Arthur Hayes: Why Ethena will shake up Tether

Written by:Arthur Hayes, Founder of BitMEX

Compiled by: Deng Tong, Golden Finance

*Originally published on March 8, 2024

Dust on the Earth's Crust has returned to Hokkaido, Japan, as expected. The days are sunny and pleasantly warm, but at night, it's freezing cold. This weather pattern creates deplorable snow conditions known as Dust on the Earth's Crust. Beneath the seemingly beautiful, unspoiled power plate lurks ice and brittle snow. It's nasty stuff.

As winter turns to spring, I wanted to revisit my article “Dust on the Earth’s Crust” which I published a year ago. In it, I proposed a method for creating a synthetically backed fiat stablecoin that does not rely on the TradFi banking system for its existence. My idea was to combine longcryptocurrencyThe hedge is combined with a short perpetual swap position to create a synthetic fiat unit. I named it Nakadollar because I envisioned using Bitcoin and short XBTUSD "perpetual" swaps as a way to create a synthetic dollar. I ended the article with a promise to support a solid team trying to do my best to turn this idea into reality.

What a difference a year makes. Guy is the founder of Ethena. Prior to Ethena, Guy worked at a $60 billion hedge fund investing in special situations such as credit, private equity, and real estate. Guy caught shitcoins during the DeFi summer that began in 2020 and never looked back. After reading Dust on the Earth's Crust, he was inspired to launch his own synthetic dollar. But as all great entrepreneurs do, he wanted to improve on my original idea. Instead of using Bitcoin, he created a synthetic dollar stablecoin that uses Ethereum.

Guy chose Ethereum because the Ethereum network provides native returns.SafetyEthereum network validators are paid a small amount of ETH for each block directly through the protocol to mine and process transactions. This is what I call the ETH staking yield. Additionally, since Ethereum is now a deflationary currency, there is a fundamental reason why ETH/USD forwards, futures, and perpetual swaps are trading at a persistent premium to spot. Short perpetual swap holders can capture this premium. Combining physically staked ETH with a short ETH/USD perpetual swap position creates a high-yielding synthetic USD. As of this week, staked Ethena USD (sUSDe) is currently yielding ~>50% per year.

The best ideas are meaningless without a team that can execute them. Guy named his synthetic dollar Ethena and assembled a rock star team to quickly and effectively execute on it.SafetyMaelstrom became a founding advisor in May 2023, and in exchange we received governanceTokenI have worked with many high-quality teams in the past, and the guys at Ethena delivered without cutting corners. Fast forward 12 months, and Ethena’s stablecoin USDe is approaching 1 billion in circulation (TVL is $1 billion; 1 USDe = 1 USD) just 3 weeks after its mainnet launch.

I believe Ethena can surpass Tether to become the largest stablecoin. This prophecy will take many years to come true. However, I would like to explain why Tether iscryptocurrencyThe best and worst stablecoins in the space. It’s the best because it’s probably the most important thing for every employee in the TradFi and crypto space.make moneyThis is the worst of all, as Tether exists to keep its poorer TradFi bank partners happy. The jealousy of the banks and the problems Tether creates for the guardians of America’s peaceful financial system could spell the end of Tether in an instant.

To all those misguided Tether FUDsters out there, let me be crystal clear. Tether is not a financial fraud, nor has Tether lied about its reserves. Furthermore, I have the utmost respect for the founders and operators of Tether. But IMHO, Ethena will rock Tether.

This article will be divided into two parts. First, I will explain why the Fed, the US Treasury, and large US banks with political connections want to destroy Tether. Second, I will discuss Ethena in depth. I will briefly outline how Ethena is built, how it maintains its peg to the US dollar, and its risk factors. Finally, I will provide Ethena governanceTokenvaluation model.

After reading this article, you will understand why I believe Ethena is the best choice in the crypto ecosystem to provide a public chain-based synthetic dollar.

注意：实物支持的法定稳定币是发行人在银行账户中持有法定货币的Token，即 Tether、Circle、First Digital 等。合成支持的法定稳定币是发行人持有加密货币并用短期衍生品进行对冲的代币，即 Ethena。

Jealous Green

Tether (code: USDT) is the largest stablecoin measured by circulating tokens. 1 USDT = 1 USD.walletTo maintain the peg, Tether holds $1 in a bank account for each unit of USDT in circulation.

