Author: Kucoin
Translation: Plain language blockchain
Ethena (ENA), a rising star in the decentralized finance (DeFi) sector, utilizes blockchain technology to provide 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 offers stability and ease of integration for the digital financial ecosystem.
1. Features of USDe
USDe is pegged 1:1 to the US dollar, aiming to maintain value stability in the highly volatile cryptocurrency market. This peg mechanism is particularly important for users needing a reliable medium of exchange or stable value storage, 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 called 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 trade and savings.
2) Funding support
Ethena has received strong support from several well-known individuals and institutions in the cryptocurrency and financial sectors. The startup raised $6 million in seed funding led by Dragonfly, a well-known venture capital firm focused on the crypto space. Additionally, Arthur Hayes, founder of BitMEX, and his family office Maelstrom also participated in the investment. Other major supporters include renowned 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 such as risk management frameworks, the composition of assets supporting USDe, and potential partners or integration plans. Additionally, ENA helps maintain the stability and functionality of USDe through various incentive mechanisms within the platform, serving as a critical link in the entire ecosystem's operation.
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 US 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 minting-redeeming arbitrage mechanisms. These characteristics ensure that USDe can serve as a reliable medium of exchange and value storage tool 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 concept of Ethena
Ethena utilizes the Ethereum blockchain framework to create a stable, scalable, and censorship-resistant digital currency, referred to as 'internet bonds'. The platform employs innovative delta hedging strategies to maintain the stability of the currency 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, countering the impact of collateral asset volatility. This process involves 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 of the derivatives positions.
3) Stability of the delta-neutral mechanism
The core stability mechanism of USDe is the delta hedging strategy. This strategy mitigates price fluctuations in the crypto market by establishing hedging positions in the derivatives market equivalent to the value of the Ethereum collateral. This design aims to maintain the stable peg of the synthetic dollar USDe to the US dollar. The adjustment of hedging positions is fully automated and can respond to market changes in real time, ensuring stability.
4) Yield generation
USDe is not only a stable currency but also provides yield opportunities for holders. The sources of yield primarily include:
Staking rewards generated from Ethereum used as collateral;
Funding rates and basis returns in delta hedging activities.
This dual yield model makes USDe similar to traditional bonds, becoming an investment that can accumulate value over time, dubbed 'internet bonds'.
5) Risk mitigation
Although Ethena is committed to building 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 transparency and verifiability of all transactions and positions through blockchain technology.
3) Mechanism of Ethena's operation
Here 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 into the Ethena system (representing Ethereum that has been staked and can earn staking rewards).
Receiving USDe: As a return, users receive an equivalent amount of USDe, approximately 100 USDe (minus any applicable transaction fees). This is based on a 1:1 US dollar peg exchange rate.
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 equivalent to the value of stETH. This is part of Ethena's delta hedging strategy to stabilize the value of USDe.
OTC settlement: The stETH deposited by users is managed through an 'OTC settlement' system. This mechanism ensures that users' stETH is securely stored outside the trading platform, thus reducing counterparty risk from hacking or bankruptcy of the trading platform.
4) Yield distribution
The staking rewards generated from users' stETH are collected by Ethena, and the platform converts these yields into more USDe, returning them to users. This yield distribution model provides users with stable returns, enhancing USDe's appeal as a yield investment tool.
5) Key points summary
Stability: Through the delta hedging strategy (balancing stETH collateral positions in the derivatives market), Ethena effectively reduces the volatility risk of collateral assets, ensuring the stability of USDe's peg to the US dollar.
Security and risk management: Managing assets through an OTC settlement mechanism reduces external threats to user deposits, 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. Uses of USDe
USDe is primarily used for trade, remittances, and as a stable medium of exchange, simplifying and securing cross-border transactions without 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 while avoiding the volatility typical of other cryptocurrencies. This stability makes USDe particularly suitable for everyday transactions, trading activities, and cross-border payments, especially in scenarios where exchange rate stability is crucial.
2) Savings and investment tools
Referred to as the 'internet bond', USDe is not only a medium of exchange but also a savings tool. By generating yields 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 liquidity of stable assets.
3) DeFi application scenarios
USDe is crucial in DeFi applications, including borrowing, lending, and yield farming. Its stability and deep integration with the Ethereum blockchain allow it to be used as collateral for loans or liquidity assets in decentralized exchanges (DEXs). This multipurpose nature broadens its use in the DeFi ecosystem, promoting safer and more efficient financial services.
4) Hedging and risk management
USDe can also serve as a hedging tool against volatility in the cryptocurrency market. Under uncertain or adverse market conditions, traders and investors can convert volatile assets into USDe to protect their investments from significant fluctuations, reducing potential losses while retaining the opportunity to quickly enter the market, 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 use, such as volatility and complexity, allowing new users to enter the crypto market with more confidence. The stability of USDe ensures that users can transition seamlessly to a crypto-based financial system without worrying about the direct risks posed by other more volatile cryptocurrencies.
