How Ethena started
In March 2023, Arthur Hayes, co-founder of BitMEX, published an essay entitled ‘Dust on Crust’ in which he criticized stablecoins such as Tether USDT and Circle UST, which are backed by fiat dollars. Hayes also proposed the idea of dropping the use of US dollars and other fiat currencies to buy Bitcoin.
Instead, he proposed the Naka Dollar (Satoshi Nakamoto Dollar), a decentralized stablecoin controlled by algorithms. This asset would be pegged to the real exchange rate of the dollar, but backed by bitcoin. More specifically, the collateral will be short positions in bitcoin and inverse perpetual swaps in US dollars. Maintaining the required price level will be done through algorithms, with Naka DAO and derivatives exchanges exchanging assets. Central crypto exchanges can act as custodians because of their volume, which is different from DEX. Hayes said that this approach will help avoid regulatory and banking system pressures. “The goal is to create a token worth 1 USD but does not require the services of the fiat banking system,” Hayes concluded in his blog-post.
The principles described in the article inspired Guy Young, the founder and CEO of Ethena Labs, to launch his synthetic dollar, with the difference that instead of bitcoin, like Hayes’, the synthetic dollar would use ether. And so the Ethena project was born, which by design solves the problem of the lack of a decentralized stablecoins that would be a globally accessible and censorship-resistant means of holding capital.
Ethena Labs received significant backing from Binance Labs, Bybit, OKX Ventures, the Dragon Capital fund, the market maker Wintermute, and the Hayes family fund Maelstrom Capital. In February 2024, after closed testing, Ethena Labs opened access to the platform and raised around $500 million TVL in the first week.
In our new article, we will explore the technology behind Ethena, how it works, and what prospects lie ahead.
What is Ethena Protocol?
Ethena is a synthetic dollar protocol built on Ethereum, offering a crypto-native solution for stablecoin without relying on traditional banking infrastructure. The protocol’s stablecoin, USDe, is backed one-to-one by delta-neutral crypto-native collateral, which currently includes assets like ETH, liquid staking tokens (stETH, WBETH, BETH), and BTC.
USDe’s architecture is built around a delta-neutral trading strategy, a concept borrowed from traditional finance. In simple terms, “delta” represents the change or difference in value, and a delta-neutral strategy aims to minimize the risk of price fluctuations by taking offsetting positions. This is typically done using derivatives like futures and options to hedge potential losses.
For example, if you hold BTC on the spot market while simultaneously shorting it in the futures market, you’ve effectively “delta-hedged” your position. Any loss on one side is offset by a gain on the other, achieving delta-neutrality. Ethena applies this strategy to the crypto assets deposited into its protocol. When collateral is deposited and an equivalent dollar value of USDe is minted, Ethena offsets the risk by shorting an equivalent amount on the futures market. This ensures that as prices fluctuate, gains and losses balance out, keeping the collateral stable in USD terms and maintaining a 1:1 backing ratio with the minted USDe.
How Ethena Solves the Stablecoin Trilemma
The stablecoin trilemma is the challenge of simultaneously achieving 3 key goals : Price Stability, Capital Efficiency, and Decentralization. Historically, stablecoin projects have had to compromise by sacrificing one of these elements.
Here’s how Ethena claims to balance all three dimensions:
1. Scalability: Ethena uses derivatives to enable USDe to scale efficiently without requiring significant overcollateralization. By fully hedging the ETH collateral with a short position of equivalent notional value, Ethena can maintain 1:1 collateralization, allowing for growth without excessive capital constraints.
2. Stability: USDe’s stability is achieved through precise hedging of transferred assets. When collateral is deposited, Ethena immediately executes hedges against it, ensuring the position remains delta-neutral. This process ensures that USDe is only issued when the initial notional balance is fully hedged, maintaining its stability.
3. Censorship Resistance: Ethena separates itself from traditional banking infrastructure by keeping all backing assets on-chain. These assets are held in transparent, programmatically managed custody accounts that are auditable 24/7, ensuring resistance to censorship and maintaining decentralization.
Apart from a decentralized stablecoin, the Ethena team also proposes an instrument for a hybrid economy — a USDe-based internet bond. It will combine returns from staked Ethereum and provide markets for futures and perpetual swaps.
Ethena’s USDe-based Internet Bond
Users can participate in earning yield by purchasing USDe through Ethena or supported DEXes and CEXes, then staking it on Ethena to receive sUSDe. At the time of writing, the APY (annual percentage yield) is approximately 4.3%.
But where does this yield come from? Ethena generates yield through two primary sources: positive funding rates and ETH staking rewards.
ETH staking works as expected. Since a portion of USDe’s collateral consists of liquid-staked ETH tokens, these tokens generate yield for holders of sUSDe in the form of newly issued ETH.
The other source of yield comes from positive funding rates, a mechanism used in Perpetual contracts to keep them closely aligned with the underlying asset’s price. When the price of a Perpetual contract is higher than the spot price, the funding rate becomes positive. This means traders holding long positions must pay a small fee to traders holding short positions, incentivizing more short positions to help bring the contract price closer to the spot price. Conversely, when the funding rate is negative, short traders pay fees to long traders.
Ethena takes advantage of this system when hedges its crypto holdings through short positions in Perpetual contracts. When the funding rate is positive, Ethena earns yield from these short positions.
By capturing value from both staked ETH and positive funding rates from its short hedges, Ethena presents the Internet Bond as an opportunity to earn yield from two sustainable and external sources.
What are the risks with Ethena?