Without a USD bank account, Tether cannot perform the functions of creating USDT, custodial USD for USDT, and redeeming USDT.

• Creation: Without a bank account, USDT cannot be created because traders cannot send USD.

• USD Custody: Without a bank account, there is nowhere to hold the dollars backing USDT.

• Redemption of USDT: Without a bank account, USDT cannot be redeemed because there is no bank account to send USD to the redeemer.

Having a bank account is not enough to ensure success, as not all banks are created equal. There are thousands of banks around the world that can accept U.S. dollar deposits, but only certain banks have master accounts at the Federal Reserve. Any bank that wishes to clear U.S. dollars through the Federal Reserve to fulfill its obligations as a U.S. dollar correspondent bank must hold a master account. The Federal Reserve retains complete discretion over which banks are granted master accounts.

I will quickly explain how correspondent banking works.

There are three banks: A, B, and C. Banks A and B are located in two non-US jurisdictions. Bank C is a US bank with a master account. Banks A and B want to be able to transfer USD in the fiat financial system. They each apply to use Bank C as a correspondent bank. Bank C evaluates the bank's customer base and approves them.

Bank A needs to remit USD 1,000 to Bank B. The funds flow is USD 1,000 from Bank A's account at Bank C to Bank B's account at Bank C.

Let's change the example a bit and add Bank D, which is also a US bank with a master account. Bank A uses Bank C as a correspondent bank, and Bank B uses Bank D as a correspondent bank. Now, what happens when Bank A wants to send $1,000 to Bank B? The flow of funds is that Bank C transfers $1,000 from its account at the Fed to Bank D's account at the Fed. Bank D ultimately deposits the $1,000 into Bank B's account.

Typically, banks outside the U.S. use correspondent banks to wire dollars around the world. This is because once dollars move between jurisdictions, they must clear directly through the Federal Reserve.

I have been in the crypto space since 2013 and typically you deposit crypto into fiat currencyexchangeThe bank is not a U.S.-domiciled bank, which means it relies on a U.S. bank with a master account to process fiat deposits and withdrawals. These smaller, non-U.S. banks are eager to take deposits and bank crypto companies because they can charge high fees and pay nothing for deposits. Globally, banks are often desperate for cheap U.S. dollar funding because the U.S. dollar is the global reserve currency. However, these smaller foreign banks must interact with their correspondent banks to process U.S. dollar deposits and withdrawals outside of their domicile. Although correspondent banks tolerate these fiat flows related to crypto businesses, sometimes certain crypto clients are removed from smaller banks at the request of the correspondent bank for whatever reason. If smaller banks do not comply, they lose the correspondent banking relationship and the ability to move dollars internationally. A bank that loses the ability to move dollars is the walking dead. Therefore, small banks will always drop crypto customers if the correspondent bank asks them to.

This correspondent banking is crucial when we analyze the strength of Tether’s banking partners.

Tether banking partners: Britannia Bank & Trust, Cantor Fitzgerald, Capital Union, Ansbacher, Deltec Bank and Trust.

Of the five banks listed, only one, Cantor Fitzgerald, is a U.S.-domiciled bank. However, none of the five banks have a Fed master account. Cantor Fitzgerald is a primary dealer that helps the Fed conduct open market operations, such as buying and selling bonds. Tether’s ability to move and hold dollars is entirely dependent on the whims of fickle correspondent banks. Given the size of Tether’s U.S. Treasury portfolio, I believe their partnership with Cantor is critical to continued access to that market.

These banking CEOs are fools if they didn’t negotiate Tether equity in exchange for providing banking services. You’ll see why when I cover Tether’s revenue per employee metric later.

This is why Tether’s banking partners are not doing well. Next, I want to explain why the Fed doesn’t like Tether’s business model and why, fundamentally, it has nothing to do with cryptocurrencies and everything to do with how the U.S. dollar money markets work.

