Original title: Stablecoin Evolution: USDe's Impact on Decentralized Finance Original source: Greythorn Asset Management
Project name: EthenaLabs
Network: Ethereum L1
Current TVL (Total Value Locked): $410 million
Project Type: CDP (Collateralized Debt Position)
· Symbols: $USDe & $ENA
Cryptocurrency ranking: #NA
Market capitalization: NA
Fully Diluted Value (FDV): NA
Circulating Supply: NA
Total Supply: NA
introduction
With the collapse of Terra and its related UST and Anchor protocols in 2022, interest in decentralized stablecoins has plummeted. Of course, as Web3 continues to develop, there is a constant rotation between the sectors and changes with each passing day. Now, the Greythorn team sees projects like Prisma, Liquity, and Lybra at the forefront of innovation in the LSD/CDP space. Meanwhile, Maker and Curve remain unchanged in terms of total locked value (TVL).
Many experts are questioning whether EthenaLabs’ new project USDe can maintain its ~27% annualized yield (APY) without investors having to go into the likes of Anchor.
EthenaLabs has reignited Defi enthusiasm after announcing its funding on July 12, 2023, using LST (stETH) to create a digital currency pegged to the US dollar. Of course, this raises a question: Will it make full use of Ethereum's Layer 1 and Layer 2, or will it continue LUNA and become the next major failure of the crypto market?
Why are USDe and stablecoins important?
Stablecoins have become key players in decentralized currency markets, significantly influencing market dynamics. They are an important part of trading in spot and futures markets. Whether on centralized or decentralized platforms, stablecoins play an important role in both supporting trading and increasing the stability of crypto markets, especially in crypto markets. against a backdrop of constant fluctuations.
In the past two years, the stablecoin field has achieved significant growth. This year, the transaction volume on the chain exceeded 9.4 trillion US dollars; it accounts for two of the top five assets in DeFi and accounts for more than 40% of the total locked value (TVL). They dominate trading, with data showing that more than 90% of order book transactions and more than 79% of on-chain transactions involve stablecoins.
Source: X: Route2FI
AllianceBernstein, a leading global asset manager with $725 billion in assets under management (AUM), predicts that the stablecoin market could reach $2.8 trillion by 2028. This forecast suggests a huge growth opportunity from the current market cap of $138 billion (which previously peaked at $187 billion).
The growing acceptance of stablecoins and their consistent performance in both centralized and decentralized environments demonstrate their integral role in the crypto ecosystem. With optimistic estimates of up to 2000% growth potential, this presents a significant opportunity for investors and market participants to interact with projects like EthenaLabs’ USDe.
Specifically, USDe aims to meet this growing demand by providing a censorship-resistant, scalable, and stable market option.
Project Overview
Inspired by Arthur Hayes' "Dust to Crust" article, EthenaLabs is committed to creating a derivatives-backed stablecoin that solves the major problem of cryptocurrency's dependence on traditional banks. Their goal is to provide a decentralized, permissionless savings product for a wide audience. EthenaLabs' synthetic dollar USDe aims to be the first crypto-native, censorship-resistant, scalable and stable financial solution achieved through Delta hedging of collateralized Ethereum.
Along with USDe, EthenaLabs plans to introduce what they call an “Internet Bond.” According to the EthenaLabs Gitbook, this will be a crypto-native, yield-generating, USD-denominated savings vehicle based on collateralized Ethereum returns and leveraging funding and basis differences in perpetual and futures markets.
EthenaLabs stands out for its unique mission and innovative approach. Unlike other CDP projects such as Maker’s DAI, Liquity’s LUSD, and Curve’s crvUSD, EthenaLabs’ USDe generates its USD value and yield through two main strategies:
Leverage stETH and its inherent yield.
Take a short ETH position to balance Delta and take advantage of perpetual/futures funding rates.
This strategy allows the protocol to synthetically create a delta-neutral CDP that combines a spot deposit of stETH with a corresponding short position established through partnerships with CEXs such as ByBit and Binance.
Holding sUSDe (collateralized USDe) on Ethena essentially becomes a basis trade, balancing the spot stETH position with the short ETH position in the market. This setup provides users with exposure to the difference in returns between these positions, currently generating an approximate yield of ~27%.
Source: EthenaLabs Gitbook
USDe: Key Risks and EthenaLabs’ Mitigation Measures
Before diving into the risk-reward analysis of staking USDe, it is important to address several potential risks associated with EthenaLabs:
● Custody risks
EthenaLabs uses "over-the-counter settlement" (OES) providers to custody assets, which creates a reliance on the operational capabilities of these providers. Challenges in performing key functions such as deposits, withdrawals, and exchanges may affect the efficiency of the protocol and the minting/redemption functionality of USDe.
Mitigation Strategies: Diversified Custody Providers: EthenaLabs minimizes risk by effectively managing concentration risk by diversifying collateral across multiple OES providers.
● Centralized Exchange (CEX) Risks
The protocol uses derivatives on centralized exchanges (such as Binance, Bybit) to balance the Delta of collateral, which poses risks if the exchange suddenly becomes unavailable.
Mitigation Strategy: Diversified CEX Gateways: By diversifying the exchanges that hold assets, EthenaLabs reduces the risk of any single exchange failing.
● Mortgage risk
The difference between the collateral asset (stETH) and the underlying asset (ETH) in a perpetual futures position introduces “collateral risk.” Significant errors in LST could lead to liquidity issues.
Mitigation Strategy: Active Monitoring and Partnerships. EthenaLabs actively monitors the on-chain integrity of stETH and stays in touch with liquidity sources, ready to replace collateral if necessary.
