TL;DR
Ethena’s USDe, the stablecoin from Ethena, has reached a market capitalization exceeding $2 billion.
USDe is not backed by physical dollars or over-collateralized with cryptocurrencies, but maintains its value pegged to the dollar through delta hedging of its crypto collateral.
Funding risk becomes critical in extremely volatile markets, implying that Ethena could face the need to cover substantial payments to maintain its positions.
Ethena’s USDe, the synthetic US dollar protocol on Ethereum, has become very popular in the market, with a market capitalization exceeding $2 billion. Unlike traditional stablecoins, USDe is not backed by physical dollars or over-collateralized with cryptocurrencies. Instead, it maintains its value pegged to the dollar through a sophisticated strategy of delta hedging its crypto collateral.
This strategy, according to Julio Moreno, Head of Research at CryptoQuant, involves hedging cryptocurrency spot exposure with short positions in perpetual futures to generate yields in “normal” market conditions. However, this strategy exposes USDe to unique risks, especially regarding funding.
— Julio Moreno (@jjcmoreno) April 16, 2024
Funding risk becomes critical in extremely volatile markets where negative funding rates occur. This implies that USDe holders could face scenarios where Ethena needs to cover substantial payments to maintain these positions.
According to Moreno, there are two essential metrics for investors: the size of the reserve fund relative to USDe’s market capitalization and the retention rate, which is the portion of generated yields reinvested in the reserve fund.
Avoiding Ethena and USDe Following Terra’s Steps
Moreno argues that “funding payments become larger as USDe’s market capitalization increases. To safely manage the extraordinary event of large negative funding rates with larger market capitalizations of $5, $7.5, or $10 billion, the reserve fund would need to increase to about $40, $60, and $80 million, respectively.”
To minimize risk, Moreno also suggests that USDe must maintain a retention rate above 20%, which is essential to adequately strengthen the reserve fund. These measures are necessary to avoid the pitfalls that led to the collapse of Terra’s UST.
The ability to quickly adapt reserve funds and retention rates in response to market dynamics will be decisive for the sustainability of USDe as a stablecoin. However, the reserve fund and retention rates must be constantly monitored to avoid risks.