Full Reserve Bank

From a TradFi perspective, Tether is a full-reserve bank, also known as a narrow bank. A full-reserve bank takes deposits without lending them out. The only service it provides is transferring money back and forth. It pays almost no interest on deposits, as depositors face no risk. If all depositors demand a refund at the same time, the bank can satisfy that request instantly. Hence the name — full-reserve. This is in contrast to a fractional-reserve bank, where the loan book is larger than the deposit base. If all depositors demand their money from a fractional-reserve bank at the same time, the bank would go bankrupt. Fractional-reserve banks pay interest to attract deposits, but depositors face risk.

Tether is essentially a fully-reserve US dollar bank that provides US dollar trading services driven by the public blockchain. No loans, no funny stuff.

The Fed doesn’t like full-reserve banks, not because of who their customers are, but because of how these banks handle deposits. To understand why the Fed hates the full-reserve banking model, I have to discuss the mechanics of quantitative easing (QE) and its effects.

Banks failed during the 2008 financial crisis because they did not have enough reserves to cover losses from bad mortgages. Reserves are funds that banks keep at the Federal Reserve. The Fed monitors the size of bank reserves based on the amount of outstanding loans. After 2008, the Fed made sure that banks would never run short of reserves. The Fed did this by implementing quantitative easing.

Quantitative easing is the process by which the Fed buys bonds from banks and credits them with the reserves they hold at the Fed. The Fed has conducted trillions of dollars worth of quantitative easing bond purchases, which has caused bank reserve balances to swell. Hooray!

QE has not been demonstrably inflationary because bank reserves remain at the Fed. Pandemic stimulus money was given directly to people to spend as they wished. If banks had instead loaned out those reserves, inflation would have risen immediately after 2008 because the money would be in the hands of businesses and individuals.

Fractional reserve banks exist to make loans; if they don’t lend, they don’t make money. Therefore, all else being equal, fractional reserve banks prefer to lend their reserves to paying customers rather than keep them at the Fed. The Fed has a problem. How do they ensure that the banking system has nearly unlimited reserves without creating inflation? The Fed chooses to “bribe” the banking industry instead of lending.

Bribe the banks by asking the Fed to pay interest on the banking system's excess reserves. To calculate the amount of the bribe, multiply the total amount of bank reserves held by the Fed by the Interest Earned on Reserve Balances (IORB). The IORB must hover between the lower and upper bounds of the federal funds rate.

Lending is risky. Borrowers default. Banks would rather earn risk-free interest income from the Fed than lend to the private sector and incur possible losses. Therefore, as QE progresses, outstanding loans in the banking system grow at a different rate than the Fed's balance sheet. However, success is not cheap. When the Fed Funds rate was 0.% to 0.25%, bribes were not expensive. But now, with the Fed Funds rate at 5.25% to 5.50%, IORB bribes are costing the Fed billions of dollars a year.

The Fed maintains a “high” policy rate to curb inflation; however, due to the high cost of IORB, the Fed becomes unprofitable. The U.S. Treasury and the American public are directly funding the Fed’s bribes to banks through the IORB program.make moneyWhen the Fed loses money, the Treasury borrows money and sends it to the Fed to make up for the losses.

QE solved the problem of insufficient bank reserves. The Fed now wants to reduce bank reserves to curb inflation. Enter quantitative tightening (QT).

QT is when the Fed sells bonds to the banking system and pays for it with reserves held by the Fed. QT increases bank reserves, while QE decreases them. As bank reserves fall, the IORB bribe costs also fall. Obviously, the Fed will not be happy if bank reserves increase while paying a high interest rate to the IORB.

The operation of the full reserve banking model runs counter to the Fed's stated goals. Full reserve banks do not make loans, which means that all deposits of 100% are deposited with the Fed as reserves. If the Fed starts granting fully reserved banking licenses to banks engaged in similar businesses to Tether, this will exacerbate the central bank's losses.

Tether is not a US licensed bank, so it cannot make deposits directly with the Fed and earn IORB. But Tether can deposit cash in a money market fund, which can use the reverse repurchase program (RRP). RRP is similar to IORB in that the Fed must pay an interest rate between the fed funds floor and ceiling in order to accurately determine the direction of short-term interest rate transactions. Treasury bills (T-bills) are zero-coupon bonds with maturities of less than one year, which trade at a yield slightly higher than the recommended retail price (RRP) rate. So while Tether is not a bank, its deposits are invested in instruments that require interest payments from the Federal Reserve and the US Treasury. Tether has nearly $81 billion invested in money market funds and Treasuries. Tether is strangling the Fed. The Fed can't either.

