Ethena, a stablecoin with a market cap of over $2.3 billion, burst onto the scene in late February and has quickly risen to become one of the fastest-growing stablecoins in history. One of its main attractions is its ability to generate yield for holders, a feature that sets it apart from leading stablecoins that keep all profits for themselves.
While the yield-generating feature of Ethena is appealing to holders, it also introduces unique risks to the protocol. According to a report by CryptoQuant, these risks become evident when cryptocurrency markets experience sharp price corrections and the funding rate turns negative as traders liquidate long positions and open short positions.
In order to keep its peg to the dollar, Ethena employs a delta-hedging strategy, backing USDe with investments in Bitcoin (BTC) and Ethereum (ETH). The protocol offsets fluctuations in the value of these investments by holding perpetual futures contracts that short both assets. This strategy differs from traditional stablecoin issuers who typically back their tokens with reserves consisting of cash and U.S. treasuries.
Ethena’s reserves are considered to be more censorship-resistant compared to traditional stablecoins, as many components of the system are based on-chain. The Ethereum and Bitcoin futures markets tend to have a bias towards long positions, resulting in regular payouts to shorts. However, when funding rates turn negative, these payouts become penalties that are covered by Ethena’s reserve fund.
According to CryptoQuant’s analysis, Ethena’s current reserve fund of $32.7 million is only sufficient to protect USDe holders if the token’s market cap remains below $4 billion. In the event that USDe’s market cap rises to $10 billion, the reserve fund would need to increase to $80 million to ensure the same level of safety. Investors are advised to closely monitor Ethena’s reserve fund to ensure that it can handle periods of extremely large negative funding rates.
While Ethena offers holders the opportunity to earn yield on their stablecoin holdings, it also comes with unique risks due to its mechanism of generating revenue. Investors should carefully consider these risks and monitor the adequacy of Ethena’s reserve fund to protect their investments.