as a “structured note” rather than a stablecoin. He analyzed four potential risks associated with USDe:

• Firstly, there is a security risk at the collateral level. The security and sustainability of the collateral nodes need to be ensured.

• Secondly, there is a security risk associated with the futures contract opening platform. Both DEX and CEX platforms are vulnerable to hacking attacks.

• Thirdly, there is a contract availability risk. Sometimes, there may not be enough liquidity available for short selling.

• Fourthly, there is a funding rate risk. While the funding rate for short positions is mostly positive, there is also a possibility that it may turn negative. If the comprehensive yield after weighted collateral returns is negative, it can be fatal for a “stablecoin”.

Analyst Duo Nine's Perspective

In the view of Duo Nine, the de-pegging of USDe is only a matter of time. The larger the bubble grows, the higher the probability of such an event occurring. The rapid growth of Ethena may pose systematic risks to everyone. Particularly for USDe, which has not been tested in a bear market, the risks become particularly prominent once billions of dollars are involved.