Tether arbitrages the Fed because Tether pays 0.% on USDT balances but earns a yield that is approximately capped at the Fed Funds rate. This is Tether’s Net Interest Margin (NIM). As you can imagine, Tether is very happy about the Fed rate hike because in less than 18 months (March 2022 to September 2023), the NIM went from essentially 0.% to nearly 6.%.

Tether is not the only stablecoin issuer targeting the Fed. Circle (USDC) and all other stablecoins that accept USD and issue tokens are doing the same thing.

If banks abandon Tether for some reason, the Fed will not provide any help.

What about Yellen? Does her Treasury have any conflicts with Tether?

Tether is too big

Treasury Secretary Janet Yellen needs a well-functioning Treasury market. It allows her to borrow the money necessary to pay for the trillion-dollar government deficit each year. After 2008, the Treasury market ballooned along with the fiscal deficit. The bigger it gets, the more vulnerable it becomes.

The chart from the U.S. Government Securities Liquidity Index clearly shows the declining liquidity in the Treasury market since the pandemic began (higher numbers mean worse liquidity conditions). It only takes a small amount of selling to disrupt the market. By disrupting the market I mean a rapid decline in bond prices or an increase in yields.

Tether is currently one of the 22 largest holders of U.S. Treasuries. If Tether for some reason had to quickly unload its holdings, it could cause chaos in global bond markets. I say global because all fiat debt instruments are priced in some way, shape or form and are not affected by the U.S. Treasury curve.

If Tether’s banking partners launch Tether, Yellen could intervene by:

• Perhaps she would stipulate that Tether be given a reasonable period of time to retain its customers so that it is not forced to sell assets to quickly satisfy redemption requests.

• Maybe she’ll freeze Tether’s assets, making it unable to sell anything, until she thinks the market can absorb Tether’s assets.

But Yellen certainly won’t help Tether find another long-term banking partner.The growth of Tether and similar stablecoins serving the cryptocurrency market poses risks to the U.S. Treasury market.

Perhaps if Tether decided to buy bonds that no one wants (i.e. long-term bonds with maturities of more than 10 years) instead of short-term notes that everyone wants, then Yellen might side with them. But why would Tether take this duration risk to earn less money than shorter-term Treasuries? This is due to an inverted yield curve (long-term interest rates are lower than short-term interest rates).

The most powerful sectors of American peacetime financial institutions would rather Tether didn’t exist. And none of this has anything to do with cryptocurrency.

Tether is too rich

The talented analysts at Maelstrom created the following speculative balance sheet and income statement for Tether. They used a combination of Tether’s public disclosures and their judgment to create this result.

Listed below are the eight "too big to fail" (TBTF) banks in the peaceful economic and political system under the United States and their net profits for fiscal year 2023.

Cantor Fitzgerald is not a bank, but a primary dealer and trading firm. There are only 23 primary dealer banks. Therefore, in the Total Deposits column, the number for Cantor represents the value of its balance sheet assets. I obtained estimates of Cantor's net income and total number of employees from Zippia.

Tether’s revenue per employee is $62 million. No other bank on this list comes close. Tether’s profitability is another example of how cryptocurrency will impact the largest wealth transfer in the history of human civilization.

Why don’t these TBTF banks offer competing fiat-pegged stablecoins? Tether makes more money per employee than any of these banks, but Tether couldn’t exist without these banks and others like them.

Perhaps one of these banks could buy Tether instead of asking Tether to be de-banked. But why would they do that? It certainly wouldn’t fit the technology.BlockchainTransparency, deploying Tether smartcontractThe cloned code is already available on the Internet.

If I were the CEO of a US bank that supported Tether’s existence, I would immediately unbank them and offer a competing product. The first US bank to offer a stablecoin will quickly dominate the market. As a user, holding JPMorgan stock is less risky than Tether. The former is the responsibility of a too-big-to-fail bank that is essentially an empire. The latter is the responsibility of a private company that is despised by the entire US banking system and its regulators.

