Ethena's Synthetic Dollar: Can It Redefine Stability in Crypto?

Ethena's crypto-native stablecoin challenges norms with rapid growth and high yields—but at what risk? Dive into the story.

Ethena, an Ethereum-based protocol, has introduced a synthetic dollar (USDe) and a yield-bearing token (sUSDe) as part of its unique approach to stablecoins. Here's a closer look at the protocol and its key aspects:

**What Is Ethena?**

Ethena is an innovative protocol in the decentralized finance (DeFi) space. It aims to create a crypto-native stablecoin and a yield-bearing asset, both within the Ethereum ecosystem. The protocol's native token is ENA, and its stablecoin is called USDe. Additionally, Ethena introduces a yield-generating token known as sUSDe, which is designed to pay interest over time and is often referred to as the "Internet Bond."

**How Ethena Works**

To understand Ethena's functioning, let's break down its components:

1. **Synthetic Dollar (USDe):** This stablecoin is pegged to the value of the US dollar and can be minted by depositing assets like Ethereum (ETH) into OES (On-chain Escrow Service) protocols. These protocols handle asset custody and interactions with exchanges.

2. **Yield-Bearing Token (sUSDe):** Also known as the "Internet Bond," this token represents a claim on future Ethena revenues. Users can deposit assets, stake USDe, and earn interest, creating a cycle of growth that drives adoption.

**Why Ethena Is Gaining Traction**

Several factors contribute to Ethena's growing popularity among crypto enthusiasts:

1. **Fully Crypto-Native Design:** Unlike over-collateralized stablecoins like DAI, which rely on cryptocurrency over-collateralization, Ethena's model is more capital efficient. This has enabled USDe to rapidly ascend in the stablecoin rankings.

2. **Attractive APYs:** Ethena's capital efficiency and yield-bearing tokens offer higher Annual Percentage Yields (APYs) compared to other stablecoins.

3. **Less Slippage in Perp Funding Rates Futures:** Ethena's integration into perpetual futures markets has reduced slippage in funding rates futures, making them more efficient.

**Potential Risks Associated with Ethena**

Despite its innovations, Ethena's model comes with significant risks:

1. **CEX Dependency:** A majority of Ethena's income depends on futures funding rates on centralized exchanges (CEXs). If these exchanges fail or encounter problems, Ethena could face serious difficulties.

2. **Custodial Risk:** Assets held by OES providers may be subject to withdrawal delays or legal challenges, impacting Ethena's ability to generate revenue.

3. **Negative Funding Rates:** Ethena relies on positive funding rates to generate income. If rates turn negative, Ethena's income could stop.

4. **Systemic Risk:** With over 10% of perpetual futures markets tied to Ethena, its collapse could ripple through DeFi, potentially leading to a loss of confidence in the broader ecosystem.

**Lessons from Terra and Ethena's Resilience**

Ethena's rapid growth and high yields have drawn comparisons to the Terra ecosystem, which collapsed in 2022 after its stablecoin, UST, lost its peg. While Ethena employs stronger mechanisms and diversifies risk, complexity adds fragility. Even small cracks in Ethena's foundation could lead to a loss of confidence and a rush for the exits.

**Should You Care About ENA?**

Ethena's governance token, ENA, offers mixed benefits:

1. **Voting Rights:** Holders of ENA are granted voting rights to participate in Ethena's governance.

2. **sENA Rewards:** Staking ENA to earn sENA provides holders with a portion of the protocol's revenue, offering additional rewards.

3. **Future Dilution Risks:** Only 20% of the ENA token supply is currently circulating, with 80% locked. This creates a risk of future dilution as more tokens enter the market.

**Valuation Metrics**

ENA's fully diluted valuation ($17 billion) far exceeds its current market cap ($300 million), raising concerns for long-term investors. However, ENA’s valuation, based on circulating supply, appears more reasonable at 3.7x Ethena's 2024 revenue projections.