USDe, a stablecoin protocol led by BitMEX co-founder Arthur Hayes, is often compared to UST due to its fully collateralized mechanism. There are concerns that USDe may face risks similar to a Ponzi scheme. So what are the risks that USDe may encounter? This article, originally published on BeWater.xyz and edited by Deep Tide, provides an analysis.
Table of Contents:
1. Definition of USDe: Fully Collateralized Semi-Centralized Stablecoin
2. Analysis of Collateral Value
1. Market Capacity Risk
2. Custodial Risk
3. Sustainable Interest Rate Risk
4. Other Risks
Stablecoins can be classified in various ways, such as:
(1) Fully collateralized and non-fully collateralized;
(2) Centralized custody and non-centralized custody;
(3) On-chain issuance and centralized institution issuance;
(4) Permissioned and permissionless.
There are also some overlaps and variations, such as algorithmic stablecoins like AMPL and UST, which are fully regulated by algorithms. According to this definition, most stablecoins belong to the category of non-fully collateralized stablecoins, but there are exceptions, such as Lumiterra’s LUAUSD. Although its minting and burning prices are regulated by algorithms, the protocol treasury provides collateral that is at least equal to the anchoring value of LUAUSD (USDT & USDC), making LUAUSD a combination of algorithmic stablecoin and fully collateralized stablecoin.
Another example is DAI. When DAI’s collateral is 100% on-chain assets, DAI is considered a non-centralized custody stablecoin. However, with the introduction of RWA, some of the collateral is controlled by real-world entities, making DAI a hybrid of centralized and non-centralized custody stablecoin.
Based on this, we can simplify the classification and abstract it into three core indicators: whether it is fully collateralized, whether it is permissionless, and whether it is non-custodial. Comparing USDe with other common stablecoins in these three aspects, there are some differences. If we consider that “decentralized” requires both “permissionless issuance” and “non-custodial” conditions, then USDe does not meet these criteria. Therefore, it is appropriate to classify USDe as a “fully collateralized semi-centralized stablecoin.”
The first question is whether USDe has sufficient collateral, and the answer is obviously yes. As described in the project documents, USDe’s collateral consists of synthetic assets that combine the value of cryptocurrencies and corresponding short futures positions.
– Synthetic asset value = Spot value + Short futures position value
– In the initial state, spot value = X, futures position value = 0, assuming the basis is Y
– Collateral value = X + 0
– Assuming that after a certain period of time, the spot price of the asset rises by a dollars, and the value of the futures position rises by b dollars (a and b can be negative), then the position value = X + a – b = X + (a-b), and the basis becomes Y + ΔY, where ΔY = (a-b).
It can be seen that if ΔY remains unchanged, the intrinsic value of the position will not change. If ΔY is positive, the intrinsic value of the position will increase, and vice versa. In addition, for delivery contracts, the initial basis is generally negative, and on the delivery date, the basis will gradually become 0 (excluding trading frictions). This means that ΔY must be a positive number. Therefore, if the basis is Y when the synthesis is made, the value of the synthetic position on the delivery date will be higher than the initial state.
Holding spot assets and shorting futures is also known as “cash and carry arbitrage,” which is a risk-free strategy (but subject to external risks). According to current data, constructing such an investment portfolio can achieve a low-risk annualized return of about 18%.
Now let’s return to Ethena. I couldn’t find an accurate definition of whether it uses delivery contracts or perpetual contracts on the official website (considering the issue of trading depth, the probability of perpetual contracts is higher), but the on-chain addresses and CEX distribution of collateral have been disclosed.
In the short term, these two methods will have some differences. Delivery contracts will provide a more “stable and predictable” rate of return, and the expiration return will always be positive. On the other hand, perpetual contracts are products with a fluctuating interest rate, and the daily interest rate may be negative under certain circumstances. However, from experience, the historical return of arbitrage in perpetual contracts is slightly higher than that of delivery contracts, and both are positive:
1) Delta-neutral futures arbitrage inherently involves lending funds, and lending funds cannot maintain a 0% interest rate or a negative interest rate for a long time. Moreover, this position carries USDT risk and centralized exchange risk, so the necessary rate of return is higher than the risk-free rate of the US dollar.
2) Perpetual contracts need to bear variable expiration returns and additional risk premiums.
Based on this, it is completely wrong to worry that “USDe” will not be able to meet its obligations or compare USDe to UST. According to the collateral risk assessment framework introduced in the article, the current core/collateralization ratio of USDe is 101.62%, and with the inclusion of ENA’s circulating market value of $1.57 billion, the broad collateralization ratio can reach approximately 178%.
The concern about “potential negative rates leading to shrinking of USDe collateral” is not a big issue. According to the law of large numbers, as long as the time is long enough, the frequency will converge to probability, and the collateral of USDe will converge to the growth rate of the average funding rate in the long run.
To put it in a more popular way: You can draw a card from a deck an infinite number of times. If you draw a joker, you lose $1, but if you draw any other of the 52 cards, you win $1. If you have $100 as your capital, should you worry about going bankrupt due to drawing too many jokers? Looking at the data directly is more intuitive. In the past 6 months, the average contract fee rate was below 0% only twice, and the historical win rate of cash and carry arbitrage is much higher than drawing cards.
