The market capitalization of USDe has surpassed $2.9 Billion at the time of writing. Following the footsteps of USDT, USDC, and DAI, USDe has swiftly risen to become the 4th largest "stablecoin" in a mere 6 months since its launch.
Notably, its growth trajectory seems sustainable, showing no signs of slowing down.
Source: https://defillama.com/stablecoin/ethena-usde
So, what makes Ethena so prevalent and what are Ethena's secrets to product and market fit? Let's find out in this blog.
What is Ethena?
Crafted by Ethena labs, Ethena is a novel derivative infrastructure in the crypto space, which utilizes stETH to configure delta-neutral positions and captures yields through its synthetic dollar: USDe. USDe lies at the core of the Ethena protocol. Unlike other stablecoins, it’s a synthetic dollar fully backed, transparently on-chain, and free to use in DeFi Legos. The stability of USDe is ensured through a mechanism known as delta hedging, which offsets the price change risk of collateral assets with corresponding short futures positions.
How does Ethena work?
The most notable feature of USDe is its high yield-bearing property. USDe stakers can earn an impressive APY of 35.9% at the time of writing, which is around seven times that of USDC lending APY in most centralized exchanges.
Source: https://ethena.fi/
Put simply, Ethena functions akin to a decentralized hedge fund. Users can deposit BTC, ETH, and other derivative assets into the protocol. The platform then employs these deposited assets to execute sophisticated yield strategies, ultimately enhancing the yield-bearing capacity of USDe.
Generally, the yield is generated from two sources:
● Staking ETH
Ethena stakes ether to a validator, earning 5% as crypto native staking yield on the capital
● Shorting ETH future
Ethena utilizes its deposited capital to capture the funding rate by shorting ether futures. The estimated funding rate is above 20% based on historical modeling
Source: https://x.com/CryptoWithNick/status/1759776854544720072
With the strategies combined, Ethena is now able to generate over $4 Million in fees in a week and become de facto one of the most profitable and fast-growing DeFi protocols in the space.
Ceilings and Market Share
Currently, the open interest in the cryptocurrency perpetual market stands at approximately $71 billion. Among the major players, BTC commands a lion’s share with $35 Billion (representing 49.3%), while ETH follows closely with $17 Billion (constituting 23.9%). As a consequence, this leaves a substantial $52 Billion target market space that remains accessible for Ethena’s delta hedging strategy.
Ethena’s short position has accounted for approximately 20% of the entire global ETH open interest since the launch. Meanwhile, the circulation of USDe has grown from less than $1 Billion to an impressive $2.9 Billion so far.
According to Guy Young, the co-founder of Ethena, the platform’s ambition extends beyond the ETH perpetual market. Ethena also aims to expand into the BTC perpetual market, with an estimated goal of bootstrapping USDe circulation up to $10 billion.
Currently, the Ethena sats campaign is still ongoing and aiming to bootstrap USDe supply to $5 billion. Users can now earn sats points by participating in various activities within the Ethena ecosystem, including depositing assets into the protocol, participating in liquidity pools, and engaging with Ethena's yield solutions on layer2s.
Associated Risks and Solutions
Despite the explosive growth since the launch, Ethena was born with controversies, where a lot of people, including some DeFi veterans, criticized its potential risks and fundamental defects.
To sum up, a few major criticisms below are in extensive discussion.
● Custody Risks
Users' assets are in the custody of Ethena and other third parties. Users cannot fully control their assets and have to trust the custodian organizations.
● Liquidity and Yield Risks
USDe will be issued with a known market ceiling, due to the limited size of the global cryptocurrency perpetual market. Since USDe captures yields from the funding rate of the perpetual market, USDe may encounter a yield decrease when the perpetual market shrinks or grows slowly.
● Risks related to Centralized Exchange
Ethena shorts a derivative (such as ETH perpetual futures contracts) to collect the funding rate in certain centralized exchanges. It introduces several risks from the exchange side, including exchange insolvency and ADL management, etc.
The Ethena team takes a comprehensive approach to risk management, trying to address various aspects to ensure the safety and stability of their digital asset infrastructure. For example, Ethena prioritizes secure custody solutions for digital assets. Ethena works with reputable custodians or uses MPC wallets for robust self-custody practices.
Source: https://app.ethena.fi/dashboards/positions
In terms of liquidity risks, Ethena diversifies its liquidity sources across decentralized and centralized exchanges (DeFi and CeFi). Currently, Ethena has allocated its assets to over five major exchanges and none of the exchanges has over 50% of Ethena's assets.
Source: https://app.ethena.fi/dashboards/positions
To protect Ethena's short position, an insurance fund is also introduced into the platform. The insurance fund has been bootstrapped with a $10 million contribution from Ethena Labs. It's sitting at $40 Million currently, all protocol revenue is being sent there.
So far, Ethena has been running safely for months and generates millions of real yields for its users. Even though the risks cannot be fully removed or eliminated, the Ethena team has made a lot of efforts to build, monitor, and improve their risk management to make sure the protocol runs securely.
Partnerships and Collaboration
To enhance the Ethena ecosystem and drive adoption, Ethena has forged several strategic partnerships with major market participants in the crypto industry.