I have no reason to believe that a U.S. bank is plotting to bring down Tether. But it would be trivial to do so. Why is Tether, owned by a crypto puppet hanging out in the Bahamas and whose existence 100% depends on access to the U.S. banking system, making more money than Jamie Dimon in a few trading days?

As the cryptocurrency bull run progresses, any stock that isn’t tied to the cryptocurrency business will rise. A U.S. bank whose stock is falling due to the market panic over bad commercial real estate loans could get a valuation boost by entering the crypto stablecoin market. This could be all the momentum Bank of America needs to finally compete directly with Tether, Circle, and others.

If Circle's IPO goes well, expect the banking system to face challenges. Stablecoin businesses such as Circle and Tether should trade at a discount to earnings because they have no competitive moat. The fact that Circle was able to IPO is a comedy in itself.

There is no mountain higher than this...

I just explained why it would be easier for the US banking system to destroy Tether than it would be to beat Caroline Ellison at the Math Olympiad. But why would we, as a crypto ecosystem, create a different type of stablecoin pegged to a fiat currency?

Thanks to Tether, we know that crypto capital markets crave a stablecoin pegged to fiat currencies. The problem is that banks provide poor services because there is no competition to make them better. With Tether, anyone with an internet connection can make USD payments 24/7.

Tether has two main problems:

• Users will not receive any share of Tether's NIM.

• Even if Tether complies with regulations, it could be shut down by the U.S. banking system overnight.

To be fair, users of any currency generally do not share in seigniorage revenue. Holding physical cash dollar bills does not entitle you to the Fed’s profits… but you can definitely take its losses. Therefore, USDT holders should not expect to receive any net interest margin from Tether. However, one user group that should be compensated is the cryptocurrencyexchange.

Tether 的主要用例是用于加密货币交易的融资货币。 Tether 还提供了一种近乎即时的方式在交易场所之间转移法定货币。 交易所作为加密货币交易的场所，为 Tether 提供了效用，但他们却得不到任何回报。 没有可以购买的 Tether 治理代币为持有者提供 NIM 索赔权。 除非交易所在 Tether 早期以某种方式收购了股权，否则就无法分享 Tether 的成功。 这并不是一个关于为什么 Tether 应该向交易所提供资金的悲惨故事。 相反，这会促使交易所支持稳定币发行人，将大部分 NIM 转嫁给持有人，并为交易所提供在发行人发展初期以低廉估值购买治理代币的机会。

Quite simply, if one wants to outperform Tether, one must pay most of the NIM to stablecoin holders and sell cheap governance tokens to exchanges. This is how the vampire squids attack physical fiat-backed stablecoins.

Ethena follows this script closely. USDe holders can stake it directly to Ethena and earn most of the NIM. All major exchanges invested in Ethena in early rounds. Ethena's cap table includes Binance Labs, Bybit via Mirana, OKX Ventures, Deribit, Gemini, and Kraken as exchange partner investors.

In terms of the market share these exchanges represent, they cover approximately 90% of ETH open interest on major exchanges.contract.

How does Ethena work?

Ethena is a synthetically backed fiat-backed USD cryptocurrency.

ETH = Ether

stETH = Lido-collateralized ETH derivatives

ETH = stETH

ETH = stETH = $10,000

ETH/USD Perpetual SwapcontractValue = 1 USD worth of ETH or stETH = 1 / ETH or stETH USD value

hook up

USDe is a stablecoin issued by Ethena that aims to be pegged 1:1 to the US dollar.

Ethena has joined various authorized participants (APs). APs can mint and destroy USDe at a 1:1 ratio with USD.

coin:

Currently, stETH Lido, Mantle mETH, Binance WBETH, and ETH are accepted. Ethena then automatically sells an ETH/USD perpetual swap to lock in the USD value of ETH or ETH LSD. The protocol then mints an equal amount of USDDe to match the USD value of the short perpetual hedge.

example:

AP deposits 1 stETH, valued at $10,000.

Ethena sells 10,000 ETH/USD per swap contract = 10,000 USD/1 USD contract value.