Now that we have clarified that collateral risk is not a concern, it doesn’t mean there are no other risks. The most significant risk is the potential limitation of contract market capacity for Ethena.
The first risk is liquidity risk.
Currently, the issuance of USDe is approximately $2.04 billion, of which ETH and LST account for about $1.24 billion. This means that under complete hedging conditions, $1.24 billion in short positions need to be opened, and the required position size is proportional to the scale of USDe.
Currently, Binance’s ETH perpetual contract position size is about $3 billion, and 78% of Ethena’s USDT reserves are stored on Binance. Assuming that the utilization of funds is uniform, this means that Ethena needs to open short positions with a notional value of $970 million * 61% * 78% = $710 million on Binance, which already accounts for 32.3% of the position size.
If Ethena’s position size occupies an excessively high proportion on Binance or other derivative exchanges, it will have many negative effects, including:
1) It may increase trading friction.
2) It may not be able to cope with large-scale redemptions in a short period of time.
3) USDe may push up the supply of short positions, leading to a decrease in fees and affecting the rate of return.
Although some mechanism designs may mitigate these risks, such as setting time-based minting/burning limits and dynamic fees (LUNA has introduced this mechanism), the best approach is to avoid putting oneself in danger.
Based on this data, the combination of Binance and the ETH trading pair can provide Ethena with a market capacity that is already very close to the limit. However, this limit can still be surpassed by introducing multiple currencies and multiple exchanges. According to Tokeninsight data, Binance occupies 50.1% of the derivatives trading market, and according to Coinglass data, the total contract position volume of the top 10 currencies on Binance, excluding ETH, is about three times that of ETH. Based on these two data points, the estimated market capacity of USDe is:
USDe market capacity theoretical upper limit = $2.04 billion * (628/800) * 60% / 4 / 50.1% = $12.8 billion
The bad news is that USDe has a capacity limit, but the good news is that there is still a growth space of 500% from the limit.
Based on these two limits, we can divide the growth of USDe’s scale into three stages:
(1) 0-2 billion: Achieve this scale through the ETH market on Binance.
(2) 2 billion – 12.8 billion: Need to expand collateral to mainstream coins with deeper market depth and fully utilize the market capacity of other exchanges.
(3) Above 12.8 billion: Need to rely on the growth of the crypto market itself and introduce additional collateral management methods (such as RWA and lending market positions).
It should be noted that if USDe wants to truly flip centralized stablecoins, it needs to surpass USDC and become the second largest stablecoin at least. The current total supply of USDC is about $34.6 billion, which is 2.7 times the potential capacity limit of USDe’s second stage, and it will be a bigger challenge.
Another point of controversy about Ethena is that the protocol’s funds are custodied by third-party institutions. This is a compromise based on the current market environment. According to Coinglass data, the total BTC contract position of dydx is $119 million, accounting for only 1.48% of Binance’s position and 2.4% of Bybit’s position. Therefore, it is unavoidable for Ethena to manage positions through centralized exchanges.
However, it should be pointed out that Ethena adopts the “Off-Exchange Settlement” custody method. Simply put, funds managed through this method do not actually enter the exchange but are transferred to a dedicated address for management. Typically, it is jointly managed by the grantor (Ethena), the custodian (third-party custodial institution), and the exchange. At the same time, the exchange generates corresponding quotas based on the scale of the custodial funds, and these funds can only be used for trading and cannot be transferred. Settlement is then carried out based on the profit and loss situation.
The biggest advantage of this mechanism is that it “eliminates the single-point risk of centralized exchanges” because the exchange never truly controls these funds. At least two out of the three parties need to sign for the transfer to be possible. Under the premise of trustworthy custodial institutions, this mechanism can effectively avoid rug pulls by exchanges (such as FTX) and project teams. In addition to the services listed by Ethena, Copper, Ceffu, Cobo, Sinohope, and Fireblocks also provide similar services.
Of course, custodial institutions also have theoretical possibilities of malfeasance. However, based on the current dominance of CEX and the frequent occurrence of on-chain security incidents, this semi-centralized approach is the best solution for regional optimization, rather than the final form. But after all, APY is not free, and the key is whether these risks should be taken on for the sake of higher returns and efficiency.
USDe requires pledging to earn returns, and since the collateralization rate is not 100%, the APY of sUSDe will be higher than the derivative fee rate. Currently, approximately $470 million of USDe is pledged in contracts, with a collateralization rate of only about 23%. The 37.1% nominal APY corresponds to an underlying asset APY of about 8.5%.
Currently, the ETH staking APY is about 3%, and the average funding rate over the past 3 years is about 6-7%. An 8.5% APY for underlying assets is sustainable, but whether the 37.1% sUSDe APY can be sustained will depend on whether there are enough applications to carry USDe, thereby reducing the collateralization rate and bringing higher returns.
Other risks include contract risks, liquidation and ADL risks, operational risks, and exchange risks. Ethena and Chaos Labs provide more detailed explanations.
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– ENA surges to $1.4 and hits a new high! Ethena introduces new incentive measures, and a whale throws in $8 million. USDe market cap exceeds $2.2 billion.
– In-depth analysis of Ethena: Why can USDe provide the highest stablecoin returns and what are the hidden risks?
– ENA surges 70% to $1.3! USDe market cap exceeds $1.9 billion, with 82% reserves composed of ETH and USDT.