The rise of Ethena in the DeFi space has garnered widespread attention, with its total locked value soaring from under $10 million to $5.5 billion. This article explores the operational mechanisms of Ethena, potential risks, and its impact on the entire DeFi ecosystem. This article is sourced from a piece written by DC | In SF and compiled and translated by Block unicorn. (Background: The Trump family increases its investment in DeFi! Buying ONDO, AAVE, ENA tokens, with holdings exceeding $80 million) (Context: Why is Ethena a real opportunity?) Ethena has significantly increased the overall usage of DeFi through its billion-dollar growth, akin to the impact of stETH on Ethereum DeFi. Ethena is one of the most successful protocols in DeFi history. About a year ago, its total locked value (TVL) was less than $10 million, and it has now grown to $5.5 billion. It integrates into multiple protocols in various ways, such as @aave, @SkyEcosystem (IE Maker / Sparklend), @MorphoLabs, @pendle_fi, and @eigenlayer. There are so many protocols collaborating with Ethena that I had to change the cover multiple times while recalling another partner. Among the top ten protocols ranked by TVL, six are either collaborating with Ethena or are Ethena itself (Ethena is ranked ninth). If Ethena were to fail, it would have profound implications for many protocols, especially AAVE, Morpho, and Maker, which would find themselves in varying degrees of insolvency. Meanwhile, Ethena has significantly increased the overall usage of DeFi through its billion-dollar growth, similar to the impact of stETH on Ethereum DeFi. Therefore, is Ethena destined to destroy the DeFi we know, or will it usher DeFi into a new renaissance? Let's delve into this question. How does Ethena actually operate? Despite being launched for over a year, there is still widespread misunderstanding about how Ethena works. Many claim it is the new Luna, then refuse to elaborate further. As someone who warned about Luna, I find this viewpoint quite one-sided, but I also believe that most people lack a sufficient understanding of the details of how Ethena operates. If you believe you fully understand how Ethena manages delta-neutral positions, custody, and redemption, feel free to skip this section; otherwise, this is crucial reading for comprehensive understanding. Overall, Ethena benefits from financial speculation and the cryptocurrency bull market like BTC, but in a more stable manner. As cryptocurrency prices rise, more and more traders want to long BTC while the number of traders willing to short decreases. Due to supply and demand, shorting traders are paid by long traders. This means traders can hold BTC while shorting the same amount of BTC, achieving a neutral position where gains and losses from long and short positions offset each other, while traders still earn interest income. Ethena's operations are entirely based on this mechanism; it exploits the current lack of sophisticated investors in the crypto market, who are more interested in profiting by earning yields rather than simply going long on BTC or ETH. However, a significant risk of this strategy lies in the custody risk of exchanges, as illustrated by the collapse of FTX and its impact on first-generation delta-neutral managers. Once an exchange collapses, all funds may be lost. This is why, despite how efficiently and safely mainstream managers may handle capital, they can still be severely negatively impacted due to the collapse of FTX, as evidenced by @galoiscapital, which was not their fault. Exchange risk is one of the key reasons Ethena chose to use @CopperHQ and @CeffuGlobal. These custody service providers act as trusted intermediaries responsible for holding assets and assisting Ethena in its interactions with exchanges while avoiding exposing Ethena to the custody risks of exchanges. The exchanges, in turn, can rely on Copper and Ceffu because they have legal agreements with custodians. Total profit and loss (i.e., the amount Ethena needs to pay to long traders, or the amount long traders owe to Ethena) is regularly settled by Copper and Ceffu, and Ethena systematically rebalances its positions based on these settlement results. This custody arrangement effectively mitigates exchange-related risks while ensuring the stability and sustainability of the system. Minting and redeeming USDe/sUSDe is relatively simple. USDe can be bought or minted using USDC or other major assets. USDe can be staked to generate sUSDe, which earns yields. sUSDe can then be sold to the market by paying the corresponding swap fees or redeemed for USDe. The redemption process typically takes seven days. USDe can then be exchanged for supporting assets at a 1:1 ratio (corresponding to a value of $1). These supporting assets come from asset reserves and the collateral used by Ethena (mainly BTC and ETH/ETH derivatives). Given that some USDe is not staked (many of which are used for Pendle or AAVE), the yields generated from the assets supporting these unstaked USDe help enhance the yields on sUSDe. So far, Ethena has been able to handle a large number of withdrawals and deposits relatively easily, although sometimes the slippage between USDe and USDC can be as high as 0.30%, which is relatively high for stablecoins but far from reaching a significant decoupling level, and does not pose a danger to lending protocols. So why are people so concerned? Well, if there is a large withdrawal demand, say 50%, how could Ethena 'fail'? Given that we now understand that Ethena's yields are not 'fake' and how it operates on a more nuanced level, what are the primary real concerns regarding Ethena? Essentially, there are a few scenarios. First, funding rates could turn negative, in which case, if Ethena's insurance fund (currently around $50 million, sufficient to withstand a 1% slippage/fund loss at the current TVL) is not enough to cover the losses, Ethena would ultimately incur losses instead of profits. This scenario seems relatively unlikely, as most users may stop using USDe when yields decrease, which has happened in the past. Another risk is custody risk, namely the risk of Copper or Ceffu attempting to operate with Ethena's funds. The fact that custodians do not have complete control over the assets mitigates this risk. Exchanges do not have signature authority and cannot control any wallet holding the underlying assets.