Key Takeaways

• The SEC is expected to approve spot Ethereum, potentially bringing up to $5 billion in inflows within the initial six months.
• The approval of the Ethereum ETF could boost yields for Ethena’s synthetic dollar, sUSDe, much like the yields observed following the Bitcoin ETF approval.
• Ethena’s products have risks related to funding rate volatility, liquidity challenges, and potential vulnerabilities in smart contracts and custody operations. However, they are now well addressed in a transparent manner.
• Ethena plans to enhance the utility of its ENA token and is positioned to launch its Ethena Appchain.

2024 was a unique year in the crypto industry. From the institutional side, the year started with the approval of a Bitcoin ETF. This allowed traditional investors to gain exposure to Bitcoin’s price movements through a regulated financial product traded on established stock exchanges, without needing to directly own or manage the cryptocurrency. This was one factor that brought positive sentiment to the market, leading to the growth in the crypto market cap.

On the crypto side, the trend was launching its own rollups and memecoins. Compared to the last bull cycle, there weren’t many significant new primitives built and used by crypto users. However, in the DeFi dapps space, Ethena stood out. Ethena’s synthetic dollar, USDe, became the fastest crypto dollar to reach $3B, surpassing the record of DAI and USDC. Many factors contributed to this success, including its unforkable architecture, unique business model, and sustainable yield opportunities.

Looking at the present, one of the biggest market focuses is on the anticipated Ethereum ETF approval, expected to be announced this July. The approval of an Ethereum ETF could bring new liquidity to the Ethereum ecosystem, leading to other opportunities. This second-wave factor could position Ethena’s products - USDe, sUSDe, and ENA - for new opportunities. In this article, let’s explore the current sentiment on the Ethereum ETF and what this means for Ethena.

1. Current Status of Ethereum ETF and Inflow Estimates

So what is the current sentiment on Ethereum? The past sentiment surrounding Ethereum ETFs prior to May 2024 was marked by skepticism and uncertainty. This uncertainty was fueled by the U.S. SEC’s historical reluctance to approve cryptocurrency ETFs, particularly those tied to altcoins like Ethereum. As of July 2024, the U.S. Securities and Exchange Commission (SEC) has taken steps towards approving spot Ethereum ETFs. Following the approval of Bitcoin spot ETFs earlier in the year, the SEC granted rule changes in May 2024 to allow exchanges to list spot Ethereum ETFs. Several asset management firms, including BlackRock, Bitwise, and Fidelity, have filed applications for these products. As of 16th of July, spot ETF is likely to begin trading on 23th of July.

Source: Sizing the Market for the Ethereum ETF | Galaxy

1.1 Inflow Estimation After Approval

Source: Galaxy Digital, CoinDesk, Crypto Adventure, CryptoSlate, CoinDesk, Cointelegraph, The Block, Investing.com

It is quite difficult to put estimate on the inflow of Ethereum, since the Ethereum ETF market dynamics are influenced by factors distinct from Bitcoin, such as the substantial portion of ETH locked in staking, bridges, and smart contracts, which may amplify ETH price sensitivity. As retail gains easier access to the asset, this demand is expected to drive early inflows, with institutional interest growing as wealth management platforms increase accessibility. However, the lack of staking rewards might diminish some appeal.

Gemini, a crypto exchange, predicts that spot Ether ETFs could see net inflows of up to $5 billion in the first six months of trading. On the other hand, JPMorgan analysts have a more conservative estimate, projecting $3 billion in net inflows for 2024. Many analysts are using Bitcoin ETF performance as a benchmark, with estimates ranging from 15% to 50% of Bitcoin ETF inflows. Bitcoin ETFs had attracted $15.1 billion in net inflows within the first five months of trading.

There’s also a debate about whether Ethereum ETF approval will have as significant an impact on ETH price as Bitcoin ETFs did for BTC. Some analysts believe the effect may be more muted due to current market conditions and investor saturation. Ilan Solot, co-head of digital assets at Marex Solutions, expressed that “The ubiquitous pessimism is a strong set-up for outperformance. Same for the sell the news strategy, many will try to replay from the BTC ETF. However, I fear many inflow predictions could be over-benchmarked by comparing them to the BTC ETF numbers.”

