USDe, the USD stablecoin protocol led by BitMEX co-founder Arthur Hayes, is often compared to UST, raising concerns about potential risks similar to a Ponzi scheme. So what are the risks that USDe may encounter? This article, sourced from BeWater.xyz and published in X, provides an analysis and interpretation.
USDe Definition: Fully Collateralized Semi-Centralized Stablecoin
1. Analysis of Collateral Value
a. Market Capacity Risk
b. Custodial Risk
c. Sustainable Interest Rate Risk
d. 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 may be overlaps and variations in these classifications. For example, algorithmic stablecoins like AMPL and UST were previously considered to be completely regulated by algorithms for supply and circulation. 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 worth at least the value of LUAUSD (USDT & USDC). LUAUSD has both the characteristics of an algorithmic stablecoin and a fully collateralized stablecoin.
Another example is DAI. When DAI’s collateral consists of 100% on-chain assets, DAI is considered a non-centralized custodial stablecoin. However, with the introduction of RWA, some of the collateral is controlled by real-world entities, making DAI a hybrid custodial stablecoin.
Based on this, we can simplify the classification into three core indicators: whether there is full collateralization, whether it is permissionless issuance, and whether it is non-custodial. Comparing USDe with other common stablecoins, there are some differences in these three attributes. If we consider that “decentralized” requires both “permissionless issuance” and “non-custodial,” then USDe does not meet the criteria. Therefore, it is appropriate to classify it as a “fully collateralized semi-centralized stablecoin.”
The first question is whether USDe has full collateral. The answer is obviously yes. As stated in the project documentation, the collateral for USDe is synthetic assets composed of cryptographic assets 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, the spot price increases by a dollars and the futures position value increases by b dollars (a, b can be negative), 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 constant, 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 it gradually approaches 0 by the delivery date (excluding trading frictions). This means that ΔY must be positive. Therefore, if the basis is Y during synthesis, the value of the synthetic position on the delivery date will be higher than the initial state.
The portfolio of holding spot and short futures positions is also known as “cash and carry arbitrage.” This arbitrage structure itself does not have risk (but has external risks). Based on current data, constructing this investment portfolio can achieve a low-risk annualized return of approximately 18%.
Now let’s return to Ethena. I couldn’t find an accurate definition on the official website regarding whether they use delivery contracts or perpetual contracts (considering trading depth issues, the probability of perpetual contracts is higher), but they have disclosed the on-chain addresses of the collateral and the distribution on CEX.
In the short term, these two methods will have some differences. Delivery contracts provide a more “stable and predictable” rate of return, and the expiration return is always positive. Perpetual contracts, on the other hand, are products with a fluctuating interest rate, and the daily interest rate may be negative in specific situations. However, based on experience, the historical returns from arbitraging perpetual contracts tend to be slightly higher than those from delivery contracts, and both are positive:
1) Delta-neutral futures short positions are essentially lending funds, and funds cannot maintain a 0 interest rate or negative interest rate for a long time. Moreover, these positions stack USDT risk and centralized exchange risk, so the necessary rate of return must be higher than the risk-free rate of return in USD.
2) Perpetual contracts need to bear variable expiration returns and pay additional risk premiums.
Based on this, it is completely wrong to worry that “USDe” will not be able to fulfill its obligations or compare it to UST. According to the collateral risk assessment framework introduced at the beginning of the article, the current core/narrow collateralization ratio of USDe is 101.62%. Taking into account ENA’s circulating market value of 1.57 billion, the broad collateralization ratio can reach approximately 178%.
The potential shrinkage of collateral due to negative funding rates is not a major problem. According to the law of large numbers, as long as the time is long enough, the frequency will converge to the probability. In the long term, the collateral value of USDe will converge to the growth rate of the average funding rate.
To put it in simpler terms: Imagine you can draw a card from a deck an infinite number of times, and if you draw a joker, you lose $1, but if you draw any other of the 52 cards, you earn $1. With an initial capital of $100, do you need to worry about bankruptcy from drawing too many jokers? Looking at the data is more intuitive. In the past 6 months, the average contract rate has been below 0% only twice. The historical success rate of cash and carry arbitrage is much higher than drawing cards from the deck.
