Written by: Kucoin
Compiled by: Blockchain in Plain Language
Ethena (ENA) is a rising star in the decentralized finance (DeFi) space, leveraging blockchain technology to offer innovative financial solutions. The platform aims to enhance the functionality and scalability of financial transactions without relying on traditional banking systems. One of Ethena's core products is USDe, a synthetic dollar that provides stability to the digital financial ecosystem and facilitates integration.
1) Features of USDe
USDe is pegged to the dollar at a 1:1 ratio, aiming to maintain value stability in the highly volatile cryptocurrency market. This pegging mechanism is especially important for users needing a reliable medium of exchange or stable store of value, effectively hedging against the common price volatility risks in the cryptocurrency market.
1) What is Ethena?
Ethena is a DeFi protocol developed on the Ethereum blockchain, focusing on creating a synthetic dollar known as USDe. The platform aims to provide a stable, scalable, and censorship-resistant digital currency without relying on traditional banking infrastructure. By adopting a Delta hedging strategy based on Ethereum collateral, Ethena ensures the stability and security of USDe, making it an ideal choice for global transactions and savings.
2) Capital Support
Ethena has received strong support from several prominent figures and institutions in the cryptocurrency and financial sectors. The startup raised $6 million in a seed round led by the venture capital firm Dragonfly, which focuses on the crypto space. Additionally, BitMEX founder Arthur Hayes and his family office Maelstrom also participated in the investment. Other major supporters include well-known crypto derivatives trading platforms such as Deribit, Bybit, OK, Gemini, and Huobi.
3) ENA - Ethena's Native Token
ENA is the native utility token of the Ethena protocol, playing a crucial role in the Ethena ecosystem. Users holding ENA can participate in protocol governance, voting on key decisions regarding risk management frameworks, the composition of USDe's supporting assets, and potential partners or integration solutions. Additionally, ENA helps maintain the stability and functionality of USDe through various incentive mechanisms within the platform, serving as a vital link in the operation of the entire ecosystem.
4) What is Ethena's Synthetic Dollar USDe?
USDe is a synthetic dollar issued by Ethena, designed to provide a stable and scalable digital currency pegged to the value of the dollar. The design goal of USDe is to become a decentralized crypto-native dollar that does not rely on traditional financial infrastructure. Its stability is achieved through a combination of Delta hedging and a minting-redemption arbitrage mechanism. These features ensure that USDe can serve as a reliable medium of exchange and store of value in the crypto market, supporting seamless and efficient transactions in the DeFi space.
2) How Does the Ethena Protocol Work?
How Ethena's Internet Bonds Work | Source: Ethena Labs' Gitbook
1) Core Philosophy of Ethena
Ethena leverages Ethereum's blockchain framework to create a stable, scalable, and censorship-resistant digital currency known as 'internet bonds'. The platform maintains currency stability through innovative Delta hedging strategies while providing users with yield opportunities.
2) Minting USDe
On the Ethena platform, users can use Ethereum or its staked derivatives as collateral to mint USDe. The system automatically establishes Delta neutral positions to stabilize the value of USDe, protecting against the impact of collateral asset volatility. This process includes opening short positions in the derivatives market equivalent to the value of the staked Ethereum, ensuring that price fluctuations of the underlying assets are offset by the gains or losses from the derivatives positions.
3) Stability of the Delta Neutral Mechanism
The core stability mechanism of USDe is the Delta hedging strategy. This strategy establishes hedging positions in the derivatives market equivalent to the Ethereum collateral to withstand price fluctuations in the crypto market. This design aims to maintain a stable peg between the synthetic dollar USDe and the dollar. The adjustment of hedging positions is fully automated, capable of responding in real-time to market changes, ensuring stability.
4) Yield Generation
USDe is not only a stable currency but also offers yield opportunities for holders. The sources of returns mainly include:
Staking rewards generated from the Ethereum used as collateral;
Funding rates and basis gains from Delta hedging activities.
This dual yield model makes USDe similar to traditional bonds, representing an investment capable of accumulating value over time, praised as 'internet bonds'.
5) Risk Mitigation
Although Ethena is committed to creating a stable and secure platform, it also recognizes the inherent risks in DeFi protocols, including smart contract risks, liquidity risks, and risks associated with external platforms. To mitigate these risks, Ethena employs diversified hedging strategies, uses multiple custodial solutions, and ensures the transparent verifiability of all transactions and positions through blockchain technology.
3) How Ethena Operates
The following is a specific example illustrating the process of obtaining USDe (synthetic dollar) through staking Ethereum (stETH):
1) User Operations
Depositing stETH: Users deposit stETH worth $100 (representing Ethereum that has been staked and can earn staking rewards) into the Ethena system.
Receiving USDe: In return, users receive an equivalent amount of USDe, approximately 100 USDe (minus any applicable transaction fees). This is based on a 1:1 dollar peg.