● Liquidation risk
Staking stETH in short ETHUSD and ETHUSDT positions introduces liquidation risk if the spread between ETH and stETH widens significantly.
Mitigation Strategies: Systematic Collateral Management: EthenaLabs has processes for rebalancing collateral, transferring assets, and leveraging insurance funds to protect against liquidation risk.
i. Systematic Collateral Rebalancing
Ethena will systematically delegate additional collateral as either risk scenario plays out to improve the margin position of our hedged positions.
ii. Transfer of assets and revolving collateral
Ethena is able to temporarily cycle delegated collateral between exchanges to support specific situations.
iii. Insurance Fund Deployment
Ethena has the ability to quickly deploy insurance funds to support hedge positions on exchanges.
iv. Protecting the value of collateral
In the event of an extreme situation, such as a critical smart contract flaw in the collateralized Ethereum asset, Ethena will immediately take steps to mitigate the risk, with the sole motivation of protecting the value of the collateral. This includes closing hedge derivative positions to avoid liquidation risk as a concern, and converting the affected asset into another asset.
● Financial risks
A sustained negative funding rate could reduce Ethena’s returns.
Mitigation strategies: Insurance fund as a yield protector: The insurance fund acts as a safety net when the comprehensive yield is negative, ensuring the stability of the collateral.
● Collateral Withdrawal Queue/Slashing Risk
There may be long queues for ETH withdrawals, which may have a negative impact on stETH.
Mitigation strategy: This mainly depends on the performance of stETH and Lido. EthenaLabs has no direct mitigation strategy.
● Regulatory risks
Concerns about USDT, USDC, and DeFi regulatory controls could impact USDe’s growth in terms of total value locked (TVL), including difficulties in user attraction and retention.
Mitigation Strategies: EU-Based Operations with MiCA Licensing: By aiming to operate under the EU’s MiCA regulations, EthenaLabs puts itself in a position to adapt effectively to regulatory changes, reducing the impact of potential legal changes.
EthenaLabs has developed a comprehensive approach to managing the various risks in its operations, emphasizing the importance of diversification, active monitoring, and strategic planning to protect the protocol and its users.
Comparison to Anchor: Are the benefits worth it?
Investors are encouraged to do their own research, especially when considering USDe, which offers a high stablecoin yield of approximately 27%. This yield, when compared to the situation with the Anchor Protocol, highlights the systemic risk in the market, where the failure of a single protocol could lead to broader financial turmoil.
Anchor's decline is primarily due to risks inherent in UST's design, which rely on reflexive mechanisms related to Luna's price. If Luna's price drops significantly, it risks a catastrophic devaluation of UST. Anchor provides borrowers with UST (or aUST) yields based on a fixed Terra ratio, regardless of market conditions, with a committed annualized rate of 19.45%.
Furthermore, Anchor’s “real yield,” from collateralized bAssets, was only about 5.81%, far below the payout rate. This discrepancy, combined with its reliance on Luna’s performance, set the stage for the financial crisis.
For those who wish to learn more about Luna and the UST collapse, including the Anchor mechanism, we have previously covered it in detail in articles titled "Demystifying Anchor" and "The Collapse of Anchor."
For USDe, how its benefits are generated, the risks involved, and its marketing strategy differ significantly from Anchor:
Transparent Marketing: Unlike Anchor’s “risk-free” returns, USDe’s marketing directly explains the risks and rewards. Its sources of income, from perpetual contracts (perps) and collateralized Ethereum (stETH), are clearly communicated, setting realistic expectations.
Real yield: sUSDe does not promise unsustainably high deposit rates. Instead, it provides real yields from its underlying assets, avoiding the trap of incentivizing borrowers at rates that cannot be supported by asset returns.
Avoid self-collateralization: Unlike some models that use their own tokens as collateral, sUSDe relies on stETH. This shift from the project’s own token to the collateral basis of a more stable asset like stETH significantly changes the risk dynamics. The focus shifts from the speculative risks associated with the project tokens to the more manageable liquidity risks of ETH and stETH and other risks mentioned above.
Comparing USDe to the collapse of UST is misleading because they are fundamentally different in risk structure and operating model. The focus of USDe investors should be to understand the specifics of perpetual funds, centralized exchange liquidity, and custody risks, rather than the unsustainable high-yield strategies seen in the UST model.
Overall, USDe presents a more thoughtful and potentially safer option in terms of risk mitigation and product structure than Terra’s UST. By leveraging local yield and effectively managing risk from derivative sources, USDe stands out not only for its yield opportunity, but also for its strategic design and risk management practices.
Outstanding team and support
The Ethena team, led by @leptokurtic_, has successfully completed three funding rounds, attracting significant participation from centralized exchanges, market makers, DeFi innovators, and traditional financial institutions. This broad support underscores the project’s credibility and potential impact on the ecosystem.
Under a tight deadline, the team demonstrated excellent planning and coordination to ensure the protocol was ready for mainnet launch. They prioritized risk management and security, and conducted a thorough audit before launch.
Source: ICO Analytics: Ethena
The success of the Shard airdrop event demonstrates the market’s interest in decentralized stablecoins. The event is off to an impressive start, with the total value locked (TVL) increasing 135x to over $410 million since the beginning of December 2023.
Source: @noxiousq Dune Analytics
This momentum shows that products like USDe are in high demand, attracting not only a large amount of TVL, but also the attention of investors who support its vision. As USDe moves forward, it aims to introduce the next billion dollars of TVL to the DeFi space, potentially opening up new opportunities similar to those seen during the Luna cycle. One begins to wonder: Does this mark the beginning of another transformative phase in decentralized finance?