Edit | defioasis
The host of this episode is WuShuo analyst defioasis, and the guests are former BitMEX analyst and host of WuShuo English podcast Shang @lasertheend; and on-chain analyst and WuShuo consultant "Watchmaker Xiao Guo" @sankin_eth.
Statement: This article does not provide any financial advice. Readers are advised to strictly abide by local laws and regulations. The views of the interviewees do not represent the views of Wu Shuo and the interviewer. Readers are advised to distinguish clearly.
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Moderator: Ethena was originally inspired by Arthur Hayes, the founder of BitMEX, who was committed to creating a stablecoin backed by derivatives. In simple terms, Ethena eliminates the price instability of the underlying collateral assets by holding equal amounts of staked ETH (i.e. LST) and ETH perpetual contract short positions to build a stablecoin, i.e. USDe. This actually creates a Delta-neutral CDP, and the yield of holding staked USDe (sUSDe) actually comes from basis trading. The asset portfolio of holding spot and shorting futures is also called "spot-futures arbitrage", and the current USDe yield is about 17%.
For stablecoins, this return is very high, because the current benchmark return rate in the United States is about 4%. This inevitably reminds people of UST in the past, when the return rate of Anchor UST reached 20%. But in the end, everyone knows that LUNA, which has a market value of tens of billions, collapsed in one day, and UST became waste paper. Of course, the mechanism of Ethena USDe is still very different from LUNA/UST.
Will Ethena USDe end up being decoupled like UST?
Shang: USDe and UST are very different. My answer is no. You may not know how high the cost of funds in the cryptocurrency world is. The reason behind Ethena's high returns is not that stablecoins are sustainable. It can be said that the cost of funds in the cryptocurrency world is unsustainable. My answer is that Ethena has some risks of its own, but I think these risks are reasonable compared to its returns.
Lao Guo: My conclusion is yes. Because all stablecoins pegged to the US dollar have some risks, but under what circumstances will these risks be greatly exposed. Including in 2019, Tether, the issuer of USDT, also had doubts about whether there were some problems. At that time, the over-the-counter quote of USDT also fell to $0.8 and $0.7. In my opinion, all US dollar stablecoins, whether they are algorithms, mortgages, or relationships like USDT mapping, have the risk of depegging. We cannot talk about whether a stablecoin can grow healthily without considering the risk of depegging, because we need it to be stable and need it to be exchanged for US dollars 1:1. So its biggest risk, all risks will be attributed to the depegging.
Shang: Ethena is a stablecoin that needs to be discussed with Tether, not a stablecoin like LUNA.
Where might USDe decouple?
Lao Guo: I think it is only a matter of time before Ethena exposes risks, but it does not prevent us from participating in it now. I am also participating in some Ethena games now, which is quite interesting. But I want to talk about the decoupling point, hoping to warn everyone about the possible problems. Whether you invest in Ethena, ENA, or USDe, it may cause some risks.
First of all, the Ethena official documents have clearly indicated these risks, which is rare. Officially, there are about 5 types of risks, namely capital risk, liquidation risk, custody risk, exchange failure risk and collateral risk. The first four risks are all related to centralized exchanges. All of Ethena's revenue sources, or most of the stablecoin products, are in exchanges. Let's talk about these four risks first.
The first risk is funding risk. Ethena's source of income is through the funding rate of perpetual contracts. The funding rate is a contract scenario, and it will have a natural default value. For short positions, there will be a benchmark value of one ten-thousandth. When the spot price and the contract price are decoupled, it will adjust this benchmark value to balance the long and short positions. So most of the time, the funding rate of short positions can make money. Simply put, the higher the bull market rises, the higher the funding rate; when a bear market or a crash occurs, the funding rate is a negative value, and at this time, short positions need to pay interest to long positions. In this case, in addition to zero income, Ethena's income also has to pay these interests. Of course, the official also prompted that there will be some hedging and the like. In the long run, this point includes 312 and 519, which briefly have negative funding rates within 30 days or 15 days.
The second risk is the risk of liquidation. Because balanced positions may have some problems. It uses ETH assets as collateral and then opens a short position on the exchange. What is the problem here? Many people say that a one-time short position will not be liquidated. Yes, but this is in the case of a coin-based perpetual. In fact, the logic that it will not be liquidated is that in a coin-based perpetual, it can use the coin-based margin to ensure that the margin is balanced against the US dollar price when it rises. However, the current way Ethena is used, we cannot directly see its position on the exchange, and the document says that it may be mixed with ETHUSDT perpetual shorts. When we use spot to open a short USDT perpetual, there will be risks under extreme market conditions.
