The total locked value of USDe has experienced a big dump of 50%! 14.8 billion evaporated to 7.6 billion, facing a crisis of profit compression.

Ethena's USDe is a native encrypted synthetic stablecoin that generates returns through perpetual funding rates. Despite its actual usage continuously growing, its Total Value Locked has recently fallen from 14.8 billion USD in October to 7.6 billion USD, a decline of over 50%. The current Annual Percentage Rate of USDe is about 5.1%, down from double-digit returns at the beginning of the year, due to a weak market and a decrease in leverage demand leading to a narrowing of the perpetual futures funding rate.

USDe Mechanism and Source of Income

(Source: The Block)

USDe maintains its peg to the USD by using spot cryptocurrencies as collateral while simultaneously establishing a hedged short position in the perpetual futures market, turning the difference in funding rates into returns for holders. This mechanism makes USDe a “yield-generating stablecoin,” which is fundamentally different from traditional fiat-backed stablecoins (like USDC) or over-collateralized stablecoins backed by crypto assets (like DAI).

Specifically, Ethena holds spot positions in cryptocurrencies such as ETH or BTC, while simultaneously establishing equivalent short positions in perpetual contracts on derivatives exchanges like Deribit. This delta-neutral strategy ensures that regardless of whether the cryptocurrency market rises or falls, the overall value of Ethena's positions remains stable. The revenue comes from the funding rate of the perpetual contracts; when the market is in a bullish sentiment, the long side has to pay the funding rate to the short side, and Ethena, as the short side, continuously collects these fees and distributes the profits to USDe holders.

The current Annual Percentage Rate of the stablecoin is approximately 5.1%, down from double-digit rates at the beginning of the year. This decline in yield is not a reflection of Ethena's operational issues, but rather a direct reflection of changes in the overall encryption market environment. At the beginning of the year, the encryption market was in the early stages of a bull market, with speculative sentiment running high, and a large number of traders using high leverage to go long, pushing the funding rate of perpetual contracts to an annualized 15% or even higher levels. As the market softened and leverage demand decreased, the funding rate of perpetual futures significantly narrowed, and the yield of USDe also declined accordingly.

The Rise and Fall of Leverage Cycle Strategies

The sharp decline in TVL (Total Value Locked) seems to primarily stem from the liquidation of a large number of leveraged cyclical strategies that have emerged in DeFi protocols, particularly in lending markets like Aave. These arbitrage trading strategies involve repeatedly depositing staked USDe (sUSDe) as collateral to borrow USDC at a high loan-to-value ratio, then exchanging back to sUSDe, and so on, thus achieving effective leverage of 10 times or more.

The operational logic of the leveraged circular strategy is as follows: Traders first stake USDe to obtain sUSDe, which is then deposited into Aave as collateral. Since Aave offers a higher collateral rate for sUSDe (assumed to be 85%), traders can borrow USDC worth 85% of their deposit. Next, traders convert the borrowed USDC back to USDe, again stake it as sUSDe, and deposit it into Aave, repeating this process. After multiple cycles, the trader's total sUSDe exposure can reach more than 10 times the initial principal.

As long as the Annual Percentage Rate (APY) of USDe is higher than the borrowing cost of USDC, the trade can be profitable. For example, when the yield of USDe is 15% and the borrowing cost of USDC is 5%, the net profit margin is 10%. If using 10x leverage, the theoretical yield can reach 100%. This high yield has attracted a large influx of funds, pushing the Total Value Locked (TVL) of USDe to a peak of 14.8 billion USD in October.

However, the yield of USDe has currently fallen below the borrowing cost of 5.4% for USDC on Aave, leading some participants to close their positions. When the yield of USDe drops to 5.1% while the borrowing cost is 5.4%, the interest rate spread turns negative. Even without considering leverage, this strategy has already incurred losses. For traders using high leverage, the negative interest rate spread is amplified, causing losses to accumulate rapidly. Rational traders will choose to close their positions, which is the fundamental reason for the sharp decline in Total Value Locked.

