Ethena’s USDe: A “Cash and Carry” Trade, Not Another UST

The recent emergence of Ethena and its “stablecoin” USDe has sparked comparisons to the dramatic collapse of Terra’s UST earlier in 2023.

While both projects deal with maintaining a price peg, a closer look reveals fundamental differences in their mechanisms and underlying assets. This article aims to dispel the misconception of Ethena being “Luna 2.0” by providing a clear distinction between the two projects.

Understanding Terra’s UST: An Algorithmic Peg with Fatal Flaws

TerraUSD (UST), the algorithmic stablecoin of the Terra blockchain, aimed to maintain a 1:1 peg with the US dollar through a complex seigniorage share mechanism. Here’s a breakdown of how it worked:

• Minting and Burning: Users could mint UST by burning $1 worth of LUNA (Terra’s native token) and vice versa. This mechanism aimed to incentivize arbitrageurs to maintain the peg.
• Algorithmic Adjustments: When UST’s price deviated above $1, more UST could be minted by burning LUNA, increasing UST supply and driving the price down. Conversely, if UST fell below $1, a burn mechanism would remove UST from circulation by converting it to LUNA, decreasing supply and raising the price.

While this system functioned during bull market conditions, it harbored a critical flaw. The peg’s stability hinged on the assumption that LUNA held inherent value independent of UST.

However, the crash revealed a high degree of correlation between the two tokens. When market sentiment turned bearish and UST depegged, a vicious cycle ensued. Users rushed to redeem UST for LUNA, leading to a hyperinflation of LUNA’s supply and a subsequent collapse in both UST’s and LUNA’s prices.

Ethena’s USDe: A “Cash and Carry” Approach with Real-World Collateral

Ethena’s USDe takes a fundamentally different approach. Instead of an algorithmic mechanism, it leverages a well-established traditional finance (TradFi) strategy called “cash and carry.” Let’s dissect this strategy and how USDe implements it:

• Delta-Neutral Hedging: Ethena establishes a long position in spot Ethereum (ETH) – essentially buying ETH. Simultaneously, they hedge this position by taking a short position in ETH futures contracts on an exchange, with the same proportional value. This creates a delta-neutral situation, meaning price movements in ETH have minimal impact on the overall portfolio value.
• Yield Generation: Ethena stakes the held ETH to earn staking rewards. These rewards contribute to the overall yield generated by USDe.
• Funding Rate Capture: The short futures positions held by Ethena benefit from the prevailing funding rate in the futures market. The funding rate incentivizes the short position, further contributing to USDe’s yield.

Key Distinctions Between UST and USDe

• Collateralization: UST wasn’t directly backed by real-world assets. Its peg relied solely on the algorithmic mechanism and the perceived value of LUNA. In contrast, USDe is backed by the underlying ETH held by Ethena, providing a layer of security and stability.
• Yield Generation: UST’s high yields were primarily driven by unsustainable Anchor Protocol incentives. USDe’s yield originates from verifiable sources like ETH staking rewards and favorable funding rates.
• Transparency: Ethena acknowledges the inherent risks involved with USDe and outlines them openly in their FAQ. Terra, on the other hand, lacked transparency regarding the potential vulnerabilities of their algorithmic system.

USDe: Not Risk-Free, But Different from UST

While Ethena’s USDe offers a more transparent and potentially less risky approach compared to UST, it’s crucial to acknowledge that it’s not without its own set of challenges:

• Market Volatility: Unforeseen market events can disrupt the “cash and carry” strategy. For instance, significant price swings in ETH or negative funding rates could negatively impact USDe’s peg.
• Liquidity Risk: The smooth functioning of the “cash and carry” strategy relies on sufficient liquidity in both the spot and futures markets for ETH. Reduced liquidity could hinder Ethena’s ability to effectively manage their positions.
• Exchange and Custody Risk: The security of USDe hinges on the reliability of the exchanges where Ethena holds its ETH and executes futures contracts. Additionally, the security of the custodian responsible for storing the ETH collateral is paramount.

Ethena is Not Terra, USDe is Not UST

Ethena’s USDe presents a distinct approach to maintaining a price peg compared to Terra’s UST. USDe leverages a “cash and carry” strategy backed by real-world collateral (ETH) and transparently acknowledges the inherent risks