2. Opportunity for sUSDe from Ethereum ETF Approval

The approval of a spot Ethereum ETF could potentially make sUSDe an attractive option for investors, drawing parallels from the recent Bitcoin ETF approval experience. Also, the approval would likely bring more institutional capital into the Ethereum ecosystem, potentially increasing the demand for dollar-denominated yield-generating assets like sUSDe. As a synthetic dollar offering high yields, sUSDe could become an attractive option for investors looking to maintain USD exposure while benefiting from the growth in the Ethereum market.

As a complmentary investment strategy for Ethereum ETF exposure, sUSDe can be a great fit. Let’s first look into what happened during the last Bitcoin ETF approval and examine how sUSDe yields work and potential influential factors.

2.1 Looking Back into When Bitcoin ETF Got Approved

The approval of Bitcoin ETF has had a profound impact on the market, driving up prices, increasing funding rates. Funding rates, which are periodic payments made between long and short positions in the futures market, saw a substantial increase, as more traders took long positions anticipating price appreciation. These rates are influenced by the demand and supply dynamics of the underlying asset.

Prior to the ETF approval, funding rates were relatively stable, hovering around 10%. However, post-approval, these rates spiked dramatically, reaching as high as 50% annualized. Similarly, an Ethereum ETF approval could drive up funding rates for ETH perpetual futures, benefiting sUSDe holders since the token’s yield is partially derived from these funding rates.

Also, the price of Bitcoin has also gone up since the approval. The chart illustrates the correlation between Bitcoin’s price and the annualized funding yield for perpetual futures contracts from July 2023 to July 2024. The data shows a significant increase in both Bitcoin’s price and funding rates following the ETF approval. The approval of the Bitcoin ETF by the U.S. SEC on January 10, 2024, led to a notable surge in Bitcoin’s price, which climbed from around $40,000 to nearly $80,000 within a few months.

Source: Ethena

Dollar-denominated assets, such as Ethena USDe, have gained prominence in the wake of the Bitcoin ETF approvals. These assets offer stability and attractive yields, making them ideal for use as a collateral in DeFi platforms. The yield on sUSDe, for instance, surged to over 30% post-ETF approval, highlighting its growing appeal among investors seeking stable and high-yielding assets. Let’s look into how this yield works and what could be the potential factor that would influence this.

Source: Ethena

2.2 Potential Impact on the Yields of sUSDe

Ethena’s USDe, a synthetic dollar token, emerged as a particularly attractive option after the Bitcoin ETF approval. By leveraging the increased market activity and higher funding rates, USDe was able to generate yields upwards of 30% post-ETF approval. This impressive return was achieved through a combination of strategies, including delta-hedging staked Ethereum collateral and capitalizing on the widened spread between spot and futures markets through its basis arbitrage. Let’s look into how it works, and why Ethereum ETF can effect this yields.

2.2.1 On How Yield is Generated in sUSDe

Source: Yield Explanation | Ethena Labs

The yield mechanism for sUSDe (Staked USDe) in the Ethena protocol works through a reward-bearing “Token Vault” system, similar to other staking tokens like Rocketpool’s rETH. When users stake their USDe, they receive sUSDe tokens, which represent a fractional interest in the total USDe held in the staking contract.

The protocol generates yield from two main sources: staking rewards from holding assets like stETH as collateral, and funding and basis spread earned from delta hedging derivatives positions. This yield is then distributed to sUSDe holders through an increase in the value of sUSDe relative to USDe over time. Importantly, the protocol ensures that the value of sUSDe can only increase or remain stable, with any potential losses covered by Ethena’s Insurance Fund. (However, the coverage of Insurance Fund is currently only around 1%.) Users don’t need to take any additional actions to earn yield; simply holding sUSDe allows them to benefit from the protocol’s generated returns. To learn more about how this works, read this article “Ethena: Growing a Synthetic Dollar into the billions” by Steve from Four Pillars.