AP receives 10,000 USDe because Ethena sells 10,000 ETH/USD per swap contract.

combustion:

To destroy USDe, the AP deposits USDe into Ethena. Ethena then automatically covers a portion of its short ETH/USD perpetual swap position, unlocking a certain amount of USD value. The protocol then destroys USDe and returns a certain amount of ETH or ETH LSD based on the total amount of unlocked USD value minus execution fees.

example:

AP deposits 10,000 USDe.

Ethena buys back 10,000 ETH/USD per swap contract = 10,000 USD/1 USD contract value

AP receives 1 stETH = 10,000 * $1 / $10,000 stETH/USD minus execution fee

To understand why, initially, USDe should trade at a slight premium to the dollar on stablecoin exchanges like Curve, I will explain why users would want to hold USDe.

US dollar yield

The combination of ETH staking yield and ETH/USD perpetual swap funding equates to a high synthetic USD yield. To earn this yield, USDe holders stake it directly on the Ethena app. It takes less than a minute to start earning yield.

Because sUSDe has a very high yield of about 30% at launch; users who already hold USD stablecoins that yield much less will turn to sUSDe. This puts pressure on the buy side and will push up the price of USDe in the Curve pool. When USDe's trading premium is large enough, AP will step in and arbitrage the difference.

Imagine: 1 USDe = 2 USDT. If the AP can create 1 USDe with ETH or stETH worth 1 USDT, they can get a risk-free profit of $1. Here is the process:

1. Wire USD to the exchange.

2. Sell 1 USD for ETH or stETH.

3. Deposit ETH or stETH on the Ethena app and receive 1 USDe.

4. Deposit USDe on Curve and sell it for 2 USDT.

5. Sell 2 USDT for 2 USD on the exchange and withdraw USD to your bank account.

If users think Ethena isSafetyIf the yield is real, then in this hypothetical example, USDT in circulation will fall, while USDDe in circulation will rise.

UST Yield

Too many people in the crypto space believe that Ethena will fail like UST. UST is a stablecoin attached to the Terra/Luna ecosystem. Anchor is a decentralized money market protocol in the Terra ecosystem that offers an annual yield of 20% to those who stake UST. People can deposit UST, and Anchor will lend the deposit to borrowers.

Any stablecoin issuer must convince users why they should switch from (usually Tether) to the new product. High yield is what motivates this switch.

UST is backed by Luna, and Bitcoin is purchased by selling Luna. Luna is the governance token of the ecosystem. The foundation owns a majority of Luna. Due to the high price of Luna, the foundation sells Luna for UST to pay high UST interest. The interest rate is not paid in physical dollars, but you earn more UST tokens. Although UST maintains a 1:1 peg with the US dollar, the market believes that if you hold more UST, you also hold more US dollars.

As the total value of UST locked by Anchor grows, so does its UST interest expense. It becomes unsustainable for the Foundation to continue selling Luna to subsidize Anchor’s UST rewards. The yield comes only from the market believing that Luna should be worth trillions of dollars.

When the price of Luna began to fall, the death spiral of algorithmic stablecoins began. Since Luna is minted and burned in a way that keeps UST pegged to the US dollar at 1:1, as Luna depreciates, it becomes more difficult to maintain UST's peg to the US dollar. Once the peg breaks sharply, all UST interest accumulated on Anchor becomes worthless.

Ethena Yield

The way USDe generates income is completely different from UST. Ethena holds two income-generating assets.

Stake ETH:

ETH is staked using liquid staking derivatives such as Lido (stETH). stETH earns ETH staking income. ETH is deposited into Lido. Lido runs a validator node capitalized with ETH deposits and remits ETH paid by the Ethereum network to stETH holders.

Perp Swaps:

Perpetual swaps are a series of consecutive short-term futures contracts. The funding rate for most perpetual contracts resets every 8 hours. The funding rate is based on the premium or discount of the perpetual to the perpetual. If in the past 8 hours, the perpetual contract has traded at a premium of 1% to other perpetual contracts. The next funding rate is +1%. If the funding rate is positive, longs pay shorts; if the rate is negative, the opposite is true.