The Chain Reaction of the Collapse of Leverage Cycle Strategy

TVL fell by 7.2 billion USD: from 14.8 billion to 7.6 billion, reflecting large-scale liquidations.

Aave Liquidity Pressure: A large amount of USDC borrowing has been repaid, and sUSDe collateral has been withdrawn.

Yield further compressed: As leverage demand decreases, the funding rate for perpetual contracts continues to weaken.

This dynamic indicates that when leveraged positions are closed, the yield stablecoins are prone to rapid capital outflows because when the Total Value Locked (TVL) increases, the same mechanism will accelerate capital outflows during declines. Leverage is a double-edged sword; it amplifies growth in a bull market and amplifies contraction in a bear market.

The Market Truth Revealed by the Divergence Between Trading Volume and TVL

Despite the decrease in Total Value Locked, the usage of USDe is on the rise, with on-chain transaction volume exceeding 50 billion USD last month. This indicates that even as speculative positions are gradually unwound, the token still holds practical value. This divergence between transaction volume and Total Value Locked reveals a profound change in the market structure of USDe.

TVL mainly reflects the amount of funds locked in DeFi protocols, particularly the staked funds used for leveraged cyclical strategies. The trading volume reflects the dynamic activities of payments, exchanges, and arbitrage. A monthly trading volume of 50 billion USD indicates that the demand for USDe in practical application scenarios has not diminished. These transactions may come from:

First, cross-border payment and settlement. USDe, as a stablecoin, can be used for fast and low-cost value transfers, especially between centralized exchanges or on-chain protocols. Second, arbitrage trading. Traders take advantage of price differences between different exchanges or DEXs for risk-free arbitrage, which generates a large volume of trading but does not necessarily increase Total Value Locked (TVL). Third, liquidity provision and trading activities within DeFi protocols. USDe is frequently traded in liquidity pools on DEXs such as Curve and Uniswap.

This divergence reveals an important fact: USDe is gradually transforming from a tool primarily serving leveraged speculation into a stablecoin with real application value. While the decline in Total Value Locked reflects the exit of speculative funds, the increase in trading volume indicates that genuine usage demand is still growing. This transition may be beneficial for the long-term healthy development of USDe, as it reduces reliance on high-leverage strategies and lowers systemic risk.

DeFi Protocol Adjustments and Sustainability Challenges

The deleveraging process of USDe has been exacerbated by the challenges faced by some DeFi protocols regarding the sustainability of their stablecoin yield farming mechanisms. Some protocols have already shut down these businesses, or their underlying mechanisms are also under scrutiny. This fall highlights the complexities of yield-bearing stablecoins in the DeFi space, where leverage mechanisms can amplify both growth cycles and contraction cycles.

Aave and other lending protocols have begun to reassess the risk parameters associated with sUSDe. When large-scale liquidations occur, the protocols face liquidity risk and liquidation risk. If the price of sUSDe suddenly deviates from its peg, or if the borrowing interest rate for USDC rises sharply, large leveraged positions may be forced to liquidate, triggering a chain reaction. To address these risks, Aave may lower the collateral rate for sUSDe or increase the borrowing interest rate, which will further compress the profit margin for leveraged cyclical strategies.

More broadly, the sustainability of yield-generating stablecoins depends on the stability of their yield sources. The yield of USDe comes from the funding rate of perpetual contracts, which is a highly volatile indicator influenced by market sentiment, leverage demand, and the macro environment. When the market enters a bear market or a sideways period, the funding rate may turn negative, meaning that USDe not only fails to generate yield but may also incur losses. Although Ethena has a reserve mechanism to buffer short-term losses, in the long run, the instability of the yield limits the appeal of USDe as a truly “stable” yield tool.

This dynamic indicates that when leveraged positions are closed, the returns of stablecoins can easily suffer from rapid capital outflows. The recent 50% decrease in TVL serves as a reminder to the market that high returns often come with high risks, and that growth in TVL relying on leveraged amplification does not represent the true health of the protocol. For Ethena and USDe, the future challenge lies in how to remain competitive in an environment of declining yields while attracting more genuine demand for application scenarios, rather than solely relying on speculative leverage strategies.