Original author: Liu Ye Jinghong
Original source: WeChat public account
Ethena has been the star product of this time, whether it is the direct debut of Binance's ENA or its stablecoin USDe, which has gained huge attention. Even with the current low market sentiment, Ethena's TVL is still $2.4 billion.
When many people see the product model of issuing stablecoins by collateral tokens and returning high-yields, the first thing that comes to mind is definitely Terra's UST algorithm stablecoin, which also relied on a 20% yield to absorb a maximum of nearly $10 billion in TVL from 2021 to 2022, and then collapsed with Terra Luna.
It is estimated that many readers will have this kind of doubt, worrying or suspecting that Ethena is another imitation of UST, and it will also thunder. But I'm going to give a conclusion here:
Ethena's USDe will not crash, but Ethena will have a marginal effect as the market size increases, and it is likely that USDe's income will be infinitely close to zero.
USDe issuance logic
Although USDe, like UST, is issued at the par value of $1 with mainstream cryptocurrencies as collateral, the logic of the two funds is completely different.
UST is very simple in terms of capital operation, and users will issue as much UST as they stake in cryptocurrency. But the most important thing is that UST is deeply bound to Luna. The higher the demand for UST, the more deflationary it can have on Luna and push up the price. And the higher the price of Luna, the more UST can be minted.
Therefore, in the essence of UST's capital operation, it is to step on the left foot and use the right foot to use the virtual market value to continuously push up. With the issuance of Luna, an almost unlimited number of UST appeared in the market, and finally this 10 billion capital disk collapsed.
USDe, on the other hand, is much more complicated in terms of capital operation.
USDe Collateral & Liquidation
First of all, although the collateral of USDe is a mainstream cryptocurrency, it does not accept ordinary users to deposit ETH or BTC directly, and only allows them to buy USDe by depositing a series of stablecoin assets (USDT, USDC, DAI, etc.), so there is no liquidation risk for ordinary users.
For whitelisted users (usually institutions, exchanges, and whales), they can deposit LST assets, that is, stETH to mint USDe, so whitelisted users need to bear the risk of liquidation, but because Ethena will hedge, they actually only need to bear the risk of the ETH/stETH spread, and Ethena predicts that the risk of this spread will be triggered when it reaches 65%. The largest spread in the history of ETH/stETH is nearly 8% during the Terra crash in 2022.
Therefore, it is almost impossible for this liquidation risk to occur under the normal operation of the product, so we can change the context: Ethena will only be liquidated in the event of systemic risk in Lido's stETH.
In addition, since Ethena's leverage ratio is close to spot, even if the liquidation does occur, it does not mean that Ethena will directly liquidate and lose all the collateral, but will gradually liquidate according to the relevant positions. And it should be noted that Ethena is not a decentralized execution product, it is a centralized product with a centralized asset management team operating 24/7 and cooperation agreements with major exchanges. Therefore, Ethena explained in the official document that when there is a real liquidation risk, the asset management team will manually intervene to reduce the risk.
USDe risk hedging
Secondly, Ethena did not lie on the books after completing the deposit, but used a more anti-Web3 instinct to carry out centralized asset management.
Whether it is a stablecoin from ordinary users or an LST asset from a whitelisted user, it will be split according to the par value of $1, and two operations will be carried out: "holding spot positions in the form of stETH" and "opening short orders of ETH on cooperative exchanges". Therefore, the official value equation is obtained:
1 USDe = 1美元ETH + 1美元ETH空头永续合约
Therefore, when Ethereum rises, the floating profit caused by the rise of spot ETH will offset the floating loss of the short ETH position, and when the Ethereum falls, the floating profit of the short ETH position will hedge the floating loss caused by the spot ETH. Finally, USDe was stabilized at a par value of $1.
In addition, Ethena relies entirely on centralized exchanges for risk hedging, and currently cooperates with more than 10 exchanges, including Binance, OKX, Bybit, Bitget, etc. As a result, Ethena circumvents Web3 hacking attacks in terms of fund security, and has access to liquidity that far exceeds that of decentralized exchanges, as well as lower operating fees.
