From cointelegraph

The synthetic stablecoin market is a dynamic part of decentralized finance (DeFi), and Ethena has left a significant mark with its innovative product. With high yields on its synthetic dollar, USDe, Ethena has captured a total value locked (TVL) of $2.7 billion, demonstrating demand for synthetic stablecoins despite the overwhelming dominance of their asset-backed equivalents. However, as with any groundbreaking product, there are risks associated with the strategy Ethena employs, especially relating to its reliance on USDT-margined contracts.

The development of the stablecoin market: Yield beyond stability

Stablecoins are a key tool for moving in and out of the crypto world. Stablecoins backed by traditional financial assets, such as Tether USDT$0.9994 and USD Coin USDC$1.00, are currently the most popular, and both rely on the banking system since they hold their collateral in fiat money and its derivatives. The collapse of Silicon Valley Bank (SVB) in early 2023 highlighted the potential risks of stablecoins. During the collapse, USDC temporarily depegged to $0.88, creating panic as a significant portion of the market’s liquidity was tied up in the stablecoin. 

The rise of projects such as Ethena, Frax, UXD or Elixir is a direct response to the growing market demand for yield-bearing stablecoins. Ethena currently leads the way among alternative stablecoin projects with a $2.8 billion market capitalization. It thus makes up 1.7% of the total stablecoin market cap. Ethena relies on USDT-margined perpetual contracts to maintain its peg.

It functions as a tokenized equivalent of the cash-and-carry trade. Upon creation, a unit of USDe is backed by $0.5 units of spot holdings (Ether ETH$2,669.52 or Bitcoin BTC$72,066) and $0.5 of a short position in the corresponding USDT-margined perpetual. The total value of this position will be $1 regardless of the asset’s price swings.

The yield on Ethena comes from the funding rates associated with perpetual contracts and staking rewards on Ethereum. Funding rates are periodic payments between long and short positions, where the side with more demand pays the other. There tends to be systemic demand for long leverage in the crypto market, contributing to the yield offered by Ethena. As the market has cooled throughout 2024, funding rates have dropped, and the annualized yield on USDe has dropped from as high as 30% to around 4% in the current market environment.

While the reliance on USDT-margined contracts has allowed Ethena to provide yield opportunities, it also introduces risks. Should USDT ever depeg due to issues in the traditional financial system, USDe would not be insulated from the impact of such an event.