Encryption Native Synthetic Stablecoin USDe: An Innovation Between Centralization and Decentralization

In the current stablecoin market landscape, a new type of encryption native synthetic dollar stablecoin USDe has emerged. It adopts a structured passive income product model that is between centralization and Decentralization, safeguarding assets on-chain while earning yields through a Delta neutral strategy to maintain stability.

The background of the birth of USDe is the result of a combination of factors such as centralized stablecoins dominating the market, decentralized stablecoins tending towards centralization, and algorithmic stablecoins facing severe setbacks. It attempts to seek a balance between the DeFi and CeFi markets.

USDe utilizes a service called OES to map on-chain custodial assets to the margin provided by the exchange. This retains the advantages of DeFi fund isolation while also gaining the convenience of ample liquidity from CeFi.

The underlying returns of USDe mainly come from two aspects: first, the staking returns from Ethereum liquidity derivatives, and second, the funding rate returns obtained by opening hedge positions on exchanges. It can be regarded as a structured funding rate arbitrage product.

Currently, USDe is incentivizing liquidity through a points system. Its ecological assets include:

• USDe: stablecoin, minted by depositing stETH
• sUSDe: The certificate token obtained after staking USDe
• ENA: Governance token of the protocol, can be obtained through points exchange.

The Minting and Redemption Mechanism of USDe

Users can deposit stETH into the protocol to mint USDe at a 1:1 ratio. The deposited stETH will be sent to a third-party custodian and mapped to the exchange via OES. The protocol will then open a short perpetual position in ETH on the exchange, ensuring the collateral value remains stable in USD.

Ordinary users can obtain USDe from external liquidity pools. Whitelisted institutions can directly mint and redeem USDe through contracts.

Assets are always kept in a transparent custody address on the chain, without relying on traditional banking infrastructure, and are not affected by exchange risks.

OES: An Innovative Custody Method Combining On-Chain Transparency and Centralization in Trading

OES uses MPC technology to build custody addresses, storing user assets on-chain to maintain transparency, jointly managed by users and custodians. This significantly reduces counterparty risk and the risk of fund abuse.

OES providers collaborate with exchanges to allow the mapping of custodial asset balances for use on the exchange. This enables Ethena to hold funds outside the exchange while still using these funds as collateral for hedging positions within the exchange.

Profit Model Analysis

The profits of USDe mainly come from two aspects:

1. Staking rewards from ETH liquidity derivatives.

2. The funding rate income obtained from opening a short position on the exchange and the basis trading income.

The funding rate is the amount paid periodically based on the difference between the spot and perpetual contract markets. When the funding rate is positive, longs pay shorts; conversely, it is the opposite. This mechanism ensures that the prices of the two markets do not deviate significantly over time.

The basis refers to the deviation between spot and futures prices. As the futures approach expiration, prices typically converge toward the spot price. Ethena develops different arbitrage strategies based on the mapped balance of funds on the exchange, providing diversified returns for USDe holders.

Yield and Sustainability Assessment

Recently, the annualized yield of the USDe protocol reached a maximum of 35%, with the yield allocated to sUSDe reaching 62%. This discrepancy arises because not all USDe is converted to sUSDe. The use of USDe in DeFi protocols such as Curve and Pendle not only meets the needs of different scenarios but also potentially enhances the yield of sUSDe.

However, as the market cools down, the funding from long positions on exchanges decreases, and the funding rate income also declines. Since April, the overall yield has noticeably dropped, with the current protocol yield falling to 2% and the sUSDe yield dropping to 4%.

The yield of USDe is largely dependent on the situation of the centralized exchange futures contract market and is also constrained by the scale of the futures market. When the issuance of USDe exceeds the corresponding capacity of the futures market, it will limit its further expansion.

Discussion on Scalability

The scalability of USDe is mainly constrained by the total value of open interest in the ETH perpetual market (Open Interest), which is currently approximately 12 billion USD.

In contrast, the current issuance of USDe is about 2.3 billion USD. This indicates that the scalability of USDe is closely related to the size of the perpetual market.

To solve the issue of on-chain liquidity constraints, Ethena chooses to collaborate with centralized exchanges. This strategy avoids problems faced by certain failed projects due to insufficient on-chain liquidity.

However, the market cap growth of USDe faces challenges. The Open Interest of ETH and BTC has approached or reached historical highs. For USDe to continue expanding, it needs to increase corresponding short positions in the existing market, which may affect yields.

Overall, USDe may become a high-yield, short-term limited scale, and long-term market-following stablecoin.

Risk Factor Analysis

1. Funding rate risk: When the market is short on bulls or there is excessive issuance of USD, negative returns may occur. Although Ethena has taken some measures to address this, caution is still required.

2. Custody Risk: Fund custody relies on OES and centralized institutions, which theoretically poses a risk of funds being stolen.

3. Liquidity risk: Large amounts of funds may face insufficient liquidity during rapid adjustments, especially during times of market stress.

4. Asset anchoring risk: The anchoring relationship between stETH and ETH may fluctuate, potentially triggering liquidation risk.

To address these risks, Ethena has established an insurance fund, with funding sourced from a portion of the protocol's revenue distribution.