After USDe Halving, Can Ethena Turn to Traditional Finance Save It?
Original Title: When the Yield Runs Out
Original Author: Prathik Desai, Token Dispatch
Original Translator: Chopper, Foresight News
In the world of finance, what is known as stability is often just an illusion. You bet on a seemingly mundane financial product, believing it can bring a stable and reliable return. It does indeed follow the script until the underlying fundamentals start to shake. Such "conservative bets" are often more deceptive than speculative targets, as people already expect the latter to be high-risk, but rarely anticipate that seemingly safe investments can also run into trouble.
This kind of plot played out 75 years ago. In the 1940s, after the Great Depression and World War II, European banks accumulated a large amount of US dollar deposits. Depositors could hold dollars in non-US banks to hedge against their local currency devaluation risk. These deposits had a substantial yield, leading to some innovative operations. Some depositors, including US corporations, began to flexibly operate by depositing dollars overseas to circumvent their home country's capital controls.
European banks happily accepted this and took in deposits to then lend at higher rates. The large amount of US dollar deposits in Europe eventually gave rise to the Eurodollar market: a parallel US dollar system unregulated by the Federal Reserve. However, as the Cold War erupted at the end of the 1940s, the situation started spiraling out of control. More and more people demanded their dollars back, but the banks did not have enough physical dollars on hand, leading to the collapse of the entire system.
Today, the stablecoin market is experiencing a similar situation. The difference is that this time, the issuer of the digital dollar seems to have learned from history's lessons.
In this article, I will analyze Ethena's pivot to the traditional stock market and whether it can save its stablecoin reserve strategy.
Origin of USDe
In early 2024, Ethena launched USDe, a unique synthetic stablecoin. USDe is pegged to the dollar but does not hold real dollars in reserves. For every USDe equivalent to 1 dollar issued, the platform holds cryptocurrencies such as Bitcoin, Ethereum, while shorting an equivalent amount of crypto futures.
These two positions hedge each other. If Bitcoin rises, the spot profit will be offset by futures short losses, and vice versa. Ultimately, even without actual dollars in the account, USDe can always maintain a value of 1 dollar.
But why would users hold USDe instead of mature stablecoins like USDT, USDC? The answer is yield.
The USDe incentive mechanism is fully aligned with the operational logic of the cryptocurrency derivatives market. During a bull market, where more traders are betting on price increases, trading platforms charge a continuous small fee to long positions known as the funding rate, which is then paid to the counterparty. Ethena collects this fee and distributes it to USDe holders as revenue.
At one point, the peak annual yield of USDe exceeded 20%. Within 18 months, the USDe circulation increased sevenfold to around $15 billion, setting the fastest growth rate in stablecoin history.
However, this design is highly dependent on the active state of the cryptocurrency market. It operates smoothly during a bull market because Ethena, as a minority, takes short positions to earn the funding rate from the majority long positions. Yet, the market always shifts, leading to cracks. On October 10th last year, during the largest-scale liquidation in crypto history with over $19 billion in positions getting liquidated, USDe briefly deviated from its peg, dropping to $0.65 on Binance.
Over the following five months, the USDe circulation plummeted from around $15 billion to less than $6 billion.
A Hindsight Lesson
Over $9 billion was redeemed. Perpetual futures once almost composed 100% of the reserve, now only make up 11%. What's more ironic is that all of this could have been avoided, as Ethena should have been forewarned.
The signals were already there: the market always operates cyclically, and the crypto space is no exception. The past 16 years have repeatedly shown that over-reliance on a single collateral asset tightly linked to market trends (perpetual futures) is a ticking time bomb in itself.
Other stablecoin issuers have already begun adjusting. With the Fed rate cuts, the top two stablecoin issuers have swiftly bolstered reserve returns. Tether diversified its reserves, hitting record levels of gold holdings, while Circle, the issuer of USDC, through its Layer 1 blockchain, Arc, and the full-stack internet payment system Circle Payments Network, aggressively built infrastructure revenue streams.
Meanwhile, Ethena's response has been sluggish. Its founder, Guy Young, admitted on X that without prompt remediation, the price drop would have been even more severe.
