The crypto world has long been in need of a decentralized base currency asset that does not rely on traditional banking infrastructure. While stablecoins have become a vital financial tool within the crypto ecosystem, they are still tied to centralized systems, presenting risks such as custodial failures and regulatory challenges.
Ethena aims to address these issues by providing a scalable, crypto-native form of currency that is censorship-resistant and independent of traditional banking infrastructure. By doing so, it strives to lay the groundwork for a truly decentralized financial system capable of operating on a large scale.
What is Ethena?
Ethena is a synthetic dollar protocol on Ethereum, enabling a stable, scalable, crypto-native currency, USDe, free from traditional banking. It utilizes delta-hedging techniques, using Ethereum as collateral, ensuring the stability and synthesizability of USDe within DeFi. The protocol also introduces "Internet Bonds," leveraging Ethereum staking and derivatives market yields to offer a unique dollar-denominated saving tool for users in compliant jurisdictions.
This initiative marks a significant advancement in crypto finance, enabling censorship-resistant transactions and innovative savings mechanisms. By leveraging on-chain transparency and liquidity staking derivatives, Ethena not only enhances the utility and efficiency of digital currencies but also helps Ethereum evolve into a stable monetary asset, fostering broader application and capital inflow into the crypto ecosystem.
How Does Ethena (ENA) Work?
At the core of Ethena is the USDe token, a fully-backed, on-chain transparent synthetic dollar free to use within DeFi. The stability of USDe is ensured through a mechanism known as Delta hedging, which involves offsetting the price fluctuation risks of collateral assets with corresponding short futures positions.
Minting and Staking USDe
Minting USDe involves users requesting a price from Ethena's pricing API and generating a signed order, which is then checked by Ethena's servers. Once approved, the order is sent to the blockchain for execution, and users receive USDe tokens in return. Slippage management ensures that transaction outcomes are predictable, thus minimizing the risk of price disparities. This process, driven by Ethena's minting system, merges centralized and decentralized elements to ensure a high degree of trustlessness.
Moreover, users can stake their USDe tokens to earn rewards. For this, users transfer USDe into the StakedUSDe smart contract and receive staked USDe (sUSDe) tokens in return. Rewards accumulate over time based on the earnings generated by the protocol, providing users with a passive income stream.
Yield Generation
Ethena generates sustainable yields from two primary sources. First, staking ETH for consensus and execution layer rewards provides variable returns. Second, funding and basis from Delta hedging derivative positions offer additional earning opportunities, with historical interest rates fluctuating according to market dynamics.
How Does Ethena Generate Dollar Yields?
eUSD yields mainly come from two aspects, both aiming to ensure the sustainability and diversity of risk management:
Staking Ethereum Rewards: Yields come from Ethereum's proof-of-stake model, including consensus layer inflation rewards, execution layer fees, and MEV capture. These rewards are paid and priced in Ethereum, with the yield percentage influenced by network activity and the quantity of Ethereum staked.
Funding and Basis: Stemming from delta-hedging derivative positions established by Ethena Labs when minting USDe. Positive funding rates and basis arise from an imbalanced demand for risk exposure to digital assets, providing additional earnings for those who short this risk exposure. This yield fluctuates annually based on market conditions.
By staking USDe for sUSDe, users participate in this yield mechanism. The "token vault" model ensures that staked USDe directly generates earnings without the need for re-collateralization. Thus, the value of sUSDe increases over time, reflecting the protocol's accumulated earnings.
This model ensures that users benefit from the intrinsic earnings of their staked assets, as the protocol continually deposits earnings into the staking contract, increasing the value of sUSDe relative to USDe.
Ethena Tokenomics
The tokenomics of Ethena Token (ENA) were announced at the conclusion of the Ethena Shard event, with a total supply of 15 billion ENA. The initial circulating supply is 1.425 billion. The allocation includes:
Core contributors: 30% of ENA allocated to the team and advisors, with a lock-up period of 1 year, followed by monthly vesting over 3 years.
Investors: The vesting schedule for investor tokens is the same as that for core contributors, to support the protocol's launch and reserve fund.
Foundation: Utilizes its grants to expand the coverage of USDe through development, audits, etc., reducing reliance on traditional financial and fiat-backed stablecoins.
Ecosystem Development and Airdrops: 30% allocated for ecosystem development, including airdrops to users and funding for various initiatives like cross-chain collaborations, managed by a DAO with multi-ID control.
This structure aims to balance incentivizing early contributors while ensuring a gradual release of tokens to the market to support ongoing development and ecosystem expansion.
Problems Solved by Ethena
In the decentralized stablecoin domain, collateral is essential to support the value of the stablecoin. Whether it's MakerDAO's DAI, Curve's crvUSD, or Aave's GHO, the essence is leveraging financial collateral to unlock purchasing power. To ensure the 'safety' of stablecoins, over-collateralization is necessary, which means that the volume of locked capital exceeds the volume of stablecoins released, also relying on the potential demand for leverage.
Ethena introduces a stablecoin, USDe, pegged 1:1 with the US dollar, aiming to be a censorship-resistant, scalable base asset in DeFi applications. By combining Ethereum staking rewards and futures market returns, it allows anyone to earn returns denominated in USD and become an 'internet bond,' widely used as a foundational asset in DeFi. Different bonds can be created based on various hedging strategies, like using perpetual contracts for floating-rate bonds or delivery contracts for fixed-rate bonds.
Ethena Yield
Ethena staking ETH to obtain USDe is profitable, thanks to the Ethereum Shanghai upgrade, turning ETH into a cryptographic treasury note, equivalent to a government bond.
USDe stakers share dual returns:
Stable returns from long positions in spot ETH staked through liquidity protocols like Lido, earning 3% - 5% APY.
Variable returns from the funding rates of short futures positions due to the perpetual contract mechanism in the crypto market, which often favors the shorts over the long term, thus ensuring overall positive returns.
The combination of these returns has led to a notable yield for USDe, with official data showing APYs reaching up to 58.9% and as low as 10.99%.
Risks of Ethena
Ethena utilizes staked Ethereum spot assets as collateral for hedged derivative positions. The assets used, like Lido's stETH, differ from the derivative's underlying asset, ETH. The positions would only start to be liquidated if the price gap between ETH and stETH widens to 65%, a scenario never seen historically, with the maximum gap being 8% before Shapella and during May 2022's Luna de-pegging.
Beyond mechanistic risks, Ethena faces risks primarily from the centralized exchanges hosting the derivative positions. Given Ethena Labs' reliance on off-exchange settlement solutions for asset custody, there's dependency on their operational capabilities. Any disruptions or degradations in deposit, withdrawal, or trading abilities at exchanges could hinder the trading workflows and the minting/redeeming of USDe functionalities.
Summary
The introduction of USDe and "internet bonds" on the Ethereum platform by Ethena marks a significant advancement in decentralized finance (DeFi). This initiative sets a new standard for financial innovation in the cryptocurrency realm by offering a stable, scalable digital currency and a unique savings tool. Leveraging Ethereum's infrastructure and adopting triangular hedging to ensure transparency and stability, Ethena aims to attract more capital into DeFi, enhancing financial empowerment and reducing reliance on traditional banking systems.
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