(Bloomberg) — A crypto token that aims to replicate a common hedge-fund trade is attracting billions of dollars worth of tokens and widespread buzz in the market. Yet the project, known as Ethena, is also stoking skepticism about the sustainability of its yields that are currently about 37%.
Ethena and its USDe token, a so-called synthetic dollar, achieves its goal through crypto’s version of the basis trade, which exploits differences in prices between spot and futures markets. The strategy, known in crypto as a cash-and-carry trade, has proven particularly profitable recently as token prices march higher and higher and funding rates — the interest paid by bullish traders to maintain a futures position — surge.
Of course, high yields tend to be accompanied by elevated risks. Look no further than the crypto-market chaos in 2022 when eye-popping rates on the TerraUSD token proved too good to be true. While Ethena’s design is nothing like Terra’s and it may not pose similar systemic risk, the challenge for investors is analyzing what may go wrong — and how badly — in an asset class famous for things that go wrong.
“It’s essentially a tokenized hedge fund where the hedge fund is managing a somewhat complex trading strategy across many different exchange venues,” Robert Leshner, partner at fintech venture fund Robot Ventures, said in a recent podcast about Ethena. “The worst-case scenario is that the hedge fund doesn’t perform in-line with the implied funding rate on all of these different crypto exchanges for any number of reasons.”
Here’s how it works. Traders create USDe tokens through an automated system by depositing stETH — a derivative of Ether, the second-largest cryptocurrency — and other accepted tokens. Then Ethena Labs, the entity behind USDe, opens short positions via Ether futures and perpetual swaps, a type of crypto futures contract that doesn’t expire. The positions are opened across a variety of crypto exchanges, including Binance.
Those short positions allow holders of sUSDe — a derivative of USDe that gets locked up in the project — to benefit from sky-high funding rates, which have reached more than 100% on an annualized basis in this year’s bull market.
“It’s quite insane,” said Guy Young, founder and CEO of Ethena Labs. “You can get that return without running any leverage or doing anything crazy.”
Ethena’s efforts are part of a broader ambition among digital-asset startups to build a decentralized cryptocurrency that pays an attractive yield while maintaining a stable value, in this case tracking the US dollar. Decentralized finance still largely depends on stablecoins like USDC and Tether operated by centralized companies. Unlike those tokens, which are backed by real-world assets, USDe is mainly backed by stETH.
Read: Crypto Fans Lured by 20% Stablecoin Yields Even After 2022 Bust
Ethena is not the first project to mimic basis trades. USDL, a stablecoin from Lemma Finance, also aims to keep its dollar peg while taking long positions in spot markets and shorting futures. Other previous attempts either failed or were unable to grow, especially those that heavily relied on decentralized futures markets where liquidity is scarcer than centralized exchanges.
However, Ethena has grown rapidly since its creation last year. More than $2 billion worth of cryptocurrencies have been deposited into the project, according to tracker DefiLlama. Much of the growth is likely due to demand for high yields that’s went unfilled after the blowup of lenders like Genesis and BlockFi in 2022.
Ethena has become one of the most-profitable crypto projects, logging more than $25 million in revenue in March, according to Token Terminal.
Basis Trades
For professional trading firms, it’s not difficult to put on basis trades across a variety of coins, not just Bitcoin and Ether, according to Jordie Alexander, founder of digital-asset trading firm Selini Capital. “Ethena’s product is less tactical and has to rely on just the major coins, BTC or ETH, in order to find enough open interest to put on for the demand it has to fulfill,” he said.
However, it’s another story for retail traders or other small operators without the same resources and industry relationships. So the goal of Ethena is to democratize basis trades and avoid intermediaries that are not transparent, according to Joshua Lim, strategic adviser of Ethena and former head of derivatives at Genesis.
Ethena works with several crypto market makers including Amber Group and it’s able to negotiate with centralized exchanges for discounted trading fees and other advantages such as off-exchange custody.
“Think of it as a collective bargaining agreement where all these retail participants, everyone who’s sort of throwing money into this basis trade, are able to negotiate better terms with the exchanges,” Lim said.
One concern is that Ethena’s performance has so far only proven the strategy works in a bullish market environment.
Ethena itself has disclosed risks of USDe on its website. One is funding risk, which means potential losses if funding rates go negative for a long period of time. Another is exchange risk, a common concern in the post-FTX crypto market. There is also custodial risk since the project relies on third-party partners to store customers’ assets. Collateral risk is another one. Ethena uses stETH as collateral for its derivatives positions. If stETH trades significantly lower than Ether, that could create problems.
While Do Kwon, the founder of Terra, was known for trash-talking his critics on social media, Ethena’s team seems to be more open about risks. It also re-branded USDe from a stablecoin to synthetic dollar in October amid rising criticism and comparisons with Terra.
Still, the team argues that most of the risks are either “unlikely” or something they are “comfortable” with.
“I do think there’s a bit of sugarcoating here,” Tarun Chitra, founder and chief executive officer of crypto risk-modeling firm Gauntlet, said on the podcast with Leshner. “And that’s fine, whatever. The market is dumb right now,” he said, adding: “I don’t think the blow up, if there is an unwind, will be as bad because it is generally more collateralized.”
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