● MakerDAO Investment and Debt Ceiling Increase
MakerDAO and Ethena have recently entered into a significant collaboration within the DeFi sector. MakerDAO has planned to invest $600 MillionDAI into Ethena’s USDe and staked USDe (sUSDe) via the DeFi lending protocol, Morpho Labs. By increasing the debt ceiling, MakerDAO aims to strengthen its collaboration with Ethena and seize additional yield opportunities for its users. On the other hand, this substantial investment also significantly boosts Ethena’s growth and adoption among DeFi protocols.
● Bybit x Ethena Collaboration
The Bybit x Ethena collaboration enables the integration of USDe on the Bybit platform. The partnership aims to incorporate USDe as a collateral asset for trading perpetual futures across all assets. Additionally, it seeks to introduce new BTC and ETH spot trading pairs denominated in USDe. The in-depth collaboration with Ethena may potentially provide Bybit users with the ability to earn yield and unlock greater capital efficiency.
● Expansion to Blast
Ethena is also looking for expansion on more networks to unlock the native yield opportunity on different blockchains. Recently, Ethena has announced to onboard Blast layer2, which is developed by the same talented team behind Blur, the popular NFT marketplace. Put simply, USDe and sUSDe will be integrated into multiple DeFi protocols on Blast and provide both high yield and leveraged points earning.
● More New Integrations: Curve, Infinex, Karak, Bouncebit and CEX integrations
More new integrations are on the way as Ethena is moving forward to amplify USDe's adoption. The new Curve stablecoin liquidity pool, Infinex integration, Karak collaboration, and Bouncebit partnership enable users to unlock native yield and boost point/token farming across various products. It's also worth noting that new CEX USDe integrations will be announced in the coming days, according to Ethena's season 2 updates.
Source: https://curve.fi/#/ethereum/pools/factory-stable-ng-166/deposit
Impacts on the CeDeFi Sector
As an innovative approach to stablecoin design, Ethena has made great success despite the criticisms. More importantly, Ethena has a significant impact on the growth of the CeDeFi (Centralized-Decentralized Finance) sector by bridging the gap between traditional financial systems and the decentralized crypto ecosystem.
Since Ethena's launch, CeDeFi has come to the attention of the crypto public and attracted tons of discussion. As a perfect merger between centralized and decentralized finance, CeDeFi brings the best functionalities of both systems and enables users to unlock higher yield as well as better capital efficiency.
At the moment, several notable projects are making attempts to explore the CeDeFi strategies to simplify user onboarding and boost yield earning.
For example, Bouncebit is a BTC restaking chain with an innovative CeDefi framework. Through a CeFi + DeFi framework, BounceBit empowers BTC holders to earn yield across multiple sources from funding rate arbitrage to PoS staking. Solv protocol serves as the yield aggregation layer and is another pioneer in the CeDeFi sector.
Source: https://x.com/bounce_bit/status/1771481179683692656
Solv protocol innovates hybrid CeFi and DeFi market management to provide an efficient, secure, and transparent way to boost staking earnings. Currently, Solv protocol has surpassed the threshold of $1 Billion TVL.
Source: https://defillama.com/protocol/solv-protocol#information
Challenges and Outlook
While Ethena ignited the CeDeFi narrative, it’s crucial to remain vigilant about associated risks. Due to the involvement of multiple counterparties, CeDeFi protocols often face heightened risk exposures, including exchange risks and liquidity risks.
Ethena, as one of the most well-known CeDeFi protocols, has made significant strides in risk management and enlarged its interest fund to over $40 million. However, it still grapples with challenges stemming from the rapid growth of USDe’s market capitalization.
Some critical questions include:
● Liquidity Issues
When USDe’s market capitalization surpasses $10 billion, maintaining sufficient liquidity becomes paramount. Ethena will need robust strategies to ensure liquidity provision, especially during high demand or market stress.
● Exchange Policies and ADL
With substantial perpetual exposure, Ethena must carefully manage its positions on exchanges. Liquidation policies (such as ADL, or Auto-Deleveraging) become critical, and balancing risk and exposure will be vital to preventing sudden liquidations
● USDe Depegging Risk
If USDe were to de-peg significantly and fall to $1, it could impact the entire ecosystem built around it. What will happen to USDe DeFi Legos when the de-pegging questions remain unanswered? Let’s watch how this CeDeFi pioneer navigates these challenges in the future.
Conclusion
Ethena has swiftly ascended in the crypto space, with its synthetic dollar, USDe, becoming the 4th largest stablecoin. Its unique approach, leveraging delta-neutral positions and high-yield strategies, distinguishes it from traditional stablecoins.
USDe's impressive APY of 35.9% and its transparent, fully backed nature make it a standout in DeFi Legos. Ethena’s innovative use of staking and shorting ETH futures enables it to generate substantial yields, positioning it as a decentralized hedge fund.
Despite rapid growth, Ethena faces criticisms related to custody, liquidity, and centralized exchange risks. The team has implemented robust risk management strategies, including secure custody solutions, diversified liquidity sources, and an insurance fund.
Strategic partnerships with MakerDAO, Bybit, and other protocols have bolstered Ethena’s ecosystem and adoption.
Ethena's success has spotlighted the CeDeFi sector, blending centralized and decentralized finance benefits.
While challenges like maintaining liquidity and managing exchange risks persist, Ethena’s efforts in risk mitigation and strategic expansion highlight its potential to navigate these hurdles and continue shaping the CeDeFi landscape.
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