Now that we have established that collateral risk is not a concern, it does not mean that there are no other risks. The most concerning risk is the potential limitation of contract market capacity on Ethena.
The first risk is liquidity risk. Currently, the issuance of USDe is about $2.04 billion, with ETH and LST accounting for approximately $1.24 billion. This means that in a complete hedge scenario, it would require opening short positions worth $1.24 billion. 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 the utilization of funds is evenly distributed, this means that Ethena needs to open short positions worth 61% * 78% * $2.04 billion = $970 million nominal value on Binance, which already accounts for 32.3% of the position size.
If Ethena’s position size dominates Binance or other derivative exchanges too much, it will have negative consequences, including:
1) It may increase trading frictions.
2) It may not be able to handle large-scale redemptions within a short period of time.
3) It may increase the supply of short positions on USDe, leading to a decrease in fees and affecting returns.
Although some mechanism designs may help mitigate these risks, such as setting time-based minting/burning limits and dynamic fees (LUNA has introduced this mechanism), the best approach is not to put oneself in danger.
Based on this data, the combination of Binance and the ETH trading pair already provides a market capacity very close to the limit for Ethena. However, this limit can be expanded by introducing multiple currencies and multiple exchanges. According to Tokeninsight data, Binance occupies 50.1% of the derivative trading market. According to Coinglass data, except for ETH, the total contract positions of the top 10 tokens on Binance are about three times that of ETH. Based on these two estimates:
The theoretical upper limit of USDe’s market capacity = $20.4 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 500% growth potential from the limit.
Based on these 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: Expand the collateral to mainstream coins with a deep market depth and fully utilize the market capacity of other exchanges.
3) Above 12.8 billion: 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 surpass centralized stablecoins, it needs to surpass USDC and become the second-largest stablecoin at least. Currently, USDC has a total circulation of approximately $34.6 billion, which is 2.7 times the potential capacity limit of USDe’s second stage. This will be a major challenge.
Another controversial point about Ethena is that the protocol’s funds are held by a third-party custodian institution. This is a compromise based on the current market environment. Coinglass data shows that dydx’s BTC contract position is $119 million, accounting for only 1.48% of Binance’s position and 2.4% of Bybit’s position. Therefore, it is inevitable for Ethena to manage positions through centralized exchanges.
However, it should be noted that Ethena adopts the “Off-Exchange Settlement” custody method. Simply put, funds managed through this method do not enter the exchange but are transferred to a dedicated address for management. Usually, it is jointly managed by the grantor (Ethena), the custodian (third-party custodian 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 made based on the profit and loss afterwards.
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 2 out of 3 parties must sign to transfer the funds. With the trustworthy premise of the custodian institution, this mechanism can effectively avoid exchange rug pulls (such as FTX) and project rug pulls. In addition to the listed Copper, Ceffu, and Cobo, Sinohope and Fireblocks also provide similar services.
Of course, custodian institutions also have the theoretical possibility of misconduct. However, considering that CEX still dominates the market and on-chain security incidents frequently occur, this semi-centralized approach is a regional best solution rather than a final form. However, APY is not free, and the key is whether it is worth taking these risks for increased returns and efficiency.
To earn income from USDe, pledging is required, and since the pledging rate is not 100%, the APY of sUSDe will be higher than the derivative rate. Currently, around $470 million of USDe is pledged in the contract, with a pledging rate of only about 23%, corresponding to a nominal APY of 37.1% and an underlying asset APY of approximately 8.5%.
Currently, the ETH staking yield is about 3%, and the average funding rate over the past 3 years has been around 6-7%. An 8.5% APY for the underlying assets can be sustained, but whether the 37.1% sUSDe APY can be sustained depends on whether there will be enough applications that can carry USDe to reduce the pledging rate and bring higher returns.
Other risks include contract risks, liquidation and ADL risks, operational risks, and exchange risks. Ethena and Chaos Labs provide more detailed explanations.
Related Reports:
– Ethena includes Bitcoin in reserves! Claims that existing USDe scale of $2 billion “can expand 2.5 times”
– Andre Cronje questions Ethena (USDe): The next death spiral after UST?
– $ENA surges 70% to $1.3! USDe market cap exceeds $1.9 billion, with 82% reserves composed of ETH and USDT.