These two are risks related to strategic trading. The custody risk and exchange failure risk mentioned later are actually not the risks of the traditional exchange Rug. We used to think that many exchanges were too big to fail, but the failure of FTX shows that the risk of the exchange is not that it does not exist, but that we use such a custody method to trade cryptocurrencies for the sake of convenience and low fees. So why are there two risks here? It is because Ethena uses a method that does not store the real assets on the exchange, but in a third-party custodian. The custodian provides some certificates to the exchange, allowing it to use the funds certified by the custodian to trade on the exchange. Here, a third party is used to reduce some of the risks of the exchange itself. Of course, as a third-party custodian, the custodian itself also has the risk of a custody plan.
The last risk is that Ethena uses a method to create more interest, that is, to exchange ETH for Lido stETH. This also creates a risk of Lido's own stETH decoupling and Lido's node staking risk, such as a large node disconnection, resulting in the deduction of node revenue and profit, or Lido's own deposit contract has a loophole and is stolen by hackers.
Taken together, these five risks are quite a lot. Many of these risks have occurred in the past. So I think it is relatively obvious that there are risks that may arise in Ethena's future or throughout its development.
Among the risks analyzed, what is the biggest risk that USDe may face in the future?
Lao Guo: I think the biggest risk should come from the violent fluctuations in the market. In my mind, the most likely point is that the violent fluctuations in the market will lead to the squeeze faced by the imbalance between its spot long positions and contract positions. But I also think that it will not be completely de-anchored like UST, completely zeroed, but partially de-anchored. As for these risks at present, there are some ways to hedge, such as placing multiple exchanges and multiple custodians. The final solution will not be completely zeroed like LUNA, but after a large number of de-anchors, everyone will lose information about this variety, making its share smaller and smaller, and the yield will not be that high. At present, most of the participants participate in it in addition to the yield of USDe itself, in order to mine ENA.
How do you view the risks mentioned by Lao Guo?
Shang: I think there are two types of decoupling. One is the LUNA/UST type, which is a decoupling that will never go back. I think USDe will not decouple like LUNA. I also completely agree with the risks mentioned by Lao Guo. When I say USDe will not decouple, I mean that it is not an independent risk in Crypto, and it will also perform with the overall Crypto market. Of course, I don’t mean that USDe is particularly good.
USDe or the mechanism behind it is directly related to the entire Crypto encryption system. If USDe has problems, then the entire industry may have problems. It is not because of USDe that the entire encryption system has problems. That is, if USDe has big problems, then its premise is that there are problems with the entire encryption system or centralized exchanges, or problems with staked ETH such as restake, which are very fatal to the entire encryption industry.
USDe is a native stablecoin that is more Crypto Native. It does not rely on any traditional financial or banking-related systems. To a certain extent, it is also a relatively good thing. Like Tether and Circle, they may be sanctioned by large centralized banks, but Ethena will not, because all its risks are in the encryption system.
Of course, I also agree with what Lao Guo just said about the risks. The mechanism of Ethena is a very simple basis transaction, long spot and short futures, which is also something we can do ourselves, and it is not particularly difficult. Risks do exist. For example, the yield of Pendle PT is 60%-70%, but 70% APY is worth participating. If the funding rate gets lower and lower in the future and the bear market comes, the results of Ethena will not return to zero, but will close the losing positions like our own transactions, which also means some slippage costs and funding fees, but overall it is controllable. It may decouple to $0.95 or $0.9, but its position value still exists, unless the entire industry is hit by a fatal blow, such as problems with centralized exchanges or staked ETH.
For example, if USDe really decouples to $0.95 or $0.9, and you think it will re-peg at the earliest, then would you consider buying the dip? Or, at what level would you consider buying the dip in the hope of getting the benefits of re-pegging?
Shang: A very important premise is the expectation for the future. All the capital costs in finance are for everyone's expectations. If I think I am still optimistic that this market will rise in the future, then naturally the capital costs in the future will become higher and higher. Perpetual futures are ultimately the cost of leverage. The more people leverage, the higher the capital cost will be. This is on the demand side. In addition, there is also the supply side to think about. Now I think Ethena has caught a particularly good opportunity. Many centralized large traditional financial institutions are increasingly afraid to touch Crypto. However, this strategy that does not make money in traditional finance can make a lot of money in Crypto. For example, no one will talk about the basis trading of gold futures in traditional finance. In Crypto, this very simple basis trading can make a lot of money. If many traditional financial institutions use their own funds to lower these interest rates in the future, it will also have a great impact on the future of Ethena.
In general, (if the market decouples), bottom fishing is not a particularly good strategy. No matter how confident you are, its risk-return ratio is not symmetrical. Whether there is a 10% or 90% probability, you should not do it, because in the end you can only make 10% at most, but you can lose 100%.
