AC publishes a long article questioning Ethena (USDe): The next UST?

Original author: Andre Cronje, co-founder of Fantom Foundation

Original translation: Azuma, Odaily Planet Daily

Editor's note: Ethena Labs officially opened the ENA airdrop application yesterday. In the past few months, with the potential airdrop expectations and the high yield from "spot + contract arbitrage", the issuance scale of USDe has grown rapidly. As of the time of writing, the minting volume of USDe has exceeded 1.8 billion US dollars, surpassing the pioneers backed by head projects such as FRAX, crvUSD, and GHO in the decentralized stablecoin track, and there is a trend of continuing to grow and shake DAI's top position.

However, when USDe's data is soaring, many doubts have also come to mind in the market. This afternoon, Andre Cronje, the "old king" of DeFi, published a long article on his personal account. Although the article did not explicitly mention Ethena Labs and USDe, it strongly questioned the design of the project from a mechanism level, and even directly compared it to the next UST.

The following is the original content of Andre Cronje, compiled by Odaily Planet Daily:

In the cryptocurrency industry, we often see something new.

For some major events that have happened in the industry, I do wish I had observed them more carefully, but I also admit that some events were completely beyond my expectations.

For example, UST, I am very sure that it will fail because its mechanism makes no sense to me, but many people who I think are very smart disagree with it, and they have been trying to convince me that they are wrong; as for FTX, I never thought it would go bankrupt. Whenever someone asks me if they should withdraw funds from FTX, I will answer "Okay, why take the risk", but this is just my unified view of all exchanges. Its collapse was a complete surprise to me.

The reason I bring these things up again is just to point out in advance that many times I don’t know the truth.

Despite this, there is indeed one thing that has caught my attention at the moment - an emerging DeFi infrastructure is rapidly gaining market traction, and I see it has been integrated into some protocols that I have always thought to be low-risk. However, according to my understanding (maybe wrong), this new protocol is extremely risky.

I'm not going to make any direct accusations, but I do want to ask people who are smarter than me, what exactly is wrong with my understanding? I've looked at all the available literature, read many outside reviews, and I still can't see how it eliminates risk.

Odaily Planet Daily Note: In the full text, Andre Cronje did not directly mention Ethena Labs and USDe, but from the market he described Judging from the situation and protocol design, the targets targeted by the doubts are Ethena Labs and USDe.

Next, let’s take a look at the structure of the above protocol.

The first is the perpetual contract. In normal spot trading, traders are simply purchasing the asset. To describe it more accurately, traders are actually selling (short) one asset and buying (long) another asset. For example, in BTC/USD trading, you are selling (short) USD. And buy (go long) BTC, if BTC appreciates relative to USD, you make money. We call this simple trading model spot trading, because you will always own some kind of spot asset. Even if BTC depreciates relative to USD, you will always own BTC assets. Perpetual contracts are a trading tool that allow traders to perform similar operations without involving any spot assets, so it is more like gambling than trading.

The special thing about perpetual contracts is that both buyers (long sellers) and sellers (short sellers) need to pay a "funding rate". If you buy If the entry demand is obviously greater than the selling demand, the seller's funding rate will be positive and the buyer's funding rate will be negative, thus ensuring that the price of the perpetual contract converges with the spot price. For traders, to maintain their trading positions, all you need to do is provide margin. Margin is essentially collateral to "fund" the funding rate "debt". If the funding rate turns negative, it will Start gradually eating away at your collateral until your position is closed.

As for the collateral (margin), another mechanism of the above agreement is the automatic interest-earning function of the collateral, that is, as long as the collateral is held, the assets will Will continue to increase in value. In the above projects, the so-called automatic interest-bearing collateral is actually stETH. If I hold  1 stETH, which is essentially equivalent to me doing long stETH, then if I then pass the perpetual contract By opening 1 short position on stETH , I can theoretically achieve "delta neutrality" because even if I lose 100 USD on stETH short, I can still stETH  Go long and get $100. Two additional points. First, the only exchange I can find that accepts stETH as margin is ByBit. Second, the "Delta neutral" discussion here ignores the funding rate issue.

Odaily Planet Daily Note: The so-called Delta is an indicator in finance to measure the impact of changes in the price of underlying assets on changes in investment portfolios, with a value range of "-1 to 1". The definition of "Delta neutrality" is that if an investment portfolio consists of related financial products and its value is not affected by small price changes in underlying assets, such an investment portfolio has the nature of "Delta neutrality".

In general, the operating logic of the above protocol is that you can buy $1,000 of stETH and use it as a margin to open a $1,000 stETH short village, thereby theoretically achieving "Delta neutrality", and continue to obtain interest income from stETH (about 3%) and bear the profit and loss of the funding rate.

I am not a professional trader, I only do some exploratory trading for the purpose of studying DeFi, and I admit that trading is not my strong point. I tried to compare the above operating logic with the basic financial elements (collateral and debt) that I understand. According to my experience, any contract position will eventually have only two outcomes, either it will be closed (that is, "Delta Neutral" will be broken) or it will be liquidated.

Therefore, my current ideal inference of the working mechanism of the protocol is that "when the market turns, the position will be closed", but this statement is like the stalk of "you only need to sell when BTC goes up and buy when it goes down". It sounds obvious, but it is almost impossible to implement in practice.

So even though everything seems to be going well now, it’s only because the market is bullish and everyone is happy to hold long orders and the funding rate for shorting is positive, but the situation will eventually change. When the funding rate for shorting turns negative, the margin (collateral) will begin to be eroded or even liquidated, and then there will be only one asset left without any support.

Some people may use the "law of large numbers" to refute, which is very similar to UST’s claim to have a $1 billion BTC guarantee fund in the past-"It’s useful until the day it doesn’t work."

Odaily Planet Daily Note: By the so-called "law of large numbers", Andre doesn’t seem to be referring to its classic statistical definition here, but to the argument that "for short positions, the funding rate is positive most of the time in the long run."

So I'm hoping some smart people on social media can help me out with this, point out where I'm getting it wrong, or point out what key information I'm missing.

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