Ethena – ENA

Ethena hopes to pioneer a new approach by providing connective infrastructure between DeFi and CeFi. Stablecoins are not only the foundation of the entire industry, they are also arguably the only asset to have found a true product market fit globally with more than 100 million users, the largest addressable market and the highest potential for revenue generation.

What is Ethena – ENA?

What is Ethena Labs?

Ethena Labs is a decentralized protocol built on Ethereum that will provide a crypto-native solution for money not reliant on traditional banking system infrastructure, alongside a globally accessible and permissionless dollar denominated savings instrument – the ‘Internet Bond’.

Independence of Traditional Infrastructure for stablecoins

Centralized exchanges are in desperate need of a reliable and transparent stablecoin for their order books, and DeFi faces ongoing existential risk by relying on USDC with a centralized kill-switch. 

Reducing reliance on the existing banking system for crypto infrastructure is, in our view, the single most important issue facing the industry today.

Global Access to Dollar Denominated Savings Instrument

Whilst US citizens have access to their own $30 trillion treasury market, individuals in the rest of the world do not have permissionless access or an ability to generate a yield on a dollar denominated savings instrument.

Stablecoins are the single most important instrument in crypto. All major trading pairs are denominated in stablecoins across spot and futures markets on both centralized and decentralized venues, with 70% of trading pairs and volumes often exceeding BTC and ETH. 

$8 trillion of stablecoin settlement took place on Ethereum in the last year, and stablecoins account for ~15% of total crypto market cap, 2 out of the 5 of the largest assets, >40% of TVL in DeFi, and are by far the most utilized assets on decentralized money markets and exchanges.

This review of Ethena – ENA was created for informational purposes. This article is not intended for promotion.

General info about Ethena – ENA

What is the mechanics behind Ethena’s stability model?

Ethena takes a distinct approach to achieving stability in the crypto market. Unlike traditional crypto-backed stablecoins that rely on a pile of collateral to support their value, Ethena hedges against price instability by employing a long position in staked ETH and a short position in ETH perpetuals. This mechanism ensures that for each price movement in ETH, the platform remains hedged.

What is delta neutral

What Happens to USDe if Ether’s Price Tanks? USDe is delta neutral, meaning its value is not directly impacted by Ether’s price fluctuations.

What determines the capacity of delta neutral stablecoins?

The capacity of delta neutral stablecoins is ultimately determined by the demand for long perps, modified by the willingness of people to have a slowly depegging decentralized stablecoin. This capacity may be in the hundreds of billions or more but is indeed limited and will inevitably lead to a slow depegging of USDe.

What is the source of the sUSDe yield?

USDe is issued by delta hedging liquid staking tokens with short Ethereum perpetuals positions. This combines the only two forms of scalable crypto native yield in a single instrument:

  1. stETH ~4%, mETH ~7% or LRTs TBD
  2. Short ETH perpetual ~13-26% last 3 months

 

How Can sUSDe Be Used in Money Markets?

While you can hold sUSDe unlevered, you may also be able to eventually deposit it on money markets like Aave, Spark Protocol, or Morpho Labs. There, you can borrow dollars from the rest of DeFi, and if those borrow costs are below the sUSDe yield, it begins to unlock very interesting post-leverage returns through looping.

Tokenizing the Cash and Carry

The point of Ethena Labs isn’t to save you some hassle to execute cash and carry. What is exciting is being able to tokenize this asset, make it extremely liquid through DeFi and CeFi, and then allow new and interesting use cases to be built upon it.

Yes, even my grandmother can do it. However, the real interest lies not in the cash and carry itself, but in what can be unlocked when this trade is transformed into a liquid and composable token. They can, but USDe provides a much more convenient, accessible, and composable solution within the DeFi ecosystem.

USDe

Ethena’s synthetic dollar, USDe, will provide the first censorship resistant, scalable and stable crypto-native solution for money by delta-hedging staked Ethereum collateral. USDe will be fully collateralized transparently on chain and free to compose throughout DeFi.

The ‘Internet Bond’ is built upon USDe and will combine yield derived from staked Ethereum as well as the basis in both perpetual swap and futures markets, to create the first onchain bond that can function as dollar denominated savings instrument for users worldwide.

Difference Between Locked Token and Ethena Hedging Strategies

When it comes to hedging your cryptocurrency holdings, there are different approaches you can take. Let’s explore two examples: one involving locked tokens and another using Ethena’s hedging mechanism.

What happens when you short locked tokens using USDC as collateral?

Think about it like this:

  • You hold USDC worth $10,000
  • You also hold locked COB from a presale which unlocks in 3 years, it’s also worth $10,000
  • You bought the COB for $50, so you’re up a lot and want to lock in these gains by shorting the perps

 

So, what happens? You use that USDC as collateral to short COB-perps worth $10,000.

Lots of people have the same idea, so it’s 65% per year funding cost to hold this short.

