Hey Edge readers,
The buzz around Ethena's groundbreaking USDe stablecoin and its promising high yields has captured everyone's attention. The comparisons to UST have sparked conversations and speculations across the DeFi community around its sustainability.
Here's what we're covering this week:
- How does Ethena work? 🧐
We investigate the mechanics behind USDe’s yield.
- Dencun is now live! ⛵️
Maker’s ‘Endgame’, memecoins and new airdrops.
Stay sharp. 🫡
– The Exponential team
How does Ethena work?
The DeFi landscape is continually evolving, and Ethena stands at the forefront of this innovation, introducing a novel approach to stablecoin design. Since launching on February 19th, the protocol has quickly amassed $1 billion in total value locked (TVL) given its allure of high yields. As discussions around Ethena and its offerings intensify, it's important to peel back the layers and understand the mechanics and potential impact of its core product, the USDe token.
What is USDe?
USDe is Ethena's answer to creating a stable yet flexible digital currency within the volatile world of digital assets. Marketed not just as another stablecoin but as a "synthetic dollar," USDe aims to offer scalability, stability, and resistance to traditional financial censorship. USDe currently boasts a staggering 67% APY, substantially higher than the majority of stablecoin offerings in DeFi.
USDe leverages Ethereum collateral and delta-hedging strategies to maintain its dollar peg:
1. Collateralization with stETH (staked ETH): Unlike other stablecoins like USD or DAI, which are backed by real-world assets like USD or crypto assets, USDe leverages only stETH as collateral. This choice allows USDe to benefit from the inherent value of ETH while also generating a passive yield from staking rewards.
2. Delta-hedging strategies: To maintain its peg, USDe utilizes short ETH positions on centralized exchanges (CEXs) to hedge its stETH collateral. This means the protocol borrows and sells ETH, aiming to profit from any price decrease. When the price of ETH goes down, the short position generates a profit, which offsets any losses in the value of the stETH collateral. If the price of ETH goes up, the losses from the short position are offset by the increase in value of the stETH collateral.
Where does the high yield come from?
One of the most compelling aspects of USDe is its promise of high yields, a feature that has undoubtedly drawn considerable attention from investors and users alike. The key to the 67% APY offered by USDe lies in the two mechanisms described above. First, holding stETH as collateral generates staking rewards, which serve as the base APY for USDe. Additionally, USDe benefits from funding rates from its short positions on CEXs. These are essentially fees paid by those holding long positions to those holding short positions. Historically, funding rates have been largely positive as traders use leverage to enhance their returns. In a healthy bull market, the positive funding rates add a significant layer of yield to USDe.
Is this a repeat of UST-Luna?
The comparison between USDe and the UST-Luna saga is inevitable, given the similar yield profiles and high-profile collapse of the latter. However, USDe sets itself apart with its collateralization strategy and risk mitigation techniques. Unlike UST, which relied on algorithmic backing with LUNA, USDe is backed by stETH and employs delta hedging to protect its peg. This method offers a more tangible security layer, aiming to avoid the pitfalls that led to UST's downfall. Yet, as with any new financial product, there are inherent risks and uncertainties that investors must understand.
A primary concern lies in USDe’s dependence on positive funding rates, specifically when market conditions shift and funding rates turn negative. In this scenario, USDe would start incurring losses on its short positions. This potentially jeopardizes its peg stability and ability to generate yield. USDe is also reliant on CEXs for its short ETH positions, which raises concerns about centralization and potential censorship. Lastly, there is also the risk of another stETH depeg from ETH, though this has been largely derisked following Shapella enabling Ethereum staking withdrawals.
To learn more about Ethena, check out our report below:
Ethena (Other)
Ethena is a synthetic dollar protocol built on Ethereum.
exponential.fi/protocols/0e521601-7896-42a8-8a7b-af743b5d2b66
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