Ethena holds a short perpetual swap position to lock in the USD value of the staked ETH it holds. Therefore, if the funds are positive, Ethena will receive interest income. If it is negative, it will pay interest. Obviously, as a USDe holder, we want to be sure that Ethena will receive interest instead of paying interest. The question is why is the forward transaction of ETH/USD at a premium?

Ethereum is now a deflationary currency. The dollar is an inflationary currency. If there is less ETH but more USD in the future, then the ETH/USD forward should trade higher. This means that any leveraged forward derivatives (such as perpetual swaps) should trade at a premium to spot. Funding should mostly be positive, which means Ethena will receive interest. The data supports this.

What would cause Ethereum to switch from a deflationary currency to an inflationary currency? If Ethereum's network usage drops significantly, much less ETH Gas will be burned per block. In this case, the Ethereum block reward will be greater than the ETH burned.

What would cause the dollar to change from an inflationary currency to a deflationary currency? American politicians need to stop spending so much money to get re-elected. The Federal Reserve must cut its balance sheet to zero. This would lead to a severe contraction in the circulation of US dollar credit money.

I think neither of these scenarios is likely to occur. Therefore, it is reasonable to expect funding rates to be positive for most of the time for the foreseeable future.

USDe is not UST.

The combination of ETH staking yield and positive perpetual swap funding generates USDe’s yield. The yield is not based on the value of the Ethena governance token. USDe and UST generate yield in completely different ways.

Ethena Risk Points

Ethena has counterparty risk. Ethena is not decentralized and does not attempt to be decentralized. Ethena holds short-term perpetual swap positions on derivatives centralized exchanges (CEXs). If these CEXs are unable to pay out profits on swap positions or return deposited collateral for a variety of reasons, Ethena will suffer capital losses. Ethena attempts to reduce direct counterparty risk by placing funds with third-party custodians, such as:

Tether’s counterparty risk comes from TradFi Bank. Ethena’s counterparty risk comes from derivatives CEX and cryptocurrency custodians.

CEX 是 Ethena 的投资者，在不被黑客攻击和确保其衍生品得到适当支付方面拥有既得利益。 衍生品 CEX 是最赚钱的加密货币公司，他们希望保持这种状态。 操你的顾客可不是什么好生意。 随着 Ethena 的发展，衍生品未平仓合约的增长会增加 CEX 的费用收入。 所有激励措施都是一致的。 CEX 希望 Ethena 表现出色。

Tether’s products help crypto capital markets function. Crypto exists to disintermediate TradFi banks. TradFi banks want crypto to fail. Fundamentally, banking Tether accelerates the demise of TradFi. Incentives are misaligned. TradFi banks don’t want Tether to do well, and regulators don’t want Tether to do well.

Ethena For Us, By Us, also known as FUBU (For Us, By Us).

Tether is for us, from them, also known as FUBAR (For Us, By Them).

LSD Smart Contracts and Penalty Risks

Ethena holds ETH LSD. It is subject to smart contract risks. For example, Lido may have problems, causing stETH to become worthless. In addition, there is the risk of being punished. Punishment occurs when Ethereum node network validators violate certain rules. As a penalty, the ETH capital held by the validator will be reduced.

Negative funds

As I mentioned before, the perpetual swap funding rate could be negative for extended periods of time. The funding rate could become so negative that the net asset value of Ethena assets is less than the amount of USDe issued. USDe would then break the downside peg.

Ethena Smart Contract Risks

Like Tether, Ethena is a publicBlockchainThere can be bugs in the code that lead to unexpected behavior and ultimately losses for USDe holders. Typically, hackers will try to mint large amounts of stablecoins for free and then trade them for another cryptocurrency on platforms like Uniswap or Curve. As the supply of stablecoins increases without a corresponding increase in the assets backing the stablecoins, this can lead to a broken peg.

However, Ethena smart contracts are relatively simple, with most of their complexity lying in off-chain engineering. The on-chain minting/redemption contracts are only about 600 lines of code, and only approved participants can interact with the most sensitive contracts on the chain, which helps reduce the risk of preventing malicious unknown counterparties from interacting with them.

