Ethena: The best choice for synthetic dollars on-chain

In the winter of 2023, the weather in Hokkaido, Japan, was unpredictable. The days were sunny, but the nights were bone-chillingly cold. This kind of weather led to severe snow conditions known as "crusty powder" - beneath the seemingly beautiful and pristine snow lies ice and fragile layers of snow.

A year ago, I published an article titled "Dust on the Crust", proposing the idea of creating a synthetic fiat stablecoin that does not rely on traditional banking systems. I named it "Nakadollar", envisioning the creation of a synthetic dollar through Bitcoin and perpetual futures contracts. I committed to supporting a reliable team to bring this idea to fruition.

A year later, things had changed dramatically. Guy is the founder of Ethena, having previously worked at a hedge fund with a market value of $60 billion. After the DeFi Summer in 2020, he came up with the idea of launching his own synthetic dollar. He decided to use ETH instead of BTC to create a synthetic dollar stablecoin.

Guy chooses ETH because the Ethereum network offers native rewards. Additionally, ETH is now a deflationary currency, and ETH/USD forward and perpetual swap trades usually carry a premium over spot. By combining ETH staking with an ETH/USD perpetual swap short position, high-yield synthetic dollars can be created. Currently, the annual yield for spot ETH USD (sUSDe) exceeds 50%.

Guy named his synthetic dollar "Ethena" and assembled an excellent team to launch the protocol quickly and securely. Just 3 weeks after going live on the mainnet, the issuance of USDe approached 1 billion.

The issue of Tether

Tether(USDT) is currently the largest stablecoin, 1 USDT = 1 dollar. To maintain the peg, Tether holds 1 dollar in bank accounts for each circulating USDT.

Tether relies entirely on bank accounts to create USDT, hold dollar reserves, and redeem USDT. However, not all banks can provide these services, and Tether's banking partners are limited in strength.

• Britannia Bank & Trust
• Cantor Fitzgerald
• Capital Union
• Ansbacher
• Deltec Bank and Trust

These banks do not have Federal Reserve master accounts and need to rely on correspondent banks to handle dollar transactions. This makes Tether susceptible to the influence of the banking system.

In addition, the Federal Reserve does not favor the full-reserve banking model of Tether. Tether invests deposits in money market funds and government bonds, while the Federal Reserve is trying to reduce bank reserves through quantitative tightening. Tether's business is contrary to the goals of the Federal Reserve.

Tether has become one of the top 22 holders of U.S. Treasury bonds. If Tether is forced to quickly sell off its holdings of bonds, it could cause chaos in the global bond market. U.S. Treasury Secretary Yellen will not help Tether find long-term banking partners.

Tether's revenue per employee reaches up to $62 million, far exceeding that of traditional big banks. However, Tether's existence relies 100% on access to the U.S. banking system. This contradictory situation is difficult to sustain in the long term.

Advantages of Ethena

Ethena solves the problem of Tether in the following ways:

1. Pay most of the profits to USDe holders. Tether users cannot share in its high profits.

2. Sell cheap governance tokens to exchanges. Major exchanges have invested in Ethena's early financing.

3. Use ETH staking and perpetual swap contracts to create synthetic dollars without relying on the banking system.

4. Aligning with the interests of the crypto ecosystem. Ethena is "For Us, By Us", while Tether is "For Us, By Them".

How Ethena Works:

• Accept ETH or ETH LSD( such as stETH) as collateral
• Automatically sell ETH/USD perpetual swap contracts to lock in US dollar value
• Mint an equivalent amount of USDe

The yield of USDe comes from ETH staking rewards and the positive funding fee of perpetual swaps. This is completely different from algorithmic stablecoins like UST.

Risks of Ethena

Ethena also faces some risks:

1. Exchange counterparty risk. Ethena holds perpetual swap positions on centralized exchanges.

2. The smart contract risks of ETH LSD.

3. The funding fee for perpetual swaps may be negative for a long time.

4. Ethena's smart contracts may have vulnerabilities.

5. Growth is constrained by the size of open contracts for ETH derivatives.

Ethena has established an insurance fund to address these risks. Compared to Tether, Ethena's risks are different, but they are not zero risks.

Valuation of Ethena

The value of Ethena can be estimated using the following model:

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

Total Revenue = USDe supply * (ETH staking yield + ETH perpetual swap funding )

Assume:

• ETH staking yield 4%
• ETH perpetual swap funding 20%
• 50% of USDe is staked

Referring to the valuation multiples of other DeFi stablecoin projects, Ethena's fully diluted valuation ( FDV ) could reach several billion dollars.

Conclusion

Ethena represents the best attempt to autonomously create synthetic dollars in the crypto ecosystem. It addresses the core issues faced by Tether and aligns with the interests of the crypto industry. Although it still faces risks and challenges, Ethena is expected to become the largest stablecoin issuer in the future.