Ethena Labs launched USDe in April as a synthetic dollar backed by a delta-hedged portfolio of futures positions on the derivatives market, sparking fears that it would follow Terra/Luna stablecoin’s disastrous journey of 2022. However, after just four months of operations it has completely outshone competitors and shot straight up into the top four by market cap – with demand even driving its governance token ENA beyond most peers in value terms.
USDe stands out with its decentralized finance (DeFi) mechanism. When users deposit cryptocurrency assets like Bitcoin or Ethereum into USDe to create new USDe, its DeFi mechanism simultaneously opens short futures positions for the same notional value on a derivatives exchange – known as delta-neutral hedging. This strategy helps protect users against volatility risk while keeping its price pegged to $1 at all times.
By doing this, USDe has attracted massive amounts of capital while remaining true to its peg – an impressive feat given that federally regulated issuers cannot provide yield on stablecoins under GENIUS Act regulations. USDe’s yield has seen exponential growth as its circulating supply has also surged; now accounting for over $8 billion of locked assets on ENA token.
Part of USDe’s growth can be attributed to the cryptocurrency bull market of early 2024; however, its long-term viability remains to be seen. If bear markets erupt again, funding rates for BTC and ETH perpetual contracts may rise sharply and exacerbate funding risk on long positions held by USDe. Furthermore, as markets become more efficient and liquid, basis spread between long and short positions could narrow further diminishing its yield on derivatives markets.
To address this risk, the USDe protocol features a special backstop fund of $32.7 million; however, should its market cap continue to expand, its size must increase accordingly in order to prevent any USDe-related issues from emerging. CryptoQuant released this week a research paper suggesting that Terra/Luna should add an additional $12 million in its insurance fund in order to avoid similar crises in future. This begs the question as to whether or not USDe’s current backstop can handle an exponential rise in market cap expansion, along with associated staking rewards and governance token distributions. Alternatively, the team may need to consider raising additional capital or restricting staking rewards in order to curb rapid expansion of the protocol. Thankfully, however, USDe’s fundamentals are strong; so long as there is market liquidity, stablecoin will continue to flourish.