The limits to growth

USDe’s circulating supply can only grow to the total open interest of Ethereum futures and currency swap contracts on exchanges. Physically-backed fiat stablecoins have a circulating supply of around $130 billion. Ethereum’s open interest across all exchanges is $8.5 billion. $12 billion across all exchanges, and another $31 billion in open interest in Bitcoin contracts that can be leveraged once Ethereum decides to accept Bitcoin as collateral. With total open interest for Bitcoin and Ethereum at around $43 billion, it’s impossible for Ethereum to take the number one spot given current market conditions. While Ethena is starting with ETH, it’s very easy for BTC and SOL to be added to their system, it’s just a matter of sequencing.

As crypto grows as an asset class, total open interest will grow exponentially. Some believe that crypto as an asset class will reach $10 trillion during this cycle. At this level, it is not absurd that Ethereum’s open interest could exceed $1 trillion, considering that Ethereum is the second largest cryptocurrency by fiat market cap.

Ethereum will grow along with the growth of cryptocurrencies.

Insurance Fund

The purpose of the insurance fund is to mitigate financial losses due to some of the risks listed above. These funds will act as bidders for USDe in the open market if the funding rate goes negative or the synthetic dollar depegs. The fund is composed of stablecoins (USDT and USDC), stETH, and USDe/USD LP positions. Currently, the insurance fund is capitalized by funds from the Ethena Labs funding round, as well as the uncollateralized portion of the returns generated by USDe. In the future, as the circulating supply of USDe grows, these funds will be capitalized through long-term yields. As of this writing, the insurance fund is $16 million.

Neither USDT nor USDe are risk-free. However, the risks are different. Tether and Ethena may eventually fail, but for different reasons.

When people begin to believe that the yield on USDe is not high, the circulation of USDe will increase.

This is where the upcoming Ethena governance token comes into play.

Ethena Valuation

Like any currency issuer, Ethena lives and dies by seigniorage. This is the difference between how much it costs to create money and how much it costs to create it. I want to propose a simple model to value Ethena based on these seigniorage revenues. For those who may buy Ethena governance tokens in the coming months, you should at least try to build a model to value the protocol.

Any USDe issued can be staked and earn ETH staked plus perpetual funds. As of now, Ethena will split the revenue generated by assets backing sUSDe, while the revenue generated by assets backing uncollateralized USDe will be sent to the insurance fund after this sharding event, and that revenue will go to the protocol. I estimate the long-term split will be 80% of the revenue generated by the protocol goes to staked USDe (sUSDe), and 20% of the revenue generated goes to the Ethena protocol.

Ethena protocol annual revenue = total revenue * (1–80% * (1 — sUSDe supply / USDe supply))

If 100% of USDe is pledged, sUSDe supply = USDe supply:

Ethena protocol annual revenue = total revenue * 20%

Total yield = USDe supply * (ETH staking yield + ETH Perp swap funds)

ETH Staking Yield and ETH Perp Swap Funding are both variable rates. Recent history can guide us to future possibilities.

ETH staking yield - I assume the PA yield is 4%.

ETH Perp Swap Funds - I assume the PA is 20%.

A key part of the model is that a fully diluted valuation (FDV) multiple of revenue should be used. This is always a guessing game, but I will suggest some future paths based on similar DeFi stablecoin projects.

Using these multiples as a guide, I created the following potential Ethena FDV.

This week, Ethena generated 67% of yield on $820M in assets. Assuming a 50% supply ratio of sUSDe to USDe, extrapolating one year from now, Ethena's annualized revenue is about $300M. Using a valuation like Ondo gives a FDV of $189B. Does this mean that Ethena's FDV will be close to $200B at launch? No. But it does mean that the market will pay a high valuation for Ethena's future revenue.

Summarize

If you don’t remember anything else from this post, remember this:

Ethena For Us, By Us, also known as FUBU (For Us, By Us).

Tether is for us, from them, also known as FUBAR (For Us, By Them).

You can decide whether to be long or short USDe or the eventual Ethena governance token. I hope this post has shed some light on Ethena’s mission and why it is so important to the success of cryptocurrency.

With that, I bid you farewell, as I have to concentrate on not damaging my thighs while shredding this crusty snow.

The article comes from the Internet:Arthur Hayes: Why Ethena will shake up Tether

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