2.2.2 Ethereum ETF and Yields of sUSDe

One of the key factors that could drive higher yields for sUSDe is the persistence of basis and funding rates in the perpetual futures markets. With the approval of Ethereum ETFs, there’s an expectation of improved demand for perpetual contracts, as institutional investors may seek exposure to Ethereum through various financial instruments. This increased demand could lead to a sustained positive funding rate environment, benefiting holders of sUSDe who can potentially earn additional yield from these funding payments.

Source: Ethena

The lagging spot demand on offshore exchanges, as more spot volume moves to regulated ETFs, could create interesting arbitrage opportunities. This situation might result in a persistent basis between spot and futures prices, which could be exploited by traders and potentially contribute to higher yields for sUSDe holders. Additionally, the positive sentiment following ETF approval could drive funding rates higher, further enhancing the yield potential for sUSDe. A historical data shows that during periods of positive sentiment, funding rates tend to increase.

However, it’s important to note that market dynamics can be complex and unpredictable, and actual outcomes may vary based on a multitude of factors.

Source: Ethereum: Funding Rates - All Exchanges | CryptoQuant

3. Risks of USDe and sUSDE

Ethena has grown in a short time frame, surpassing the previous record of other crypto dollars. It has been the fastest crypto dollar to reach $3 Billion, in about 200 days. This raises the question, will this be sustainable? What are the risks? In this part, let’s go through some of the risks.

3.1 Risks in Funding Rate and Liquidity

Source: App | Ethena

Ethena faces risks related to funding rates and liquidity. Funding rates can turn negative if there are more short positions than long positions, leading to losses for the protocol. If funding rates turn negative, the protocol will be required to make substantial payments to long positions, which can deplete the reserve fund (insurance fund). According to the research by Ethena, it shows that the combined yield of stETH and short ETH funding is positive on 89% of days, but negative on 11% of days.

This can be more difficult to manage as the market capitalization of USDe grows too large, making it difficult to maintain its delta-neutral position, and utilize reserve fund. Additionally, liquidity risks arise if there is insufficient liquidity in the underlying derivatives markets. This can impact the stability of USDe and the overall yield distributed to stakers. For example, if liquidity on centralized exchanges decreases during market downturns, Ethena may struggle to rebalance positions.

3.2 Custody and Smart Contract Risks

Source: Solution: The Internet Bond | Ethena Labs

Ethena is also exposed to custody and smart contract risks. The protocol relies on external platforms, such as centralized exchanges and Off-Exchange Settlement (OES) providers, which introduces potential risks stemming from their operations or security breaches. If these platforms face insolvency or operational issues, it can impact Ethena’s ability to execute trades and maintain its delta-neutral position. However, if a centralized exchange becomes insolvent, Ethena’s perpetual position will close, but the collateral assets themselves should be safe as they were never in the exchanges to begin with.

Furthermore, smart contract vulnerabilities or bugs can lead to unintended consequences or exploitation. While Ethena has implemented measures to mitigate these risks, such as using multiple providers and active monitoring, they remain a significant concern.

3.3 On Risks of Ethena

Like Conor Ryder, the head of research at Ethena have said, Ethena has potential risks, however, it has been one of the projects that have been open with it and has done public research, and has built real-time dashboard to be public about the status of Ethena.

These dashboards, accessible at Ethena website and other platforms like Dune Analytics and DefiLlama, provide real-time information on custodial wallet holdings, exchange sub-account positions, on-chain wallet assets, USDe supply, and key metrics for USDe and sUSDe. The positions dashboard display details on collateral assets, derivatives positions for delta-hedging, and USDe circulation. (Some information is not accessible in other platforms.)

Conor Ryder, the head of research at Ethena also said “To be clear, USDe isn’t safer or better than any other projects - we are simply offering something with an uncorrelated risk profile to the rest of DeFi. No ties to the traditional banking system. A real yield that isn’t plucked from thin air. Bringing a CeFi cashflow to DeFi.”

4. $ENA, Behind the Scene of USDe

Ethena launched its governance token ENA on April 2, 2024. The ENA token launch marked a milestone in Ethena’s journey towards decentralization and community governance. As part of the launch, Ethena distributed 750 million ENA tokens, representing 5% of the total supply of 15 billion, to early ecosystem contributors and participants of their “Shard Campaign.”

