Ethena (ENA): Analysis of the USDe stablecoin issuer

The Big Whale's opinion 🐳

Ethena is the latest protocol issuing decentralised stablecoins.

It offers an innovative model for maintaining its parity without the need to over-collateralise the reserve.

The returns offered to its holders are very attractive (currently 12% per annum).

The project is sometimes unfairly compared to the UST (which collapsed in 2022), but it is unclear how it will adapt to the fluctuations in the futures markets it seeks to exploit.

Overview 🧬

Ethena is a protocol that was launched in February 2024. It issues the decentralised stablecoin USDe from a pool consisting of BTC, ETH, ETH LST (ETH staked on liquid staking protocols such as Lido) and USDT.

A decentralised stablecoin has the benefit of not being regulated or classified as electronic money. This legal ambiguity offers more options to its users.

The problem with legacy projects like MakerDAO's DAI is that they require over-collateralisation of the volatile asset pool to protect against falling prices. This is therefore not very efficient.

Ethena offers to hedge on the futures market. In simple terms, a "short" position (which makes money when prices fall) is created for each BTC or ETH deposited in Ethena's reserve.

Thus, the protocol never loses (and never gains either). This is known as a "delta neutral" strategy.

To generate income, Ethena uses the funding rate, which is historically favourable to short positions (this mechanism is explained in detail in the "how it works" section).

This income is paid back to USDe stablecoin stakers (the yield is currently around 12% per year, but has sometimes reached 60%).

The concept on which Ethena is based was sketched out in March 2023 by Arthur Hayes, the former CEO and co-founder of derivatives exchange BitMEX, who has also invested in the project.

Financing 💰

Ethena Labs, the company developing the Ethena protocol, has raised a total of $20.5m from leading structures.

A $6.5m fundraising round took place in July 2023 from Dragon Fly Capital, Delphi Digital, OKX Ventures, Wintermute, GSR, Gemini and HTX Ventures.

A $14 million fundraising extension took place in February 2024 from DragonFly Capital, Maelstrom, Binance Labs, Brevan Howard Digital, Franklin Templeton, Galaxy Digital, Hashed and Arthur Hayes.

Team and community 👾

Guy Young is the founder and CEO of Ethena Labs. He spent 6 years at Cerberus Capital Management, a US alternative investment firm.

The second key person in the project, Seraphim Czecker, is responsible for the development of Ethena Labs. He was an emerging markets currency trader at Goldman Sachs and then head of risk at Euler Labs until April 2023. It should be noted that the Euler protocol was the victim of a $200 million hack in March 2023. Subsequently, he held a business development position at Lido.

Ethena Labs is a Lisbon-based start-up with around ten employees.

The project has 180,000 followers on X (formerly Twitter) and 31.000 members on Discord.

Function ⚙️

Only players authorised by the protocol can deposit cryptocurrencies to create new USDe. Individuals can only buy or sell existing USDe.

The assets that make up the protocol's reserve are secured by specialist custodians. These selected companies may change regularly, but currently they include Copper, Cobo and CEFFU (no US players). These players are chosen mainly because they enable "off-exchange settlements".

When Ethena creates short positions on various centralised exchange platforms (currently Binance, Bybit, OKX, Deribit, Bidget), the funds do not leave the custody companies' vaults. The flows with the exchanges only concern operating costs, gains and losses.

This is the system that largely protects the centralised exchange platforms from bankruptcy.

To earn a return, Ethena uses the "funding" rate. This rate represents the commission paid by players who take positions on the futures markets. When long positions exceed short positions, traders in long positions pay fees to those in short positions and vice versa.

Ethena is betting on the fact that BTC and ETH funding has always historically been favourable to short positions. This is due to the market's willingness to take broad exposure to the upside of these assets.

Thus, Ethena manages to hedge against its pool of volatile assets, while still collecting the returns generated by the funding.

Risks and limitations 😨

Like any protocol, the smart contract carries a risk of failure or piracy. Several auditing firms have already produced comprehensive reports, which you can find here. Although this does not offer a 100% guarantee of security, it does contribute to it.

• Incertainty linked to the funding rate

In our opinion, Ethena's risk lies rather in the sustainability of its business model, which is financed by the funding rate. There is no guarantee that this rate will remain favourable to short positions. We do not know how Ethena's model will react if the market changes permanently.

An initial test took place on 13 April when Iran attacked Israel, after which the markets fell and the funding rate went negative. The USDe briefly lost its anchor at $0.995. For Seraphim Czecker, this was a successful first stress test.

However, a prolonged market downturn could threaten the balance: with an unfavourable funding rate over a long period, shorter would be extremely expensive in operating costs and would threaten the overall balance.

Ethena Labs boss Guy Young said that if such an event were to occur, USDe holders will have an incentive to redeem their assets to avoid losing the value of the collateral and this should help protect the system.

Even if funding remains favourable to shorters, Ethena will need the number of long positions to increase as it creates more and more short positions, otherwise we could see an imbalance this time unfavourable (although we are still a long way from it, see chart below).