USDe's source of revenue
There are only two sources of income for USDe:
- Rewards earned from staked assets;
- the funding rate and basis earned from risk hedging;
The reward obtained by staking assets is very easy to understand, that is, the consensus reward obtained by staking ETH, and Ethena currently guarantees returns by holding stETH, and the current annualized interest rate is about 3%.
The most noteworthy is the second income earned from risk hedging. The basis is actually the well-known term arbitrage, and the funding rate is the rate paid by the long and short sides to each other according to the market advantage in the contract transaction.
According to Ethena's calculations, the yield on term arbitrage is 18% in 2021, -0.6% in 2022, 7% in 2023, and 18% so far in 2024. Although the market varies greatly from year to year, the long-term average is above 10%.
The funding rate is determined by the bulls and bears in the market. When Bitcoin traded sideways above $70,000 last month, Binance's funding rate was as high as 0.1%, thus pushing the sUSDe yield directly to 30%.
But there is a very important point here, the core of Ethena's hedging method is to short ETH, which means that once the market weakens, then Ethena needs to pay a short fee. As a result, Ethena will have a situation where the yield of sUSDe will be infinitely close to zero for a period of time in a bear market.
However, more optimistically, Ethena also found that historical ETH and BTC perpetual futures had negative returns on 19.1% and 16.1% of the days respectively, with an average return of 8.79% for ETH and 7.63% for BTC during the entire period.
The most extreme case is still in 2022, when the Ethereum PoW hard fork arbitrage caused the market to experience a negative quarterly average return.
Therefore, from a year-by-year perspective, the strategy executed by Ethena is indeed profitable in the long term. However, it is a bit anti-human for the currency circle, because players in the currency circle often use stablecoins to manage their finances in the bear market for the winter, and take out the stablecoins in the bull market to charge. Ethena's yield curve is the opposite, with very high yields during bull markets and very low yields during bear markets.
USDe risks and bottlenecks
While Ethena seems to be well established in theory, and all kinds of risk controls are taken into account, there are still some potential black swan risks, and I don't think it's too far away.
Exchange Risk
At present, Ethena's risk hedging strategy relies entirely on centralized exchanges to execute, but the exchanges themselves are a risk point. For example, daily downtime and unplugging cables are likely to widen the spread, but these can be solved by payouts or rollbacks. What can't really be solved are policy and systemic risks.
The regulation of cryptocurrency exchanges in the United States has become more and more stringent, with Binance's CZ being pledged for mining, and various exchanges being sued by the SEC. What's more, will there be a direct collapse of the next FTX, resulting in a huge bad debt in Ethena. These are the risk points of black swans.
Lido Systemic Risk
Lido, as the leader of the Ethereum LST track, has not had any major security incidents so far. But once it happens, not only Ethena's collateral, but even the Ethereum ecosystem will be severely damaged. Don't forget that two years ago, before Ethereum switched to PoS upgrade, stETH had a large amount of de-pegging.
Ethena will act as a headwind for the market to rise
There is a joke in the cryptocurrency circle that if you play short contracts, you are equivalent to shorting your own business. That's right, that's what Ethena did.
This is a data dashboard from Ethena, the entire market has $8.6 billion in open interest in ETH, and Ethena's position accounts for 13.52%, or $1.162 billion. In addition, it is worth noting that 86% of the market contracts include the positions of the long and short sides, even if the long and short sides are evenly divided, then the short capital should be 4.3 billion US dollars. Ethena is only short in the futures market, which means that Ethena accounts for 27% of the entire ETH Air Force funds.
And that's just after Ethena was launched for just a few months, and the market was sluggish. Once the market returns to the upcycle and Ethena earnings start to rise, then more funds will inevitably be deposited into Ethena, and the Air Force position will be even larger.
And because Ethena has more and more short positions, the funding rate that needs to be paid when the market is down will also be higher, and there will be a marginal effect at this time, resulting in an infinitely close to zero return.
summary
To sum up, Ethena is a well-designed product, but it's not DeFi, and it's not a Ponzi like UST. If I had to describe it accurately, Ethena is a cryptocurrency-based fund product.
It brings the risk hedging of traditional finance to cryptocurrencies and captures gains from more violent fluctuations. At the same time, because of the permissionless nature of the blockchain, anyone can buy such fund products without KYC and AML.