Ethena's Proposition on Crypto Native Stablecoins
Lao Guo: Shang mentioned a proposition of Ethena, which is to make Crypto native stablecoins. I think Ethena is a newer exploration and newer method compared to Aave, MakerDAO, USDT, and even earlier algorithmic stablecoins. This method itself also has some problems. It is called the native stablecoin of cryptocurrency, but we found that its yield, balance, and stability are all derived from being non-transparent and non-public, and generated in a centralized environment. Its transparency is contrary to the entire crypto-native attribute. So from my point of view, if you really want to fight this solgan from the point of Crypto Native, I will not be too attracted by this point. From the perspective of Ethena's investors, they are all relatively large centralized exchanges. What attracts me more is that Hayes brings these people together by face recognition and puts funds in it. Of course, he will not say that this is a centralized stablecoin, so no one will buy its governance token.
Shang: I don’t think it’s because he wants to go to these centralized places, but because most of the positions are held and opened in centralized exchanges, so he has to open positions in a decentralized way. If you want to make this money, the largest volume is in centralized exchanges. It’s not that you can only do it on centralized exchanges, to a certain extent it’s a last resort. This is a lot of money, this is not a meme, anyone with a little financial knowledge can do such a transaction, the technical threshold is very low. I believe that in the future everyone will go to decentralized on-chain exchanges to trade, and they will also transfer these short orders to decentralized exchanges.
The limitation of contract market capacity on Ethena
Lao Guo: I think this question is a bit of a fuss. First of all, the generation of USDe is also managed in a relatively centralized way. Ordinary users cannot generate USDe through USDT or USDC, but can only exchange it through some liquidity pools. It has a whitelist mechanism that allows certain special addresses to generate directly from USDT, etc., instead of purchasing through liquidity pools. Secondly, its contract has a total upper limit switch to limit the total issuance of USDe. The total issuance limit is used to avoid capital collapse.
The current contract market has tens of billions, how to reach 100 billion or hundreds of billions in the future, I think this question is a bit self-inflicted. If USDe can really reach 10 billion or 100 billion, then the prosperity of the entire contract market will not be as small as it is now. The current market value of USDe is more than 2 billion, which is indeed small compared to Tether's market value of nearly 100 billion, but it has not said that its vision is to issue 50 billion or 100 billion when the contract market is only 30 billion. It has not said so, and it is still in a relatively restrained state. This is a bit like worrying about something before that time comes. I think this worry is a bit too pessimistic.
Shang: The founder and I mentioned this issue in the English podcast. In the end, we think there is no need to compare USDe with Tether, because Tether makes too much money. The money that Ethena's project team and ENA holders can make is enough. So I think its upper limit will not affect its success. As it is now, it is also a very successful product. In my eyes, I will not regard USDe as a stable currency, but as a financial product. This is a lazy DeFi farmer or someone with a certain financial background who does not want to manage the risks of these yields or basis transactions, then he will buy Ethena to stake. The risks just discussed are worth ENA subsidies. I think it will have a rising ceiling, but there is no way to think about these long-term problems that we cannot control. In the end, it will not have a particularly large risk of decoupling if the entire encryption system remains stable.
The worst case scenario is that Ethena eats up all the funding rates in the market, and futures trading may only be 5% or 10%, or even negative in the worst case. In this case, we will take the money back, and the project will close all positions. There may be some losses in this process, but it is worth it. Even if this project and token cannot reach too high a height, it is actually a very successful project.
In addition, it does not mean that once we hit the ceiling, our money will be stuck there. We can still redeem it and make money before that. The final loss will be at most 5% or 10%.
Holding spot and shorting an equal amount of positions to capture delta-neutral USDe. What are the suitable usage scenarios for this type of stablecoin?
Shang: Its biggest use is to increase the basic income of all stablecoins. If you look at it from the perspective of financial products, if you are interested in DeFi, you will do a very natural thing, which is to add leverage to ordinary USD at a lower interest rate, for example, 10%, and then use this 10% cost to buy USDe. USDe has an annualized rate of 70%, so you earn 60% in the middle. If you transfer USDe to Mantle, the benefits to Mantle will be particularly great, and the stablecoins on it will have a greater demand for lending. This is what I see USDe doing to the entire industry. It tokenizes the basis, which allows both hardworking and lazy people to enjoy better returns, and makes the competition cost of the entire market more reasonable.
