The stablecoin market is often seen as one of the holy grails of the crypto world. Major players like Tether’s USDT and the former Terra’s UST have held significant positions in the industry. Over the past two months, a new high-yield stablecoin project has emerged, rapidly becoming the fifth-largest stablecoin: on February 19th, Ethena Labs, the issuer of USDe, launched its public mainnet, aiming to create a synthetic dollar, USDe, based on Ethereum (ETH). As of this writing, USDe’s supply has surpassed 2.366 billion, making it second only to USDT, USDC, DAI, and FDUSD.

Source: https://www.coingecko.com

What exactly is the USDe stablecoin project, how has it managed to stand out in such a short period, and what controversies surround it? Additionally, what new variables are emerging in the recent stablecoin market?

The Rapid Rise of the Stablecoin USDe

The biggest impact of USDe on the stablecoin market is undoubtedly its rapid rise to over $2.3 billion in total supply within just two months, thanks to its high-yield characteristics. According to data from Ethena Labs’ official website, as of the time of writing, the annualized yield of USDe is still as high as 11.6%, and previously it even maintained above 30%, reminiscent of the 20% annualized yield of UST in the Anchor Protocol.

Ethena Annualized Yield and USDe Annualized Yield

So, what exactly is the stablecoin mechanism of USDe, and why does it offer such a high annualized yield? The answer lies in a refined version of the Satoshi dollar concept that the BitMEX founder discussed in the article “Dust on Crust.” Simply put, aside from the expected Airdrop yields, USDe’s high yields mainly come from two sources:

ETH LSD staking yield;

Funding fee income from delta-hedged positions (i.e., perpetual futures short positions);

The former is relatively stable, currently fluctuating around 4%, while the latter is entirely dependent on market sentiment. Thus, USDe’s annualized yield is, to some extent, directly influenced by the overall network funding rate (market sentiment).

The key to this mechanism’s operation is the “delta-neutral strategy” — if a portfolio is composed of related financial products and its value remains unaffected by small price movements of the underlying asset, it possesses a “delta-neutral” property.

This means USDe achieves a “delta-neutral strategy” by balancing equal amounts of spot ETH/BTC long positions and futures ETH/BTC short positions: the spot position’s delta value is 1, while the futures short position’s delta value is -1, resulting in a total delta value of 0 after hedging, thus achieving “delta neutrality.”

In simple terms, when the stablecoin module of USDe receives funds from users and buys ETH/BTC, it will simultaneously open an equal amount of short positions through futures contracts, thus maintaining the value stability of each USDe token through hedging. This also ensures that there is no risk of liquidation loss for the collateralized positions.

For example, if BTC’s price is assumed to be $80,000, when a user deposits 1 UBTC, the USDe stablecoin module will simultaneously sell 1 futures BTC, creating a “delta-neutral” investment portfolio for USDe.

For example:

If BTC is initially priced at $80,000, the total value of the portfolio is $80,000 (80,000 + 0), so the total position value remains $80,000.

If BTC drops to $40,000, the total value of the portfolio still remains $80,000 (40,000 + 40,000), so the total position value remains $80,000 (and this is true for price increases as well).

Meanwhile, the futures short positions in the USDe stablecoin module, due to shorting 1 BTC in perpetual futures, earn funding fee income from the long positions. Historically, Bitcoin’s funding rate has been positive most of the time, meaning the overall return of the short positions is positive. This is especially true during bull markets with strong long sentiment.

When these factors are combined, USDe’s annualized yield can reach 20% or even higher. This shows that during extremely bullish markets, USDe’s high annual yield is especially reliable—because Ethena Labs capitalizes on the opportunity to earn funding fees by shorting in a bull market.

An old Ponzi scheme or a new innovation?

Interestingly, recent community debates about ENA/USDe have been intensifying, with many people comparing it to the former Terra/Luna and calling it a new version of Terra/UST’s Ponzi scheme. Objectively, USDe’s stablecoin generation and stabilization mechanism are significantly different from Terra’s approach and do not follow the self-reinforcing Ponzi-like strategy (similar to the martial arts technique of stepping on one’s own feet to reach great heights). Instead, USDe earns its high yields by collecting funding fees from traders going long during a bull market, providing a more sustainable support for its high returns. This is the biggest difference from Terra.