Ethena is now incentivizing participants to get involved in the Ethena ecosystem. It previously ran the Season 1 “Shards” Campaign for the launch of the ENA token in early April 2024. Ethena is currently in Season 2 “Sats” Campaign, concluding on September 2nd, 2024. This campaign incentivizes participants to earn Sats through strategies involving Pendle and Morpho, with a total token distribution commitment of 15-20% across all points campaigns.

The tokenomics of ENA are structured to balance incentivizing contributors and maintaining an active ecosystem. Core contributors hold 30% of the token allocation, investors hold 25%, the Ethena Foundation holds 15%, and the remaining 30% is reserved for ecosystem development, including airdrops and funding for new projects.

Source: ENA Token Launch — Ethena Labs

Like many application tokens, $ENA serves as a governance token for the Ethena protocol, allowing holders to make decisions on various matters, including deciding on USDe collateral assets (modifying or adding), decisions regarding custodian entities (OES Providers), cross-chain implementations, grants, which exchanges to use, and selecting a risk management framework.

However, current ENA token has not much utility for now. Although Ethena’s TVL has grown fast and has been one of the top projects that have generated significant amount of revenue, it is not currently shared with the token holders.

This is come to change a lot in the upcoming development of Ethena. Ethena won’t be just another DeFi project. It has a roadmap that will make $ENA become more opportunistic, and the two opportunities are on Potential Revenue Sharing and Ethena Appchain.

4.1 Potential Revenue Sharing

Source: Token Terminal [Date: Week from Monday May 27, 2024]

Ethena has experienced significant revenue growth, with its synthetic dollar, USDe, becoming the fourth-largest stablecoin by market capitalization. Here are some key points about Ethena’s revenue growth:

• Revenue Leader: In the last week of May, Ethena’s USDe generated $7 million in revenue, outpacing Solana’s $6.3 million. Only Tron and Ethereum outperformed the DApp’s revenue generation.
• Market Cap: The market capitalization of USDe has surpassed $3 billion, making it the fastest-growing crypto dollar asset in crypto history.
• Revenue Projections: According to the data from Token Terminal, it is predicted that Ethena is on track to generate a staggering $222.5 million in revenue over the next 12 months.

As ENA token serves as the governance token for the Ethena protocol, token holders may have the opportunity to vote on proposals that could include revenue distribution mechanisms. This could potentially allow ENA holders to influence decisions on how protocol revenues are allocated, which might include directing a portion of the yields generated from USDe staking or other protocol activities back to token holders.

4.2 ENA Appchain and Restaking

Recently, Ethena announced an update to the roadmap of ENA token and introduced new initiatives to the tokenomics of ENA. Ethena is launching staking capabilities for ENA, which will provide security for cross-chain transfers and integrate ENA into its financial infrastructure, including the upcoming Ethena Appchain. Also a new requirement mandates users to lock at least 50% of their claimable tokens, incentivizing long-term alignment among ENA holders. This move is part of a broader strategy to ensure ecosystem stability and growth.

Source: Update to $ENA Tokenomics — Ethena Labs

The protocol introduced a generalized restaking for ENA, with potential rewards for ENA restaking pools within Symbiotic. The introduction of generalized restaking pools marks a expansion in the utility of ENA. These pools will provide economic security for cross-chain transfers of USDe, leveraging the LayerZero DVN messaging system. This initiative is part of the broader Ethena Appchain development, which aims to build financial applications and infrastructure using USDe as the primary asset. Staked ENA in these pools will receive various rewards, including high multipliers, Symbiotic points, and potential future allocations from LayerZero.

Looking towards the future, the utility of ENA is set to expand significantly. The Ethena roadmap outlines plans to integrate ENA into various financial applications and infrastructure solutions on the Ethena Appchain. These include spot DEX, perpetual decentralized exchanges, yield trading platforms, money markets, and undercollateralized lending protocols. Additionally, ENA can play a role in on-chain prime brokerage services, options, and structured products. This broad range of applications will not only enhance the utility of ENA but also drive its demand as the ecosystem grows.

