Will Ethena collapse in a UST-style crisis?
I see that there are some misunderstandings in the content of some posts, and I just wanted to clarify those misconceptions in this article. (I have no relationship with them and do not benefit from their successes or failures.) )
First of all, what is Ethena? It is a synthetic dollar protocol, taking 1 ETH synthetic dollar as an example, buying spot ETH (or stETH) will hedge a notional equivalent of ETH shorts accordingly.
So why a dollar? This is because under any normal circumstances, the return is fixed. As long as the basis of the forward/futures/perpetual contract to the spot remains unchanged, the basket of cash and its corresponding short positions will remain of the same value, with no position and no funding rate.
So why is it so attractive? In short, because capital injections have been very aggressive – in a bull market, everybody is looking for leverage and cheap dollar borrowing. 5bps every 8 hours? If the market goes up 10% per day, that’s not a problem.
As a result, Ethena’s recent yield looks to be around 35%. This is likely to persist as long as there is a need for leverage in this area.
UST failed because the collateral backing the issued UST was native Luna, and as the Luna price collapsed, the available collateral denominated in USD experienced a self-reinforcing vicious cycle when Luna was issued and sold to the market.
Overall, however, for Ethena, the collateral backing the issued USDE is a basket of assets that typically holds its value across the entire price range. As long as the basis of the spot/perpetual contract or the spot/futures contract has not skyrocketed.
Cryptocurrencies often exhibit downward convexity. Prices are falling faster than they are rising. In my opinion, this design is actually very beneficial to Ethena.
As the price continued to fall, the percentage of cash in USD held by Ethena actually increased without closing the position. In the example below, you can see that when ETH falls to 1k, it causes 2.5k in the 3.5k collateral basket to be cash……
Is there a risk, and if there is a risk, it is the use of stETH as collateral. The spot liquidity of stETH is much smaller compared to ETH. However, after the Shapella upgrade, the stETH/ETH discount IMO bottomed out.
Before Shapella, stETH sellers were at the mercy of buyers. After Shapella, if the stETH/ETH exchange rate rises severely, sellers can choose to wait longer (1-5 days) and then withdraw stETH to exchange for ETH.
The other elephant in the room will be counterparty/exchange risk. If an exchange goes bankrupt due to a crisis, Ethena could experience significant impairments. Their list of exchanging looks pretty good, though.
There is one last risk left – operational risk. The Ethena concept should work. It’s quite ingenious. However, it also relies to some extent on expert advisors, execution, and risk management with uncertainty.
In a crisis of confidence, as long as Ethena executes perfectly, USDe will have a bottom, as the basket of assets will retain its value. What I’ve noticed, however, is that in general, crisis situations can lead us to missteps – traders may be tempted or forced to exit basis trade, creating delta risk. Overall, however, the basic concept of Ethena should be viable.
Ethena may also change the market mechanism and bring about new price relationships – however, this can only be evaluated in the future.
I think Ethena will actually add another boost to the bull market. Current market makers don’t typically hedge their perpetual contract shorts with spot longs (unless they’re polishing the basis), and what they want to see is a general disappearance of delta.
Although Ethena is delta neutral, the spot demand it inadvertently creates will create more upside price slippage while putting pressure on the basis.
In short, Ethena has a good concept and good features. If it fails, it’s because of execution and risk issues in edge cases.