What is truly noteworthy is the second half of Ethena’s mechanism. If USDe faces a depegging challenge, it could potentially follow a path similar to LUNA/UST’s negative spiral, leading to bank runs and an accelerated collapse. This suggests the existence of a non-linear tipping point—if the funding rate becomes persistently negative and continues to widen, market discussions around FUD (fear, uncertainty, and doubt) would start, causing USDe’s yield to drop sharply and its peg to break, leading to a significant market cap decline (due to user redemptions):

For instance, if the market cap falls from $10 billion to $5 billion, Ethena would need to close short positions and redeem the collateral (such as ETH or BTC). If any issues occur during this redemption process (like liquidity problems in extreme market conditions or significant market volatility), USDe’s peg would be further compromised.

Source: coinglass

This negative feedback mechanism could be maliciously targeted, triggering the tipping point and leading to a negative spiral similar to the UST collapse. For investors, the critical concern is whether this “collapse tipping point” will occur, when it will happen, and whether they can exit in time.

To stay ahead, investors need to closely monitor factors like Ethena’s ETH and BTC holdings as a proportion of the total network and any shifts in the network-wide funding rate turning negative. Notably, with the recent market downturn, BTC and ETH network-wide funding rates have significantly dropped from over 20% annualized, even showing signs of turning negative. The latest data shows BTC at -1.68% and ETH at 0.32%.

According to Ethena Labs’ official website, the total value of USDe’s Bitcoin collateral exceeds $800 million, and Ethereum positions exceed $1 billion, making up nearly 80% of their assets.

Since Ethena’s strategy involves harvesting funding fees from all the crypto traders going long during a bull market, the high yields are heavily reliant on positive funding rates driven by market sentiment. If the network-wide funding rates continue to turn negative and this trend intensifies, USDe could face a significant challenge with sharply reduced yields.

The shifting dynamics of the stablecoin market
Zooming out to a macro perspective, the stablecoin market has always been a highly lucrative space. In fact, comparing horizontally, leading players like Tether have money-printing capabilities that rival those of centralized exchanges (CEXs):

In 2023, Tether generated around $6.2 billion in net income, which is 78% of Goldman Sachs’ $7.9 billion and 72% of Morgan Stanley’s $8.5 billion for the same period. Remarkably, Tether achieved this with about 100 employees, whereas Goldman Sachs and Morgan Stanley employ 49,000 and 82,000 people, respectively.

As of December 31, 2023, here are the net incomes, total employee counts, and income per employee of major companies (source: @teddyfuse). Previously, the article “Quarterly Income of $700 Million! How USDT’s Quiet Profits Explain the Fierce Competition in the Stablecoin Market” highlighted that Tether is currently one of the most profitable crypto companies outside of trading platforms (with Binance likely being the only one ahead).

For most Web3 projects and crypto companies, which often operate at a loss and rely on token sales for subsidies, Tether’s profitability is an unattainable benchmark. This is one of the main reasons the stablecoin business is so attractive.

According to CoinGecko, among the top 5 stablecoin issuers, USDT’s total circulation has surpassed $109 billion, making up about 69% of the entire stablecoin market, firmly holding the lead.

Besides the dominant USDT, since US regulators closed Silicon Valley Bank on March 10, 2023, USDC has seen a net outflow of over $112 billion, reducing its total circulation to around $33 billion—a drop of about 30%, placing it second. This is a significant lead over the third-place DAI ($5 billion).

Additionally, BUSD has been replaced by FUSD due to regulatory pressures, and with Binance increasing the frequency of LaunchPool, its total has quickly surpassed $3.5 billion. Following this is the rapidly emerging USDe, which brings a promising new variable to the market.

Overall, as decentralized stablecoins are removed from stability considerations and centralized stablecoins face challenges with “reserves + regulation,” decentralized stablecoins have become the greatest hope for the stablecoin market. This is why the high-yield USDe can rise quickly.

Currently, we are only in the early stages of the long-term stablecoin race. The arrival of new players like FDUSD and USDe is likely to change the competitive landscape and bring new dynamics to the stablecoin market, which is something to look forward to.

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