Innovation or a New Breed of Risk? A Deep Dive into Ethena's Synthetic Dollar, USDe

This article was written by Jay Park, Business Advisor at SOOHO.IO.

Hello to our readers interested in the digital asset market.

One of the hottest topics in the Korean digital asset market recently has been the Won-denominated stablecoin. Amid active discussions about stable-value digital assets, a new type of stablecoin has emerged on the global stage, attracting immense attention for its fundamentally different approach to tracking the U.S. dollar.

The protagonist of this story is Ethena Labs' 'USDe'. Officially launched in February 2024, this "synthetic dollar" has seen its supply surge to several billion dollars in just a few months, shaking up the stablecoin market landscape.

In this post, we will conduct an in-depth analysis of what USDe is, how it differs from traditional stablecoins, and what opportunities and risks it entails.

1. What is USDe?

USDe is an Ethereum-based digital asset issued by Ethena Labs. It is a 'Synthetic Dollar', structurally distinct from traditional stablecoins like USDT or USDC.

Its most significant feature is that instead of being backed by traditional financial assets like physical dollars or U.S. Treasuries, it maintains its $1 peg by combining volatile cryptocurrency assets (primarily ETH and stETH) with derivatives positions.

2. What is a "Synthetic Dollar"?

As the name suggests, a "synthetic dollar" is a digital asset that "synthesizes" the value of the dollar using a combination of financial instruments.

• It is not directly backed by or pegged to real-world dollars or traditional financial assets.

• It replicates the value of the dollar through a combination of on-chain assets and derivatives.

• Through this structure, USDe aims to create a fully 'crypto-native' dollar asset that is not reliant on centralized issuers or the traditional banking system.

3. USDe vs. Traditional Stablecoins: Key Differences

The following table summarizes the core differences between USDe and traditional stablecoins like USDT/USDC.

4. The Core Mechanism of USDe: The Delta-Neutral Strategy

The stability of USDe is built on a sophisticated financial engineering strategy known as 'delta-neutral'.

1. Asset Deposit: A user deposits Ethereum (ETH) or a liquid staking token (stETH) into the Ethena protocol.

2. Position Establishment: Ethena takes the deposited asset (a long spot position) and simultaneously opens a short futures position for the exact same value on a centralized or decentralized exchange.

3. Value Neutralization:

   • If the price of Ethereum rises: The value of the spot collateral increases, but the short futures position incurs an equivalent loss.

   • If the price of Ethereum falls: The value of the spot collateral decreases, but the short futures position generates an equivalent profit.

Because the gains and losses of these two positions offset each other, the total USD value of the position remains stable at around $1, regardless of the price fluctuations of the underlying collateral (ETH). This is the secret to how USDe maintains a stable value while being backed by volatile assets.

5. The Opportunity: The Source of Its High Yield

The primary reason for USDe's explosive growth is its ability to generate yield. The USDe system creates revenue through two main streams, which it then distributes to USDe holders:

1. Staking Rewards: The collateral, such as stETH (liquid staking tokens), earns stable staking rewards from the Ethereum network (typically around 3-4% APY).

2. Funding Rate Yield: In perpetual futures markets, when long positions are more dominant than short positions, those holding long positions pay a "funding rate" to those holding short positions. Historically, the crypto market has had a bullish bias, meaning funding rates have often been positive.

By combining these two yield sources, USDe has been able to offer attractive returns to its users, which has been the core engine of its growth.

6. The Risks: What You Must Understand

As innovative as it is, USDe carries a new set of risks different from those of traditional stablecoins. It is crucial to be aware of the following before engaging with it:

• Funding Rate Risk: This is the most significant risk. If the market enters a prolonged bear phase where funding rates remain negative, Ethena will have to continuously pay out, severely threatening the system's profitability and stability.

• Counterparty and Custody Risk: To maintain its short futures positions, Ethena relies on centralized exchanges (CEXs) like Binance. If one of these exchanges is hacked or goes bankrupt (like the FTX incident), Ethena's collateral could be at risk.

• Smart Contract Risk: The entire logic is executed by code (smart contracts). If there are vulnerabilities or bugs in the code, it could be exploited by hackers, leading to a loss of funds.

• Liquidity and De-pegging Risk: During periods of extreme market volatility, the orderly liquidation of collateral may be disrupted, or liquidity in the futures market could dry up, potentially causing a temporary break in the $1 peg.

Conclusion: New Possibilities and a Cautious Approach

USDe represents a bold and innovative attempt to create dollar value using only crypto-native assets, thereby breaking away from its dependency on the traditional financial system. It holds the potential to significantly enhance the scalability and capital efficiency of Decentralized Finance (DeFi).

However, beneath the surface lie complex, novel risks such as funding rates and counterparty exposure. Therefore, it is crucial to approach USDe not as a "safe savings account," but as a "complex financial product that pursues high yields."

The market is watching closely to see if Ethena's experiment will succeed. We urge all investors to thoroughly study the mechanics and risks of this new asset before making any informed decisions.

A Note on Korean Stablecoin Trends and SOOHO.IO's Contribution

In Korea, the concept of 'Purpose-Bound Money' (PBM), which applies technical restrictions to limit the use of funds to specific purposes, is gaining traction.

Our team at SOOHO.IO has demonstrated its technical prowess by participating in the Bank of Korea's CBDC pilot project, where we successfully integrated PBM technology with the CBDC to implement various use cases. Building on this experience and technology, we are dedicated to providing practical solutions that combine stablecoin issuance with PBM technology, ensuring both stability and transparency. We will continue to contribute to the development of a digital asset ecosystem optimized for the Korean environment.

* Disclaimer: This content is for informational and educational purposes only and should not be construed as financial advice. The views and opinions expressed are those of the author and do not necessarily reflect the official policy or position of SOOHO.IO. Always consult with a qualified financial advisor before making any investment decisions.