• Incertainty linked to liquidation risks

Although Ethena is not subject to liquidation risk because the assets deposited as collateral are the same as those shorted, a risk exists for a small part of them.

Ethena holds a quantity of liquid ETH staking tokens (currently 16% of the reserve). These tokens may momentarily lose their ETH anchor, leading to liquidation risk.

In addition, if the protocols that issued these liquid staking tokens get hacked, then some of the collateral backing USDe will be worthless.

• A rescue fund in case of problems

There are therefore many risks on Ethena, but a special fund is being built up to absorb any unforeseen circumstances. This fund currently consists of $37 million, including $10 million deposited by Ethena Labs.

Below, the evolution of ETH funding in recent years. It can be seen that there are historically far more long positions (in green), which advantages shorters.

The ENA token 🪙

The ENA token is the governance token for the Ethena protocol. It is not intended to be able to receive any income from the latter, as this is distributed to sUSDe holders and the reserve fund.

There are a total of 15 billion ENA tokens, initially distributed as follows:

- 30% for the development team
- 25% for private investors
- 30% for ecosystem development, the first 5% of which were distributed to the community via airdrop
- 15% for the foundation

More than half of the tokens are allocated to the team and private investors, which is much higher than average. Their tokens are locked in for a year, after which 25% will be released and the remainder distributed over a 3-year period.

Competition ⚔️

Several projects have tried to launch a stablecoin with the same concept as the USDe, but all have failed mainly because they wanted to rely solely on decentralised exchange platforms (such as dYdX, for example).

This desire to avoid dependence on a centralised player has run up against reality: the liquidity of derivatives is almost 25 times lower on decentralised exchange platforms than on their centralised versions. This severely limits the growth capacity of a stablecoin, which has to maintain short positions to stabilise its value.

Among decentralised stablecoins, the DAI issued by Maker has the highest capitalisation, at $5.2 billion. USDe is in second place with a capitalisation of $2.4 billion.

Maker and Ethena are both competitors and partners, as Maker plans to use USDe to boost its returns. For more details, read the article by Sébastien Deriveaux, a leading member of the Maker community.

The USDD has a capitalisation of $713 million, and the FRAX $384 million.

However, all these decentralised stablecoins are far behind USDT and USDC, which have capitalisations of $110 billion and $31 billion respectively.

Regulation ⚖️

Ethena has no clear legal framework for what it offers. The protocol has protected itself from the US regulator by only working with non-US based players.

The ENA governance token is not designed to capture the profits of the protocol, which could allow it to escape financial securities regulation.

However, the Ethena project could be threatened by changing legal frameworks. Although decentralised stablecoins seem (for now) to escape any clear definition in Europe, it is established that MiCA 2, the second text that will regulate digital assets in Europe, will take a close look at how they operate.

Roadmap 📝

Ethena plans to use "ZeKnown Solv" to transparently verify and prove assets and positions held through the protocol. This is based on zero-knowledge proofs technology, which allows a claim to be proven true without revealing the details.

In the meantime, the protocol publishes attestations from its partner account holders.

Ethena plans to support new collateral assets to expand its growth opportunities. Bitcoin was added recently and other cryptos with high exchange volumes are expected to follow.

The protocol is also looking to deploy USDe on new chains, including Ethereum layers 2.

Market analysis by Chadi El Adnani, Head of Content & Research at SUN ZU Lab 📈

Ethena airdropped its ENA governance token on 2 April, distributing 750 million tokens to eligible wallets, or 5% of the total offering. The token was quickly listed on several exchange platforms, including Binance, Bybit, KuCoin, HTX, MEXC and BitMart.

Despite a rocky start where ENA dropped 15% in the first 24 hours to a price of $0.58 per token, it tripled in a week to reach the $1.5 mark. It is currently trading at $1, with a market capitalisation of $1.4 billion.

Daily volumes on Binance and Bybit often exceed $300 million, and reached $900 million on 11 and 13 April. In addition, the average market depth at 50 basis points on Binance is well over $1 million. This ranks ENA among the most liquid tokens on cryptocurrency markets.

Where can you buy the ENA token? 🛒

ENA is available on a few centralised exchange platforms, including Binance (the only regulated one in Europe).

Conclusion 🧭

Ethena is a new and interesting proposition among decentralised stablecoins.

Its price stability mechanism, based on futures markets, has yet to prove its resilience. A cautious attitude should therefore be adopted.

The yields offered to USDe holders (currently at 12% per annum) reflect the level of risk (it exceeded 60% a few weeks ago).

Although decentralised, Ethena also depends on centralised exchange platforms (where the project places short positions) and the centralised stablecoin USDT, the failure of which could threaten its sustainability.

The concept of decentralised stablecoin necessarily involves risks of losing parity with the dollar. However, Ethena should not be compared to UST, which disappeared in spring 2022 (whose value was linked to its governance token LUNA).

Its governance token, ENA, is not intended to capture the protocol's revenues, which limits its interest. However, it could gain in value as the project gains momentum.

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