A key concern arises during periods of negative funding rates, which occur when demand for long positions declines significantly. In such cases, Ethena would have to pay the funding rate to maintain its short positions. According to Connor Ryder, the project’s head of research, there has historically been more demand for long exposure to Bitcoin and Ethereum, resulting in positive funding rates for over 80% of days in the last three years.
Source: CryptoQuant
On the 20% of days when funding rates were negative, only 11% of those days were costly enough to cut into Ethena’s ETH staking yield. Ryder further noted that these periods were brief and should serve as an incentive for users to redeem USDe.
However, this data does not fully account for Ethena’s open short interest on the futures market. Given Ethena’s pegging and yield-generating mechanisms, its large-scale shorting could potentially lead to more frequent negative funding rate days. In other words, if Ethena keeps growing, it might become such a large part of the market that there will be too many short positions on the market. This could cause funding rates to drop, and Ethena might face negative funding rates more often because it has become too big for the market to handle smoothly.To mitigate this risk, Ethena maintains a reserve fund designed to cover periods of negative funding rates and act as a bidder of last resort for USDe, protecting holders from negative protocol yields.
The question remains whether this reserve fund is sufficient enough to cover the risk of extended negative funding rates. On-chain data provider CryptoQuant highlighted that Ethena needs to maintain a keep rate (the amount of yield that goes into the reserve fund) above 32% to grow the reserve fund enough to withstand extremely negative funding rates during a bear market.
Meanwhile Ryder says that a reserve fund of $20 million for every $1 billion of USDe supply, which is just a 2% keep rate), should be sufficient to survive almost all bearish scenarios, according to their research. Ryder also mentioned that in a worst-case scenario of prolonged negative funding rates, USDe would gradually depeg and lose value until funding rates turn positive again, rather than experiencing a sudden collapse like UST.
Beyond funding rate risk, there is also the risk of liquidation of short positions on exchanges. To address this, Ethena can add more collateral to protect positions and move collateral between exchanges as needed. The reserve fund also supports the protocol’s hedging strategies.
A third risk involves the potential refusal of cooperation or service disruptions by exchanges. Ethena claims to model these scenarios in and states that potential losses could be covered by funding rates.
And last but not least — while Ethena claims to have robust risk management strategies in place, it’s essential to keep in mind the additional threats posed by unscrupulous partners and potential defaults by staking platform representatives.
What will be the Price of USDe in 2024
Predicting the future price of USDe, as any cryptocurrency, involves a great deal of uncertainty, but several platforms provide projections based on market analysis and trends. Here’s a breakdown of USDe’s potential price outlook from 2024 to 2030, based on various sources:
As of today, USDe ranks among the top 10 stablecoins by market capitalization, currently sitting in the 6th position with a market cap of $2,892,546,470 at the time of writing.
USDe aims to maintain a 1:1 peg to the US Dollar, a critical feature for its utility as a means of payment. This peg needs to hold even during periods of high market volatility. Since its appearance on trading charts in late February 2024, USDe’s price has fluctuated slightly, reaching $1.0019 at its peak. Initially trading slightly above $1 until mid-March, it has since traded just below $1, though not by a significant margin.
– Bitscreener predicts that in 2024, USDe could reach a high of $1.43 and a low of around $0.9716.
– DigitalCoinPrice offers a similar outlook, suggesting that USDe’s price in 2024 may fluctuate between $0.91 and $2.21.
Price of USDe in 2025
Looking further ahead, predictions for USDe’s price in 2025 are generally positive:
– DigitalCoinPrice forecasts USDe trading between $2.16 and $2.62 in 2025.
– CryptoTicker projects a minimum trading value of $2.325, with potential peaks reaching up to $3.4716.
Price of USDe in 2030
Long-term projections are more speculative, but several platforms provide optimistic outlooks for USDe in 2030:
– Bitscreener suggests that USDe could fluctuate between $0.9656 and as high as $8.83 by 2030.
– CryptoTicker is even more bullish, forecasting that USDe could trade between $14.068 and $22.949 during the year 2030.
These forecasts indicate significant potential price growth for USDe, reflecting optimism about the synthetic dollar’s adoption and use within the crypto ecosystem. However, as with any cryptocurrency, market conditions, regulatory developments, and technological advancements will play a crucial role in shaping USDe’s future price trajectory.
Conclusion
In summary, overcollateralized stablecoins have historically faced scalability challenges. Their growth was often tied to the demand for leverage on the Ethereum network. To scale these projects, they were often “pumped” with centralized stablecoins like USDC or USDT, undermining their original decentralized appeal. The catastrophic collapse of Terra’s algorithmic stablecoin UST, triggered by issues in the Anchor protocol, further dampened the development of decentralized stablecoins, casting doubt on their long-term viability.
However, Ethena’s USDe stands apart from other decentralized stablecoins like DAI, LUSD, crvUSD, FRAX, and GHO. Ethena aims to solve the problems that plagued its predecessors by offering a new monetary protocol that benefits all participants in the ecosystem.
In the most favorable scenario, Ethena’s innovative approach combined with Ethereum’s resilient infrastructure will create a powerful synergy. This could provide a secure and decentralized environment for creating and managing synthetic assets like USDe. Yet, as with any project in the crypto space, it must prove its robustness in the long term, especially in the face of unpredictable market cycles and potential risks such as negative funding rates, exchange disruptions, and market volatility. If Ethena successfully navigates these hurdles, it has the potential to reshape the stablecoin landscape.
FAQ
What is Ethena?
Ethena is a synthetic dollar protocol on Ethereum, providing a crypto-native stablecoin, USDe, without traditional banking. It’s backed 1:1 by delta-neutral crypto assets, including ETH, liquid staking tokens (stETH, WBETH, BETH), and BTC.