Now, the price of COB goes up. Your short is losing money, and you have to add more USDC to the short. It goes up even higher, and you have no USDC left. You get liquidated.

How does Ethena’s hedging strategy work?

Ethena example:

  • You own $10,000 ETH
  • You want to hedge it and earn funding

 

What do you do?You take your ETH and use it as collateral to short ETH-perp worth $10,000.

Lots of people are going long crypto, so funding is high and you get paid 30% per year to be short.

If ETH goes up in price, both your collateral and your position move together — so you’d be down $5,000 on your short, but up $5,000 on your collateral, so you remain breakeven from the initial position. You can’t get liquidated unless ETH on perps is worth almost 2x spot ETH.

The Key Difference

The main difference between these two strategies lies in the collateral used and the risk of liquidation.

In the locked token example, USDC is used as collateral to short COB-perps. If the price of COB increases significantly, the short position loses money, requiring more USDC to be added. If the price continues to rise and there’s no more USDC available, liquidation occurs.

On the other hand, Ethena’s strategy uses ETH as both the collateral and the asset being shorted. If the price of ETH increases, the collateral value and the short position move together, maintaining a breakeven point from the initial position. Liquidation only happens if the value of ETH on perps is nearly double the spot ETH price.

By using the same asset for collateral and shorting, Ethena’s approach minimizes the risk of liquidation while allowing users to earn funding.

Relationship Between Funding Rates and Yield

Ethana’s yield comes partly from funding rates paid due to an imbalance favoring those seeking to go long on underlying assets in crypto. This funding rate exists even for proposed stablecoin backups like Ether that see demand outweigh supply.

Ethana’s yield comes both from the funding rate paid for shorting assets like Ether, as well as trading fees from facilitating trades on the underlying assets. The funding rate exists due to an imbalance between those seeking to go long or short on the underlying asset. In crypto, there is generally a bias towards the long side, resulting in rates being paid to take the short side of trades.

If funding rates sink too low or negative, it will be clear to users holding Ethana. They will likely redeem and exit the protocol, lifting the underlying shorts and allowing rates to revert positively. This user behavior helps calibrate supply in a robust manner.

Can historical data be used to predict the consequences and behavior of delta neutral stablecoins like Ethena?

No, it is wrong to look at historical negative funding rates by duration and degree when the success of delta neutral stablecoins would alter the entire landscape. The data cited is irresponsibly presented with first-order thinking, and the reasoning justifying the size of the insurance fund per $1B is embarrassing.

Mitigating Risks from Funding Rate Fluctuations

Ethana incorporates an insurance fund capitalized from revenue and yield to provide a buffer if funding rates flip negative. Historical data also shows funding rates are negatively correlated to market interest rates, further reducing risk.

Can I verify the funding rates from third-party sources? Are the Audits for USDe Reliable?

USDe’s collateral is held with custodians using on-chain escrow services (OES), which reduces counterparty risk. You can check the funding rates from third-party sources like Laevitas, CoinGlass, Velo Data, and Coinalyze.

Chaos Labs, a top-notch auditor, has audited USDe. However, the potential conflict of interest between auditors and projects exists for all audits. This is known as the “principal-agent problem.”

App | Ethena / App | Ethena Swaps Perpetual

What Happens if Funding Rates for USDe Go Negative?

Historically, funding rates have only been net negative 10.8% of the time over the past 3 years, and only for brief periods, amounting to a few basis points per day. This risk is mitigated by USDe’s insurance fund, which builds up a buffer during times of positive funding. Potential future solutions include risk tranching via a governance token or staking. Importantly, this problem is self-correcting as shorts close out their positions.

Use case of Ethena – ENA

While Ethena is often referred to as a stablecoin, it is important to note that it differs from traditional stablecoins backed by fiat currencies. No, USDe is not marketed as a stablecoin.

Ethena functions more like structured notes and carries a risk profile akin to such financial instruments. It is an intriguing experiment within the crypto space, but it is not a stablecoin in the strict sense. The design of Ethena introduces inherent risks that can impact its stability over time.

Is Ethena a Risky Design for a Stablecoin?

The model Ethena is using attempts to eliminate the price instability of the underlying crypto collateral by having a long position in staked ETH and a short position in ETH perpetuals. Therefore, for each price movement in ETH, they are hedged.

As a form of structured financial product, this is a very interesting experiment. However, calling it a stablecoin, marketing it as such, or promising any degree of safety is questionable.

Ethena doesn’t have the same blow-up risk as Terra and UST due to funding rates. Their main blow-up risk is due to counterparty risk from CEXs and smart contracts. The long-term risk is a slow bleed as negative rates inevitably wipe out the insurance fund and force a slow depegging.

Ethena is now exposed to the following risks:

Market/liquidity risk around maintaining hedges, as seen in 2008

Ethena’s unique stability model introduces certain risks, including market/liquidity risk and operational risks. These risks can be attributed to:

Market/liquidity risk: In times of market volatility or economic crises, maintaining hedges can become challenging due to gaps in liquidity and price fluctuations. This can impact Ethena’s ability to effectively hedge against price instability.

