Will it fail like UST? Analyzing the differences between Ethena and UST

Will Ethena Collapse in a UST-Style Crisis?

I've seen some misunderstandings in some of the posts, and I just wanted to clear them up in this post. (I have no connection with them and I don't stand to gain anything from their success or failure.)

First of all, what is Ethena? It is a synthetic dollar protocol. Taking 1 ETH synthetic dollar as an example, when buying spot ETH (or stETH), it will hedge the nominal equivalent of ETH shorts accordingly.

So why one dollar? This is because in any normal situation, the return is fixed. As long as the basis of the forward/futures/perpetual contract to the spot remains unchanged, a basket of spot and its corresponding short position will maintain the same value, without holding and funding rate.

So why is it so attractive? In short, because capital injections have been very aggressive - in a bull market, everyone is looking for leverage and cheap USD borrowing. 5bps every 8 hours? If the market is going up 10% a day, this is not a problem.

As a result, Ethena’s recent yield looks to be around 35%. This is likely to continue as long as there is demand for leverage in the space.

UST failed because the collateral backing the issued UST was native Luna, and as the price of Luna collapsed, the available collateral denominated in USD experienced a self-reinforcing vicious cycle when Luna was issued and sold to the market.

However, in general, for Ethena, the collateral backing the issued USDE is a basket of assets that will generally maintain value across the price range, as long as the spot/perpetual contract or spot/futures contract basis does not explode.

Cryptocurrencies often exhibit downside convexity. Prices fall faster than they rise. In my opinion, this design is actually very beneficial to Ethena.

As the price continues to fall, without liquidation, the percentage of USD cash held by Ethena actually increases. In the example below, you can see that a drop in ETH to 1k would result in 2.5k of the 3.5k collateral basket being cash…

Is there a risk here? If there is a risk, it is using stETH as collateral. Compared to ETH, stETH has much less spot liquidity. However, after the Shapella upgrade, the stETH/ETH discount IMO hit bottom.

Before Shapella, stETH sellers were subject to buyers. After Shapella, if the stETH/ETH exchange rate rises severely, sellers can choose to wait longer (1-5 days) and then withdraw stETH to exchange for ETH.

The other elephant in the room would be counterparty/exchange risk. If an exchange went bankrupt due to the crisis, Ethena could experience significant impairment. Their exchange listings look pretty good, though.

That leaves one last risk - operational risk. The Ethena concept should work. It's pretty neat. However, it also relies to some extent on smart trading, execution and risk management with uncertainty.

In a crisis of confidence, as long as Ethena's execution is perfect, USDe will have a floor price, as the basket of assets will maintain its value. However, what I have noticed is that, in general, crisis situations can make us blunder - traders may be tempted or forced to exit basis trades, thereby creating delta risk. Overall, however, the basic concept of Ethena should work.

Ethena may also change market mechanisms and bring about new price relationships - however, this is something we can only evaluate in the future.

I think Ethena will actually add fuel to the bull run. Current market makers generally don’t hedge their perpetual shorts with spot longs (unless they are grinding basis), and what they want to see is a general disappearance of delta.

Even though Ethena is delta neutral, the spot demand it inadvertently creates will cause more upward price slippage while putting pressure on the basis.

In summary, Ethena is a good concept and it does good things. If it fails, it will be because of execution and risk issues in edge cases.