2) Operations of Ethena Labs
Opening short positions: After users deposit stETH, Ethena Labs opens a short perpetual contract position on a derivatives trading platform equal to the value of the stETH. This is part of Ethena's Delta hedging strategy to stabilize the value of USDe.
Over-the-counter settlement: The stETH deposited by users is managed through an 'over-the-counter settlement' system. This mechanism ensures that users' stETH is securely stored outside the trading platform, thereby reducing counterparty risk from hacks or bankruptcies of trading platforms.
4) Yield Distribution
Rewards generated from users' stETH are collected by Ethena, and the platform converts these earnings into more USDe, returning them to users. This reward distribution model offers users stable returns, enhancing USDe's appeal as a yield investment tool.
5) Key Points Summary
Stability: Through the Delta hedging strategy (balancing the positions of the stETH collateral in the derivatives market), Ethena effectively reduces the volatility risk of the collateral assets, ensuring the stability of USDe's peg to the dollar.
Security and Risk Management: By managing assets through an over-the-counter settlement mechanism, the impact of external threats on user deposits is reduced, providing a safer environment for investors.
Yield Generation: Converting staking rewards into USDe provides users with predictable and stable returns, making USDe an ideal passive income tool.
4) Use Cases of USDe
USDe is primarily used for trade, remittances, and as a stable medium of exchange, simplifying and securing cross-border transactions without the need for traditional financial intermediaries. This makes it an ideal choice for businesses and individuals seeking efficient, low-cost solutions in international trade.
1) USDe as a Medium of Exchange
Ethena's USDe is a stable medium of exchange that can be used for various financial transactions, avoiding the volatility often associated with other cryptocurrencies. This stability makes USDe highly suitable for daily transactions, trading activities, and cross-border payments, especially in scenarios where exchange rate stability is crucial.
2) Savings and Investment Tools
Referred to as 'internet bonds', USDe is not only a medium of exchange but also a savings tool. By generating returns through staking and hedging operations, USDe offers users investment opportunities similar to traditional bonds, but operates within the DeFi market. This feature attracts investors looking to earn passive income while maintaining stable asset liquidity.
3) DeFi Use Cases
USDe is crucial in DeFi applications, including borrowing, lending, and yield farming. Its stability and deep integration with the Ethereum blockchain make it usable as collateral for loans or liquidity assets on decentralized exchanges (DEXs). This multipurpose utility broadens its application within the DeFi ecosystem, promoting safer and more efficient financial services.
4) Hedging and Risk Management
USDe can also serve as a hedging tool against cryptocurrency market volatility. In uncertain or adverse market conditions, traders and investors can convert volatile assets into USDe, protecting their investments from significant fluctuations and minimizing potential losses while retaining the opportunity to re-enter the market quickly, preparing for future investments.
5) Promoting Cryptocurrency Adoption
By providing a stable, scalable, and censorship-resistant form of currency, USDe supports broader cryptocurrency adoption. It addresses common barriers to cryptocurrency usage, such as volatility and complexity, enabling new users to enter the crypto market with more confidence. The stability of USDe ensures that users can seamlessly transition to a crypto-based financial system without worrying about the direct risks posed by other more volatile cryptocurrencies.
6) Future Outlook
USDe has a wide range of potential applications. With the continuous development of the DeFi space, USDe is expected to play a significant role in decentralized borrowing, yield farming, and more complex financial instruments. This could have a profound impact on the entire cryptocurrency market by providing more stability and reliability, thus promoting the broader adoption of cryptocurrency-based financial solutions.
7) Integration into Major DeFi Protocols
Ethena's USDe has been integrated into major DeFi protocols such as MakerDAO, Frax, Curve Finance, and Aave, highlighting its growing importance and potential to reshape financial interactions globally.
5) Comparison of USDe with Other Stablecoins
Exploring the Comparison of Other Stablecoins with USDe | Source: Ethena Labs' Gitbook
USDe is one of hundreds of stablecoins in the crypto market, pegged to real-world assets (in this case, the dollar). As a crypto-based synthetic dollar protocol, USDe differs from other stablecoins in the following ways:
1) Stability Mechanism
USDe: Maintains its peg to the dollar by using a delta hedging mechanism with Ethereum derivatives to offset the volatility of its collateral. This approach ensures the stability of USDe even during significant market fluctuations.
Traditional stablecoins (e.g., USDT, USDC): Typically rely on fiat reserves to maintain their peg, meaning their stability depends on the sufficiency of the reserves and the financial health of the reserve custodian.
2) Decentralization
USDe: Operating on a decentralized platform without a single entity controlling its issuance or redemption processes, this structure helps enhance security and reduce the likelihood of censorship or intervention.
Other DeFi stablecoins (e.g., DAI): DAI also operates on a decentralized framework but uses an over-collateralization mechanism involving a mix of other cryptocurrencies, which may introduce different risks and dependencies.
3) Yield Generation
USDe: Provides inherent returns through its 'internet bonds', with returns derived from Ethereum staking and price differentials in the derivatives market. This unique feature allows USDe holders to earn direct returns.