Availability risk, presuming there will be adequate depth at constant prices for the short leg. In times of crisis, prices can gap, liquidity dries up, and shorting in adequate size may not be possible.

Operational risks: Ethena’s stability model relies on running validators or protocols for staked ETH. Operational risks arise from the security and continuity of these validators or the outsourced party. Additionally, if liquid staking protocols are utilized, there is a risk associated with the underlying protocols.

The security and continual operation of their staking method, whether running their own validators, outsourcing, or using liquid staking protocols. If it goes bad, it could go very bad.

Counterparty risk to staking intermediaries and exchanges for perpetuals

Ethena Labs created a “decentralized stablecoin,” USDe, that isn’t decentralized at all and uses Tether fraud exchanges like Binance to execute -1x perp shorts against spot stETH for delta neutral positioning. This is not a “stablecoin.” One of the bigger issues with current stablecoin’s is poor counterparty diversification. Only a few banks are willing to work with them. Isn’t that the trifecta of crappy exchanges? OKX BYBIT BINANCE (Also Bitmex is trash as well, but trifecta sounds cooler) …this thing is a disaster already primed for implosion.

Decentralized stablecoin,” but we use centralized exchanges to execute -1x perp shorts….

Utilizing recent developments in “off-exchange” secured custody accounts we are able to access centralized liquidity while retaining the core value proposition of transparency and onchain custody within DeFi. 

The exchange (centralized or decentralized) where the perpetuals reside. There is exposure to credit risk in the CEX case and security/protocol risk in the DEX case given the prevalence of hacks. Copper, cobo and ceffu, they can keep the funds outside of CEXes while delegating the full amount

Potential long-term rate risk if carrying costs exceed returns

Ethena’s stability model assumes that the net of staking returns and perpetual funding will be a positive number. However, there is a possibility that carrying costs could exceed returns. If the net result is negative over the long term, it could impact the stability of Ethena as a stablecoin.

Rate risk, assuming the net of staking returns + perpetual funding is a positive number, which may not always be true. Bleeding to maintain the hedge would be lethal over time to a stablecoin.

Rate risk: The assumption that the net of staking returns + perpetual funding is positive introduces the possibility of bleeding to maintain the hedge, which can be detrimental to the stability of a stablecoin.

Is a slow depegging inevitable if Ethena sees massive adoption?

Yes, a slow depegging is the inevitable outcome if Ethena sees massive adoption. Expanding to allow shorting perps on CEXs only delays the inevitable; it doesn’t fix it. The mistake is dismissing the inevitable because it is not imminent.

The capacity of delta neutral stablecoins is ultimately determined by the demand for long perps, modified by the willingness of people to have a slowly depegging decentralized stablecoin. This total capacity may be in the hundreds of billions or more but is indeed limited. Inevitably, massive adoption will lead to a slow depegging of USDe, as seen with other delta neutral stablecoins that have failed in this exact manner. Expanding to allow shorting perps on CEXs only delays the inevitable; it doesn’t fix it. Dismissing the inevitable because it is not imminent is a mistake, as seen with Terra and many other projects. If USDe is successful, it’s a matter of when, not if, the permanent depeg happens.

Opacity of a complex model versus simple fiat-backed alternatives

Ethena’s stability model involves a complex structure with various components, including staked ETH, ETH perpetuals, and hedging mechanisms. This complexity can introduce challenges in understanding and managing risks associated with the model. In contrast, simple fiat-backed stablecoins offer a more straightforward approach where the value is tied directly to a fiat currency, eliminating the need for complex hedging strategies.

The opacity of Ethena’s model, resulting from its complexity, contrasts with the transparency and simplicity of fiat-backed alternatives. Fiat-backed stablecoins provide a clear and easily understandable link between the stablecoin’s value and a specific fiat currency.

Where to buy and sell Ethena – ENA?

What do we think about Ethena – ENA?

The decision to use Ethena depends on a thorough understanding of its risks and tradeoffs. Users who fully comprehend the mechanics and potential pitfalls may find it a worthwhile option compared to other stablecoin alternatives. However, it is crucial to acknowledge that Ethena’s stability is not guaranteed in the long run and that there is a possibility of it losing its peg with near certainty over time.

UXD and Lemma attempted similar models. UXD had counterparty risk via Mango, while Lemma wound down because the decentralized perpetual futures market was too small. However, Lemma never lost any depositor funds.

Ethena - ENA Logo

Ethena – ENA conclusion

Ethena presents a unique experiment in the crypto market by employing a hedging strategy to address price instability. While it offers an alternative to traditional stablecoins, it is essential to recognize the risks associated with its design. Ethena operates more like structured notes, and its stability is subject to various factors, including credit risk, exchange exposure, availability risk, and rate risk. Understanding these complexities is crucial for both buyers and issuers in effectively managing these risks.

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