Ethena Labs, a decentralized protocol focusing on the yield-bearing USDe stablecoin, has stirred debate among crypto traders since its public introduction in February, with comparisons drawn to the Terra ecosystem, which collapsed in 2021.
Individuals staking USDe for a minimum of seven days currently enjoy an annualized yield of approximately 37%, leading to a surge in total value locked (TVL) on the protocol from $178 million to $2.3 billion in just 60 days – a twelve-fold increase. However, such high yield comes with inherent risk, as exemplified by Terra's UST, which paid out nearly 20% to stakers prior to its downfall.
In contrast to asset-backed stablecoins like tether (USDT) and USDC, which are pegged to the value of dollars or dollar-equivalents such as U.S. government debt, USDe describes itself as a synthetic stablecoin. Its $1 value is maintained through a financial strategy known as the cash-and-carry trade. This technique involves buying an asset while simultaneously shorting a derivative of the asset to profit from the funding rate, or the price difference between the two. This approach is familiar in traditional finance and does not entail directional risk.
"Many people (including Folkvang) have been running trades like this for years; the trade itself is very safe and well understood," stated Mike van Rossum, the founder of Folkvang, in a post on X. "But keep in mind it’s only risk free when talking about delta. There are a lot of things that can go wrong here. Such as any issue with any of the exchanges these positions (and collateral) are managed on. As well as issues around trying to execute hundreds of millions (or billions) in very volatile markets."
How does Ethena function?
By adding stablecoins to the Ethena protocol, such as USDT, dai (DAI), and USDC, users can mint USDe tokens. The minted USDe, which has a $21.3 billion market capitalization, can then be staked by them in exchange for the yield.
Ethena has implemented a number of tactics centered on the cash-and-carry trade in order to produce that yield.
As long positions pay short positions on bitcoin (BTC) and ether (ETH) perpetuals, those shorting the market will benefit from positive funding rates. If the cryptocurrency market experiences another bearish cycle, Ethena's yield source may disappear as funding rates usually turn negative in declining markets.
Whales of crypto remain unfazed. Ten wallets removed $51 million in Ethena's native governance token (ENA) from exchanges earlier this week, locking the funds on Ethena for a minimum of seven days.
Chief investment officer at Arca Jeff Dorman stated in an interview that "the risks to Ethena are that the yield goes away due to natural market forces, or that they have a counterparty blow up, not the collateral itself."
"What Ethena is trying to do with basis trades is fairly easy, and has been done in traditional markets for decades," he stated. "Anyone can do the same thing on their own, if they have enough capital for collateral, and trusted counterparties. All Ethena is doing is increasing the risk while decreasing the time it takes for you to do it on your own."
Many other cryptocurrency companies had to file for bankruptcy as a result of Terra's catastrophic collapse, which left deep wounds in the sector. Because of aggressive selling and a decline in the value of LUNA, the collateral, UST, an algorithmic stablecoin, entered a death spiral, which caused it to blow up.
Founder of Ethena Labs Guy Young stated, "It is a really weak, surface-level argument to compare what Ethena is doing to Luna," during a podcast discussion with Laura Shin. "The core difference here is thinking about what's backing the stable asset. So UST was backed by the LUNA token, which mooned up 100% and dumped 50% in a week. Ethena's USD is fully backed and fully collateralized."
Regarding its dependence on a bull market, Young said: "I think it's a valid concern around this. What we did see even in 2022 when you had staked ETH together with basis you could still sustain rates above U.S. Treasuries, but I do imagine that in a bear market you do see a reasonable unwind of USDe supply."
"We are comfortable with this," Young stated. "It's just something that is responding to market dynamics, and if there is less leverage demand to be long as the interest rate is lower, we're going to adjust to a smaller size."
Young did not rule out altering Ethena's yield-generation approach to one that "makes sense in a bear market" should the need arise.
April 2024, Cryptoniteuae