Other stablecoins: Most traditional stablecoins do not directly provide returns, and users must rely on external avenues, such as lending platforms or DeFi yield farms, to earn rewards.
4) Scalability and Efficiency
USDe: Leveraging the Ethereum network to utilize existing DeFi protocols and infrastructure to achieve high scalability and efficiency, facilitating broader adoption and multi-platform integration.
Other stablecoins: While also having certain scalability, traditional stablecoins are often constrained by the reserve management of traditional banking systems, making them slower to adapt to new blockchain technologies.
5) Risks and Transparency
USDe: Offers highly transparent on-chain transaction and position records. However, the complexity of its delta hedging strategy and potential risks posed by derivatives market volatility need to be addressed.
Other stablecoins: The risks of traditional stablecoins usually include counterparty risk, reserve audit transparency issues, and potential regulatory challenges. However, their operational mechanisms are relatively simple, which may lead some users to perceive them as lower risk.
6) Potential Risks and Challenges of Ethena and USDe
Before participating in the Ethena ecosystem, it is essential to understand the following potential risks and challenges:
1) Regulatory Challenges
Ethena faces regulatory scrutiny similar to many DeFi projects, especially regarding the issuance of synthetic stablecoins like USDe, which may vary according to different regulatory frameworks in jurisdictions. The current regulatory environment is evolving, and new rules may impact stablecoins and their operational methods. Response measures: Ethena actively communicates with regulators and seeks legal compliance in all operational regions, including stringent KYC and anti-money laundering (AML) checks for users, particularly those minting or redeeming USDe.
2) Market Acceptance
The adoption of USDe depends on user acceptance and its integration into mainstream DeFi platforms. Market acceptance may be slow, especially when users are cautious about new technologies or face competition from established stablecoins. Response measures: Ethena promotes the adoption of USDe by establishing strategic partnerships with major DeFi protocols in the crypto ecosystem and providing incentives for early adopters. Additionally, by enhancing user confidence in USDe's advantages and operation through educational outreach and transparent operational communication.
3) Technical Challenges
Ethena's core technology (particularly the delta hedging mechanism used to stabilize USDe) is complex and may have technical issues or vulnerabilities. The implementation of such complex mechanisms brings inherent risks, including smart contract vulnerabilities. Response measures: Ethena reduces risks through extensive testing and by commissioning reputable third-party security firms to audit its smart contracts. Additionally, continuous monitoring and updating of the protocol's infrastructure are conducted to ensure the robustness of technical safeguards against potential vulnerabilities.
4) Liquidity and Volatility Risk
Like any financial instrument, the risks of liquidity constraints, especially during market pressure or rapid changes in investor sentiment, need to be considered. Moreover, although USDe is designed to maintain stability, its underlying collateral (ETH and its derivatives) can be highly volatile. Response measures: Ethena addresses liquidity issues by maintaining reserve funds and establishing deep liquidity pools across multiple trading platforms. For volatility, the protocol strictly enforces neutral hedging strategies to ensure that the synthetic dollar remains pegged despite fluctuations in the underlying assets.
5) Dependence on Ethereum
As a protocol built on the Ethereum blockchain, Ethena's operation is influenced by Ethereum's scalability and gas fees, which may affect transaction costs and speed. Response measures: Ethena plans to leverage Ethereum's second-layer solutions and may consider cross-chain integration to reduce high transaction fees and improve scalability. This not only enhances efficiency but also broadens the protocol's accessibility and user base.
6) Counterparty Risk
Maintaining USDe's stability through derivatives and other financial instruments means the protocol is exposed to counterparty risks, particularly in decentralized environments where counterparties may not be fully reliable or transparent. Response measures: Ethena chooses reputable, reliable trading platforms and derivatives partners, ensuring all positions are over-collateralized while maintaining transparency in hedging activities.
7) Summary
Ethena and its USDe stablecoin showcase an important innovation in the decentralized finance sector. By leveraging Ethereum's robust and secure infrastructure, Ethena provides a crypto-native, stable, and scalable digital dollar, freeing itself from reliance on the traditional banking system while introducing a yield-generating asset in the form of 'internet bonds'.
USDe employs advanced Delta hedging strategies to maintain its stability, distinguishing it from traditional stablecoins and providing users with a reliable store of value while actively generating returns. This innovative approach addresses the volatility issues often associated with cryptocurrencies, making USDe a viable solution for everyday transactions, savings, and financial planning in decentralized environments.
As the DeFi space continues to evolve, Ethena's commitment to transparency, security, and user-centered innovation may play a crucial role in shaping its development trajectory. While time will tell whether it can secure a place in the rapidly growing digital finance sector, its potential to redefine the perspectives and applications of stablecoins and synthetic assets within the DeFi ecosystem is undeniable. The ongoing development, adoption, and integration of Ethena and USDe could set a new standard for stability and functionality in the cryptocurrency market.
