Ethena: Financial innovation beyond traditional stablecoins

Author: Bobby; Source: Preface Observation

On April 2, 2024, Ethena was launched on Binance and performed well, attracting widespread attention in the cryptocurrency market. Among them, Arthur Hayes, an early investor, cheered for it on social media, further highlighting its potential influence in the market.

For ordinary investors, they focus on the performance of currency prices. As an industry practitioner, I prefer to explore the value behind Ethena and its actual impact on the industry. Among the many analyses of Ethena, some articles have obvious subjective biases or lose their original accuracy in the translation process. Therefore, I try to provide a more balanced and detailed perspective. Of course, because I am not a financial practitioner, please forgive me if I am not rigorous enough in some financial terms.

Initial Impression

When I first came into contact with Ethena, I had some reservations about it. Especially when I saw the Staking Yield of more than 30%, I always felt like Luna was reappearing. But as I studied it in depth, I found that Ethena is a very interesting product. Although it is not perfect, its underlying logic is consistent with the development trend of contemporary society.

Introduction to Ethena

Ethena is a structured note that holds a long position in stETH (thereby indirectly holding a long position in ETH) and shorts ETH through perpetual contracts on major centralized exchanges. This hedging strategy makes the price of Ethena (to the US dollar) relatively stable.

For users, this means that when the price of ETH rises, they can benefit from three aspects: the staking income of stETH, the income from the increase in the price of ETH, and the rate income obtained from shorting perpetual contracts. At the same time, the generated USDe can be used to participate in various other transactions. However, when the price of ETH falls, the overall income may decrease or even become negative. To this end, the Ethena team has purchased insurance to deal with extreme situations. However, there is still a risk when ETH falls sharply - the rate cost of shorting may increase sharply, and there may even be insufficient counterparties until it enters a death spiral.

Comparison with UST

Many people's first reaction to Ethena is "the next UST".

The underlying asset of Ethena is ETH, while the underlying asset of UST is Luna. Although some people claim that the two are fundamentally different, in fact, the main difference between the two lies in the choice of underlying assets. Ethena relies on the broad consensus of ETH, and in comparison, ETH's stability is much more reliable than Luna.

Is Ethena a stablecoin?

Calling Ethena a "stablecoin" is more like a marketing strategy. In fact, it should be regarded as a financial engineering product, and its volatility is smaller than that of pure ETH against the US dollar. But the debate over defining it as a "stablecoin" is not substantive. After all, all existing concepts of "stability" are relative to the US dollar. The stability of the US dollar is a relative concept.

What are the (main) risks of Ethena?

Like all financial products, Ethena faces multiple risks. In addition to the "death spiral" mentioned above, other risks mainly come from two aspects:

First, the stability of exchanges is not as good as that of banks. Centralized virtual currency exchanges are indeed a new thing compared to banks, so concerns about their stability are justified. However, the collapse of SVB, Signature, and Silvergate in recent years shows that banks are not infallible.

Second, the total supply of Ethena is capped, which is subject to the total amount of Eth perpetual contract airdrops on centralized exchanges. This is indeed true. There are only two possibilities to solve this problem. The first is the growth of the total market value of Eth. The second is to seek an underlying asset with a larger "plate". It is said that the Ethena team has begun to design an iterative version around Bitcoin.

It is worth mentioning that there are many ways to design structured notes. After Ethena becomes popular, I believe that more similar products will appear. As long as some parameters in the product design are adjusted, the values ​​of risk and return will change.

Why I like Ethena

My love for Ethena stems from its attempt to establish a transparent "consensus stability" mechanism that is independent of the US dollar standard.

First of all, it is transparent. Since Ethena's pledge and issuance are both carried out on the chain (only the airdrops on centralized exchanges are not on the chain), its issuance is more transparent than Tether or Circle. Tether's audit has always been criticized by the industry. Although Circle is more self-disciplined and has the Big Four accounting firms auditing it twice a month, there is still a certain gap compared to the "all the time" transparent on-chain data.

More importantly, Ethena shows everyone a possibility - in some scenarios, people do not necessarily need to use the US dollar as an anchor benchmark, but need a new "relatively stable" and "easy to understand" consensus basis. The development of Bitcoin has proved that financial products that seek to break away from the hegemony of the US dollar have their necessity and market demand. As technology develops, there will be many application scenarios in the future that do not necessarily need to be fully anchored to the US dollar (such as the natural anchoring between AI and computing power). Looking forward to the future, Ethena, as a financial product, although not perfect, has opened up a new path - using new underlying assets to build relatively stable financial engineering products. This is a new perspective to explore the establishment of stability outside the US dollar.