Ethena, the protocol behind the USThe digital dollarnow makes up almost 5% of global open interest on ether perpetual futures, according to the platform data dashboard.
USDe is a token that is pegged to the value of a dollar and offers high returns. Although it has been described as a stablecoin, the team avoids using the term, preferring the term “synthetic dollar.” George Calle, VP of Research at The Block, highlighted that Ethena’s USDe is essentially a tokenized representation of the cash and carry arbitrage present in crypto markets. As such, shorting ether futures and staking ether generates returns.
The project’s advertised yields of up to 27% have enticed users to mint around $420 million USDe tokens to date, according to CoinGecko data. Although the project initially paid out only 15% of the proceeds to holders in the first week, it still succeeded quickly reversed course After a backlash, it paid out the entire 24% return generated by its assets, instead of setting aside money for the core team’s operations.
Sustainable yield?
This growing market share has raised concerns that as market share increases, the protocol’s revenue could decline significantly. Yet EthenaFounder Guy Young, who goes by the pseudonym Leptokurtic, said he isn’t concerned at these levels, but the protocol may struggle with increasing market share.
Young said a self-correcting mechanism will kick in if USDe interest rates fall significantly. He explained that in such a scenario, market participants would refrain from betting their USDe. If they do, he said, it could return the funding rate to a new equilibrium.
He added that the situation would be more worrying if the protocol made up around 30% to 40% of the open interest on ether perpetual futures. “That’s when a product like Ethena starts to experience more severe capacity constraints,” he added.
Calle noted that Ethena’s design will likely put downward pressure on financing rates, but said this does not raise questions about solvency or systemic risk. Instead, it begs the question of how much capital the protocol can absorb before yields shrink to levels unattractive to token holders.
Differences with Luna and UST
One of crypto’s biggest collapses was the luna token and its sister token UST, a stablecoin that delivered high yields of almost 20%. Because of this close similarity, there have been many comparisons between UST and USDe.
Still, Calle argued that this comparison is misplaced. He noted that crypto markets have historically seen positive funding rates and that Ethena’s strategy is to create a delta-neutral position that leverages this positive funding rate – with a touch of betting returns.
“Given the 20-40% annual return this strategy projects at current funding rates, many have incorrectly equated the strategy with previous algorithmic stablecoins like Terra, which infamously advertised a ~20% return on UST,” Calle said. “However, Terra was designed in a way that relied on continued capital inflows to avoid the inevitable death spiral of May 2022, while Ethena can safely exist even if the yield or total value set in the protocol is reduced.”
Calle added that the protocol’s mechanism can actually generate positive returns even during periods of negative financing rates, as long as the negative financing costs do not outweigh the positive ones. ETH
-1.34%
plot returns. He noted that the protocol also has an insurance fund, currently set at $10 million, that could be drawn upon if this were to happen.
“What will be interesting to see is whether Ethena becomes so popular that this question becomes relevant, and whether the Ethena team would take other measures, such as limiting deposits, to maintain an arbitrary level of expected yield,” he said.
Ethena Labs’ recent funding round
Last week, Ethena Labs announced it had raised $14 million in a strategic funding round. The family office of Dragonfly and BitMEX founder Arthur Hayes, Maelstromco-led the round, Ethena Labs said on February 15.
The decentralized finance platform had commitments of more than $50 million for the round, but capped it at $14 million because it didn’t need more cash at this point, Young told The Block. Ethena Labs originally disclosed an incorrect selection of high-profile investors, including companies like PayPal Ventures and Fidelity, but this was later corrected.
The round began in late December and closed last week, Young said, adding that it was structured as a simple future equity deal with token warrants. The round brought Ethena’s valuation to $300 million, he added.