"Since October 10th last year, Ethena was unprepared to face a significant shift in the market landscape. Over the past few months, we have been building infrastructure to safely acquire other secure and scalable collateral sources to make our business more resilient during such cycles."
He also outlined the measures Ethena has started taking to adapt to the changing market.
Embracing Traditional Finance Solutions
Ethena will expand the collateral scope to include stock and commodity basis trading, overcollateralized institutional lending, prime brokerage services, and a broader range of real-world assets (RWA).
Ethena was initially a crypto-native synthetic dollar, very different from stablecoins like USDT and USDC that are backed by real dollars or treasury reserves.
Today, it has come full circle, re-entering the traditional financial system to continue paying yields to holders and access multiple sources of revenue.
In stock basis trading, Ethena will buy the S&P 500 spot while simultaneously shorting its futures to profit from the spread, mirroring the strategy it used in its early years on Bitcoin and Ethereum. Though these gains are small, they are predictable and unrelated to the crypto market's movements.
Similarly, Ethena can replicate the same strategy across various asset classes such as gold, silver, wheat, oil, stock indices, and credit markets. Each asset has a spread being driven by supply and demand, allowing Ethena to conduct delta-neutral arbitrage in all categories, earning spreads around the clock without being affected by crypto market sentiment.
While this reduces reliance on the crypto market, it ties Ethena to stocks, commodities, and other markets. If the volatility of these markets spikes, and futures liquidity dries up, the strategy could also fail.
However, this pessimistic outlook is akin to betting that an investment portfolio highly diversified across assets will entirely fail. While such a possibility exists, it is minimal. The financial world is built on probabilities, and diversification is not about remaining profitable in a market-wide crash but about reducing the probability and magnitude of losses.
For Ethena, diversifying into revenue sources unrelated to the crypto market achieves the same effect. Even if one or two asset classes underperform, its overall returns are unlikely to be completely drained.
Liquidity Test
Ethena's diversified strategy is a reasonable response to market cycles. Spreading risks across stocks, commodities, credit, and crypto assets can make the income stream more resilient. This may be its only advantage over USDT and USDC, which are backed by treasury but offer holders almost no returns.
However, the new strategy still faces significant resistance.
The liability side of USDe is fully liquid, with holders able to redeem at any time; however, the yield-generating assets may not have ideal liquidity during periods of stress. Stock basis positions take time to unwind smoothly, institutional loans have fixed terms, and collateralized loan obligations often lack liquidity in volatile markets.
This mismatch between high liquidity liabilities and imperfectly liquid assets becomes a structural contradiction for all interest-bearing stablecoins, which cannot be fully resolved even with a diversified income strategy.
In a stable market, different assets move in response to different signals: inflation concerns drive up gold prices, positive earnings boost the stock market, geopolitical crises in oil-producing countries raise oil prices, and retail investor optimism drives up cryptocurrency funding rates.
However, in extreme stress, all logic fails. The assumption of asset correlation collapses, and the advantage of diversification disappears. The only common core of all assets is: liquidity.
Once the market deteriorates across the board, everyone will choose to cash out and exit.
Harry Markowitz won the Nobel Prize for his portfolio diversification risk reduction theory, but the 2008 financial crisis proved there are exceptions to modern portfolio theory. Scholar Nassim Taleb also raised a similar point in "The Black Swan": correlation is not a constant attribute of assets, but a variable that changes with market conditions.
Despite these anomalies, it must be acknowledged that Black Swan events are inevitable and extremely rare, almost impossible to predict or control. Diversified cross-asset portfolios still have a higher probability of success than reliance on a single asset class. The 2008 money market collapse is a case in point.
Overcollateralization is one of Ethena's means to address such risks. If the borrower collateralizes assets exceeding the loan amount, theoretically, losses will be absorbed before affecting USDe holders. However, the overcollateralization ratio is based on historical volatility and may be breached during extreme stress events.
No strategy can fully eliminate risk. What Ethena needs to do is make investors believe that this new diversified strategy is more robust than the previous model that relied entirely on the cryptocurrency market.
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