Ethena's rise in the DeFi space has garnered widespread attention, with its total locked value skyrocketing from less than 10 million USD to 5.5 billion USD. This article explores Ethena's operational mechanisms, potential risks, and its impact on the entire DeFi ecosystem. This article is sourced from a piece written by DC | In SF and compiled by Block Unicorn. (Background: The Trump family increases their DeFi holdings! Purchasing ONDO, AAVE, and ENA tokens, with holdings exceeding 80 million USD) (Background Note: Why is Ethena a real opportunity?) Ethena has significantly increased the overall DeFi usage through billions of dollars in 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 USD, and now it has grown to 5.5 billion USD. 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 when recalling another partner. Among the top ten protocols by TVL, six are either collaborating with Ethena or are Ethena itself (Ethena ranks ninth). If Ethena fails, it will have profound implications for many protocols, especially AAVE, Morpho, and Maker, which will face varying degrees of insolvency in functionality. Meanwhile, Ethena has significantly increased the overall DeFi usage through billions of dollars in growth, similar to the impact of stETH on Ethereum DeFi. Therefore, is Ethena destined to destroy DeFi as we know it, or will it bring DeFi into a new renaissance? Let's delve into this question. How does Ethena actually operate? Despite being launched for over a year, there remains a 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 very one-sided, but I also believe that most people lack a sufficient understanding of the details of how Ethena operates. If you think you fully understand how Ethena manages Delta-neutral positions, custody, and redemptions, feel free to skip this section; otherwise, this is essential reading for a complete 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 go long on BTC and ETH, while fewer are willing to short. Due to supply and demand, shorting traders are paid by those going long. This means traders can hold BTC while shorting the same amount of BTC to achieve a neutral position, such that when BTC prices rise, the gains and losses of long and short positions offset each other, allowing traders to still earn interest income. Ethena operates entirely based on this mechanism; it capitalizes on the current lack of sophisticated investors in the crypto market, who are more interested in profiting by earning yield rather than simply going long on BTC or ETH. However, a significant risk of this strategy is the custodial risk of exchanges, as illustrated by the collapse of FTX and its impact on the first generation of Delta-neutral managers. Once an exchange goes down, all funds may be lost. This is why, regardless of how efficiently and securely mainstream managers handle capital, they are negatively affected by the collapse of FTX, with @galoiscapital being a prominent example, and this is not their fault. Exchange risk is one of the significant reasons why Ethena chose to use @CopperHQ and @CeffuGlobal. These custodial service providers act as trusted intermediaries responsible for holding assets and assisting Ethena in its interactions with exchanges while avoiding exposing Ethena to custodial risks from exchanges. Exchanges, in turn, can rely on Copper and Ceffu because they have legal agreements with the custodians. Total gains and losses (that is, the amount Ethena needs to pay to long traders or the amount long traders owe to Ethena) are settled regularly by Copper and Ceffu, and Ethena systematically rebalances its positions based on these settlement results. This custodial arrangement effectively reduces exchange-related risks while ensuring the system's stability and sustainability. Minting and redeeming USDe/sUSDe is relatively straightforward. USDe can be purchased or minted using USDC or other major assets. USDe can be staked to generate sUSDe, which earns yield. 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 at a 1:1 ratio for supported assets (corresponding to a value of $1). These supported assets come from asset reserves and the collateral used by Ethena (primarily BTC and ETH/ETH derivatives). Given that some USDe is not staked (many of which are used for Pendle or AAVE), the yield generated from the assets backing these unstaked USDe helps enhance the yield of sUSDe. So far, Ethena has been able to handle a large volume of withdrawals and deposits relatively easily, although sometimes the slippage of USDe-USDC can be as high as 0.30%, which is relatively high for stablecoins but far from reaching a significant decoupling level and is nowhere near posing a danger to lending protocols. So, why are people so concerned? Well, if there is a high demand for withdrawals, say 50%, how could Ethena 'fail'? Given that we now understand that Ethena's yield is not 'false' and how it operates on a more nuanced level, what are the main real concerns about Ethena? Basically, there are several potential scenarios. First, funding rates could turn negative, in which case if Ethena's insurance fund (currently about 50 million USD, sufficient to cover a 1% slippage/fund loss under the current TVL) is insufficient to cover the losses, Ethena will ultimately incur losses rather than profits. This scenario seems relatively unlikely because most users may stop using USDe when yields decrease, which has happened in the past. Another risk is custodial risk, which is the risk that Copper or Ceffu might attempt 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 signing rights and cannot control any wallets holding the underlying assets.