Lao Guo: Shang mentioned a point that inspired me. When I thought about USDe before, I thought of it as a stablecoin. In fact, it should be thought of as a DeFi strategy or a yield pool. Then its entire logic is different. Compared with many DeFi products, I think Ethena's risk is much smaller. Then, I think USDe has a new point in that it has become a so-called golden shovel. Like Pendle and Mantle, we talked about before, through some cooperation methods, USDe can be used to mine the platform coins of other platforms. For example, Mantle will also give some points or more incentives to USDe providers in the future. So if we regard USDe as a golden shovel or a DeFi yield pool, I think the comparison between its value and risk is quite interesting.
Is Ethena worth investing in now?
Lao Guo: Our current investment strategies for Ethena are mainly divided into two types, one is to buy USDe, and the other is to buy ENA. The total circulation market value of ENA is quite exaggerated, close to 18 billion US dollars. I used to have a very simple and rough valuation method for all DeFi products, using FDV/TVL. At present, the market value ratio of most markets is about 2. At present, ENA is 7-8, which is a relatively overvalued state. But at the same time, ENA also has a large number of lock-up mechanisms. Currently, only about 10% of ENA is circulating in the market. From the perspective of investment cost-effectiveness, if you have a little knowledge of DeFi or on-chain experience, you should use USDe to mine ENA, rather than directly buying ENA on the exchange and waiting for its rise, because its direct rise space may not be particularly high. Directly owning USDe can make various combinations, and its own income and stable odds are more suitable than ENA. I think you should not buy ENA on the exchange, but instead obtain and mine ENA through some on-chain operations, which is equivalent to obtaining ENA at a very low cost, although its volume will be viewed based on the USDe holdings.
Shang: I agree with the FDV/TVL method mentioned by Lao Guo. Based on this method, I looked at some other projects and found that this is indeed a relatively good way to judge whether they are underestimated or overestimated in the long run. For example, AAVE has a FDV of more than 10 billion. If I remember correctly, Ethena ENA is eight or ten times that of AAVE, which is very exaggerated.
I think there are two points. The first point is that ENA's current valuation is not particularly high compared to its moat. It's not that we can't do these things ourselves. If it weren't for the ENA token, we could do this transaction ourselves, because it's very, very simple. In fact, I also did such a transaction before the big drop. Suppose there is $50,000, spend $25,000 to buy ETH, convert ETH into Renzo's ezETH, and then sell ezETH to Arbitrum Pendle, mint it into PT, and expire in 75 days. In these 75 days, I can earn 10% of the income. The remaining $25,000 goes to Binance's futures platform to earn 20% basis. This is about 40% annualized. This is much higher than the current interest rate of staking USDe directly on Ethena. If you use this basis to calculate how much everyone expects ENA's valuation, I feel that everyone's expectations are already very, very high, and I don't think it can be much higher in the future. I also participated in the first ENA airdrop. Everyone made a lot of money. I couldn't believe that so much could be airdropped. The first wave made so much money, so the number of people who came to pay for the second and third waves will be less and less, and everyone will think about digging ENA. Now USDe has more than 2 billion, and everyone may think that this plate may not be able to support so much selling pressure. In the end, no one will buy ENA, but USDe and sell ENA.
I think the recent sharp drop is also because there are too many new projects in the market, and the market funds simply cannot bear so much liquidity. With more and more projects being launched, the liquidity left by each project may become smaller and smaller, because in the end, except for Bitcoin, which is constantly expanding, other altcoins are all PvP situations. So, what I will do is to buy USDe, sell it directly on Pendle and convert it into PT to lock in 70% annualized returns. In the end, even if it fails, the loss will not exceed 10%. I believe that Ethena has raised so much funds and the team's execution ability.
Free sharing
Shang: Let me give you an overview. I think Ethena USDe is a very interesting project that everyone can participate in, especially when the expectations and yields are high. I don’t think USDe will return to zero like LUNA/UST, but I do think it will have a certain risk of decoupling. In the end, it is directly different from traditional stablecoins such as the US dollar and USDT.
Lao Guo: I think the audience (readers) who can come here are very interested in the Ethena project. My point of view is that whether you have bought USDe or ENA before, you should participate in this event in person. A joke in the currency circle last year was that people with IQ 50 and IQ 150 can make money, and people with IQ 100 will identify and recognize risks and see this as a ponzi and that as a scam. In the end, they gained the recognition of smart risks, but in the end they did not make a dime. I think Ethena is also such a variety. Its risks are there, visible, and can be analyzed, but it is undeniable that its income and growth prospects are very large at this stage. If you think it is risky and don't participate in it, then I think you are not a person who comes to Crypto to take risks. Everyone has different risk preferences. Some people trade ENA directly in the secondary market, and some people use USDe to combine these risks. In any case, you should participate, but the degree of participation does not require so much funds or full commitment. You can use part of the funds to perform some simple operations to truly understand the operating mechanism of Ethena. Action is far more important than analysis and understanding.
