USDe: The Hidden Gem of DeFi
By Adin Hefland. Published on Feb 28, 2024.
On February 19, 2024, Ethena Labs sent shockwaves through the crypto community with the launch of its USDe synthetic stablecoin to the public mainnet. The token is novel for a couple of reasons, specifically its above-average yield and unique approach of leveraging shorting ether futures. Ethena hopes to revolutionize the decentralized finance (DeFi) system, but remains the subject of discussion over its experimental risk.
DeFi refers to a financial system built on blockchain technology, primarily using smart contracts on platforms like Ethereum. Unlike traditional finance, DeFi eliminates intermediaries (such as banks) and empowers individuals with peer-to-peer transactions. Stablecoins, tokens that exist on a public blockchain like Bitcoin or Ethereum, emerged as a solution for crypto traders seeking swift movement between USD and cryptocurrencies. These tokens maintain a value pegged to one USD, allowing seamless trading across various blockchains without relying on traditional banking systems.
In a part-whitepaper, part-Satoshi-homage, Ethena Labs’ primary investor and former BitMEX CEO Arthur Hayes laments the confusion surrounding stablecoins’ purpose. Stablecoins aren’t meant to be a decentralized alternative to exchanging value that curbs the risks of centralized banking. He says we already have one: “It’s called Bitcoin.” Stablecoins allow traders to quickly move between fiat and crypto currencies. In other words, they bridge CeFi and DeFi.
Ethena’s CEO and co-founder Guy Young succinctly describes the USDe model. In a tweet, USDe “combines the only two forms of scalable crypto native yield in a single instrument: i) stETH ~4%, mETH ~7% or LRTs TBD + ii) Short ETH perpetual ~13-26% last 3m.” In layman’s terms, USDe offers users a way to earn money (yield). There are two forms of yield in one investment. stETH and mETH are like investment options. When you stake your USDe (akin to putting money in a high-yield savings account), you can earn around 4-7% interest. Short ETH perpetual (ranges from 13% to 26%) is essentially betting that the price of Ethereum (ETH) will go down; if Ethena’s right, users make money. Together, these contribute to Ethena’s impressive proposition of over 20% yield.
What’s the catch? As Zero Knowledge Consulting firm founder and LGST 2440 guest speaker Austin Campbell put, Ethena is an “interesting” experiment substituting credit risk with price risk. As a crypto-collateralized stablecoin, USDe’s value is tied to Etherum’s Ether price. Funding rates for ETH short positions can turn negative as market conditions change. While Ethereum’s funding rates have been positive for the past six months, Ethereum did have a price negative in September 2023. To mitigate these risks, Ethena maintains a $10 million insurance fund. As of 12pm EST, February 28, 2024, Ethena has a total value locked (TVL) >$500 million.
How does USDe stack up to other stablecoins? USDe’s high yield is reminiscent of Terra’s (UST) 19% yield. As an algorithmic stablecoin, it doesn’t rely on collateral and instead stabilizes value by adjusting its supply based on market demand. UST’s popularity surged in 2021, leading to a market cap of $16 billion. However, Terra faced challenges, including a collapse in May 2022. MakerDAO’s stablecoin DAI, while similarly crypto-backed, is also different from USDe. DAI maintains its value by being overcollateralized with other crypto assets (such as Ethereum) locked in smart contracts. For every DAI minted, there must be more than one USD-equivalent worth of collateral. Historically, DAI held greater prominence than UST (Terra’s stablecoin). Despite competition from UST and other stablecoins, DAI has endured and remains a reliable choice for traders and DeFi enthusiasts. Young appears to say that USDe isn’t trying to replace DAI. In a tweet likening the two to wagyu and chocolate, he said you can have both.
Several factors hinder USDe’s universal adoption or even significant market share in the $130 billion stablecoin market. USDe’s unique blend of staking returns and funding rates introduces price risks, which some investors may perceive as too risky compared to traditional stablecoins. Comparisons of USDe to UST erode trust. USDe faces competition from well-known players who already have inertia and brand recognition. Ethena also requires infrastructure investment to make the interface more user-friendly, especially for those new to the crypto environment.
There’s also a question of nomenclature. While USDe is being called a stablecoin, industry experts like Syncracy Capital co-founder Ryan Watkins, Castle Island co-founder Nic Carter, and 21.co VP Eliezer Ndinga have said USDe should be conceptualized as a structured product. They believe its mislabelling as a stablecoin leads to erroneous comparisons to Terra and DAI. Perhaps misconception is yet another reason why USDe is being underappreciated.
Arthur Hayes asserts that the true challenge inhibiting the mass adoption of stablecoins isn’t centralization but the absence of stablecoins launched by reputable banks. He predicts that if, say, JP Morgan were to introduce a suite of fiat currency stablecoins, they would revolutionize cross-currency transfers and outperform all existing options.
So is your portfolio missing USDe? Ethena’s protocol isn’t the most accessible to crypto-newbies. The ideal audience for USDe includes risk-tolerant yield seekers, seasoned crypto enthusiasts, and diversified portfolio managers. That said, Ethena’s protocol transparently breaks down its collateral yield and provides clear information about its structure. Well-informed users can stand to benefit from providing liquidity to the ecosystem. As for whether USDe is the next big thing, that remains to be seen.