6) Future outlook
The potential applications of USDe are vast. As the DeFi space continues to evolve, USDe is expected to play a significant role in decentralized lending, yield farming, and more complex financial instruments. This could have profound implications for the entire cryptocurrency market, promoting broader adoption of crypto-based financial solutions by providing more stability and reliability.
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 comparisons between other stablecoins and USDe | Source: Ethena Labs' Gitbook
USDe is one of the hundreds of stablecoins in the cryptocurrency market, with its value pegged to real-world assets (in this case, the US Dollar). As a crypto-based synthetic dollar protocol, USDe differs from other stablecoins in the market in several ways:
1) Stability mechanisms
USDe: By using delta hedging mechanisms with Ethereum derivatives to offset the volatility of its collateral, it maintains its peg to the US dollar. This method ensures the stability of USDe even during significant market fluctuations.
Traditional stablecoins (like USDT, USDC): Typically rely on fiat reserves to maintain their peg, meaning their stability depends on the sufficiency of reserves and the financial health of the reserve custodians.
2) Decentralization
USDe: Operates on a decentralized platform without a single entity controlling its issuance or redemption processes, which helps to enhance security and reduce the likelihood of censorship or intervention.
Other DeFi stablecoins (like 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 intrinsic yields through its 'internet bonds', with returns sourced from staking Ethereum and price differences in the derivatives market. This unique feature allows USDe holders to directly earn yields.
Other stablecoins: Most traditional stablecoins do not directly provide yields; users must seek external avenues, such as lending platforms or DeFi yield farms, to earn returns.
4) Scalability and efficiency
USDe: Leveraging the Ethereum network, utilizing existing DeFi protocols and infrastructure for high scalability and efficiency, facilitating broader adoption and multi-platform integration.
Other stablecoins: Although they also have some scalability, traditional stablecoins are generally limited by traditional banking system reserve management, making them slower to adapt to new blockchain technologies.
5) Risks and transparency
USDe: Provides highly transparent on-chain transactions and position records. However, the complexity of its delta hedging strategy and the potential risks from volatility in the derivatives market should be noted.
Other stablecoins: The risks of traditional stablecoins typically 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 lower risk.
6) Potential risks and challenges of Ethena and USDe
Before participating in the Ethena ecosystem, it is essential to understand the 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 due to different regulatory frameworks in jurisdictions. The current regulatory environment is constantly evolving, and new rules may impact stablecoins and their operational methods. Mitigation: Ethena actively communicates with regulatory authorities and seeks legal compliance in all operational areas, including strict KYC and AML reviews for users, particularly those minting and 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, particularly when users are cautious about new technologies or face competition from established stablecoins. Mitigation: Ethena promotes the adoption of USDe by establishing strategic partnerships with major DeFi protocols in the crypto ecosystem and providing incentives for early adopters. Furthermore, enhancing user confidence in the advantages and operational mechanisms of USDe through educational campaigns and transparent operational communication.
3) Technical challenges
The core technology of Ethena (especially the delta hedging mechanism used to stabilize USDe) is complex and may have technical issues or vulnerabilities. Implementing such complex mechanisms carries inherent risks, including smart contract vulnerabilities. Mitigation: Ethena reduces risks through extensive testing and commissions renowned third-party security firms to audit smart contracts. At the same time, continuous monitoring and updating of the protocol infrastructure ensure the robustness of technical safeguards against potential vulnerabilities.
4) Liquidity and volatility risk
Like any financial instrument, the risk of liquidity constraints, especially during market pressure or rapid changes in investor sentiment, is a consideration. Additionally, while USDe aims to remain stable, the underlying collateral (ETH and its derivatives) is highly volatile. Mitigation: 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 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. Mitigation: Ethena plans to utilize Ethereum's second-layer solutions and may consider cross-chain integration to reduce high transaction fees and improve scalability. This will not only enhance efficiency but also broaden the protocol's accessibility and user base.
6) Counterparty risk
Maintaining the stability of USDe through derivatives and other financial instruments means the protocol is exposed to counterparty risk, especially in decentralized environments where counterparties may not be entirely reliable or transparent. Mitigation: Ethena chooses reputable and reliable trading platforms and derivatives partners, ensuring all positions are over-collateralized while maintaining transparency in hedging activities.
7) Conclusion
Ethena and its USDe stablecoin demonstrate a significant innovation in the decentralized finance sector. By leveraging Ethereum's robust and secure infrastructure, Ethena provides a crypto-native, stable, and scalable digital dollar that not only frees itself from dependence on traditional banking systems but also introduces 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, providing users with a reliable value storage tool while actively generating returns. This innovative approach addresses the volatility 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 develop, Ethena's commitment to transparency, security, and user-centric innovation may play a crucial role in shaping its trajectory. While it remains to be seen whether it can secure a place in the rapidly growing digital finance space, its potential to redefine the views and applications of stablecoins and synthetic assets within the DeFi ecosystem is undeniable. The ongoing development, adoption, and integration of Ethena and USDe may bring a new standard of stability and functionality to the cryptocurrency market.