5. Looking Ahead

Source: X (@leptokurtic_)

The approval of Ethereum ETFs marks a pivotal moment for the cryptocurrency market, similar to the impact of Bitcoin ETFs earlier in the year. This development is poised to bring substantial liquidity and institutional interest to Ethereum, potentially influencing prices and market. Ethena, with its synthetic dollar USDe and yield-bearing token sUSDe, is in a prime position to benefit from these changes. The potential for increased demand in ETH-related financial instruments could drive positive funding rates and create arbitrage opportunities, resulting in higher yields for sUSDe holders. This kind of increase was present after the approval of Bitcoin ETF.

However, it is crucial to recognize the inherent risks associated with such rapid growth and market changes. Ethena must navigate challenges related to funding rate volatility, liquidity management, and custodial and smart contract vulnerabilities. Despite these risks, the platform’s transparent approach to risk management and proactive measures, such as real-time dashboards and diversified provider use, put a degree of confidence in it.

USDe has seen exponential growth since its inception, making it the fastest crypto dollar to reach a $3 billion market cap. With the approval of the Ethereum ETF, Ethena is expected to grow further. Also, the impending expansion of ENA’s utility through initiatives like revenue sharing and the Ethena Appchain may provide additional value and stability. So it would be important to keep an eye on for opportunity

APPENDIX A: Major Timeline of Ethereum ETF

A.1 January 2024: Bitcoin ETFs Pave the Way

The approval of spot Bitcoin ETFs in January 2024 marked a significant milestone and paved the way for altcoin ETFs, with Ethereum emerging as the next likely candidate. The success of Bitcoin ETFs, which saw unprecedented net inflows and solidified BTC’s status as a legitimate investment asset. The launch of these Bitcoin-tracking funds proved to be one of the most biggest debuts in ETF history. It translated into a $8 billion in net inflows, according to Morningstar Direct data. By late June, the nine newly introduced products had amassed $38 billion in assets, which proved the robust investor appetite for cryptocurrency exposure through traditional financial instruments.

Source: Bitcoin ETF Flow – Farside Investors

A.2 May 2024: Ethereum ETFs Gain Momentum

In May 2024, the USEC made a significant rule change by approving applications from major exchanges to list spot Ethereum ETFs. This decision allowed the Nasdaq, New York Stock Exchange, and Cboe exchanges to list eight Ethereum ETFs. The SEC’s approval came after applicants amended their filings to align with regulatory preferences, notably removing Ethereum staking from the ETF fund operations, which was seen as a potential obstacle to approval.

The rule change required ETF issuers to update their 19b-4 forms, which are used to propose new rules or changes to existing ones for self-regulatory organizations like stock exchanges. While the SEC approved these forms for eight spot Ethereum ETFs, including those from Bitwise, BlackRock, and VanEck, the issuers still need to gain approval for their individual S-1 registration statements before trading can officially begin.

A.3 June 2024: Expectations and Delays

In June 2024, expectations for Ethereum ETF approval continued to grow. SEC Chair Gary Gensler indicated that the approval process was progressing smoothly, with some analysts predicting a launch as early as July 4. However, the SEC delayed the launch of spot Ether ETFs, pushing the timeline to mid-July or later.

A.4 July 2024: Delay and Uncertainty

By July 2024, the delay in the approval of Ethereum ETFs had led to uncertainty among investors. Despite some analysts predicting a launch in the next two weeks, the market remained cautious. Bitwise filed an amended S-1 form, indicating that the products were nearly ready for launch, but the SEC’s comments pushed the timeline further back. Market sentiment was mixed, with some analysts predicting a potential decline in ETH’s price if the ETFs did not generate significant inflows.

A.5 Mid July 2024: Confirmation is Near

There were reports that spot Ethereum ETFs could begin trading as early as next week. According to sources familiar with the matter, the U.S. SEC has informed ETH exchange-traded fund issuers that their funds can start trading on July 23, 2024. The SEC reportedly had no further comments on the recently submitted S-1 forms and requested that final versions be submitted by Wednesday, July 17. The market’s reaction reflects growing optimism about the potential impact of these new financial products on the broader cryptocurrency ecosystem.

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