In a world where most cryptocurrencies struggle to demonstrate practical utility, stablecoins stand out as an asset class that has found product-market fit:
- They serve as bridges between cryptocurrency and traditional finance (TradFi).
- The most liquid trading pairs on both centralized (CEXes) and decentralized exchanges (DEXes) are denominated in stablecoins.
- They facilitate instant peer-to-peer payments, particularly for cross-border transactions.
- For those forced to hold weak currencies, they function as stores of value.
However, current stablecoin designs face significant challenges:
1. The Problems with Current Stablecoin Models
Fiat-backed Stablecoins Lack Decentralization
The most widely used stablecoins today are fiat-backed and controlled by centralized entities, presenting several drawbacks:
- They're issued by centralized entities vulnerable to censorship.
- Supporting fiat currencies are held in potentially insolvent banks with opaque, freezable deposit accounts.
- Backing securities are custodied by government-regulated entities with non-transparent processes.
- Their value is constrained by rules and laws that may change with political climates.
Ironically, these tokens—meant to promote decentralized, transparent, censorship-resistant transactions—are themselves centralized, backed by assets held in traditional financial infrastructure vulnerable to government control.
Crypto-backed Stablecoins Lack Scalability
Before incorporating real-world assets (RWAs), MakerDAO's DAI was a relatively decentralized stablecoin with verifiable on-chain backing. DAI's collateral consisted of volatile assets like ETH, requiring 110-200% overcollateralization for safety margins. This made DAI capital-inefficient and difficult to scale.
Algorithmic Stablecoins Lack Stability
Assets like Terra Luna's UST had advantages in scalability, capital efficiency, and decentralization, but their spectacular collapse demonstrated instability that plunged crypto into a prolonged bear market.
Ethena Labs' USDe attempts to address these challenges. Below we evaluate its potential to succeed.
2. Understanding USDe
USDe is a scalable synthetic dollar supported by a delta-neutral investment portfolio combining long spot positions with short derivative positions. Designed for DeFi protocols, it operates independently of traditional banking infrastructure.
How USDe Maintains Its Dollar Peg
USDe's supporting assets include:
- Long spot collateral: Liquid staking tokens (LSTs) like stETH, rETH, BTC, and USDT
- Short derivative positions using the same collateral
The mechanism works as follows:
KYC-approved institutions in permitted jurisdictions can mint USDe by depositing LSTs, BTC, or USDT with Ethena Labs. For example:
- At 1 ETH = $3000, a user deposits 1 ETH to mint 3,000 USDe
- Ethena Labs uses the ETH as collateral to open a hedge position on derivative platforms
The initial 3,000 USDe is backed by:
- 1 ETH worth $3,000
- 1 ETH short futures position (execution price $3,000) worth $0 (ignoring funding rates/basis difference)
Price movements demonstrate the delta-neutral protection:
- ETH rises $1,000: Portfolio value remains $3,000 (1 ETH @ $4,000 + short position @ -$1,000)
- ETH falls $1,000: Portfolio value remains $3,000 (1 ETH @ $2,000 + short position @ +$1,000)
USDe's Yield Generation Mechanism
USDe offers two income streams:
- Staking yield from LST collateral (consensus layer inflation, execution layer fees, MEV)
- Basis difference and funding rates from perpetual contracts
Not all USDe earns yield automatically—only stUSDe qualifies. Users must stake USDe to receive allocated yields, amplifying returns since yield is generated on all minted USDe but distributed only to stakers.
Example with 20% staking participation:
- Total minted USDe: 100
- Staking yield: 4%
- Funding rate: 3%
- Total protocol yield: 7%
- stUSDe yield: 35% (7/20*100)
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3. Does USDe Solve the Stablecoin Trilemma?
USDe's approach to scalability, decentralization, and stability:
Scalability Considerations
Spot positions: Compared to DAI, USDe doesn't require overcollateralization but accepts fewer collateral types (ETH, BTC, USDT). Fiat-backed stablecoins like USDT have greater scalability potential given Treasury markets' depth.
Derivatives: Ethena Labs chose CEXes over DEXes for liquidity, enabling 25x greater capacity. While USDe has expansion limits, significant growth potential remains at current market caps.
Decentralization Features
Unlike fiat-backed stablecoins, USDe doesn't rely on traditional banking infrastructure. Supporting LSTs, USDT, or BTC are transparently observable on-chain. Derivative positions using CEXes introduce centralization, mitigated through "off-exchange settlement" providers that hold collateral without transferring ownership to exchanges.
Stability Mechanisms
The cash-and-carry arbitrage strategy underpinning USDe is well-established in TradFi. Crypto derivatives markets now support this proven approach, but questions remain about stability under extreme conditions.
Two protection layers support USDe's peg:
- Staking yields as primary protection
- Reserve fund as secondary protection if yields can't cover negative funding rates
Historically, funding rates average 6-8% positivity over three years, including 2022's bear market. However, prolonged negative periods could threaten the peg.
Ethena Labs as Hedge Fund Manager
Ethena Labs functions similarly to a hedge fund managing complex portfolio risks. While yields are real, users face market volatility and operational risks in maintaining delta-neutral positions across:
- Multiple exchange contract specifications
- Coin-margined vs. USD-margined contracts
- Theoretical vs. actual derivative pricing
- Transaction costs and slippage
Trust in Ethena's experienced team is essential for responsible portfolio management.
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4. Potential Growth Limitations
The primary constraint on USDe's expansion may be insufficient minting incentives. While staking USDe offers compelling returns, the rationale for minting remains unclear:
- Unlike DAI, minting USDe doesn't preserve rights to original collateral
- Redemption returns equivalent value, not original asset amounts
- This effectively constitutes selling collateral assets today
- Yields benefit stakers, not minters
- Primary minting incentive appears limited to potential ENA token airdrops
Without clearer minting rewards, attracting sufficient assets under management (AUM) to scale meaningfully may prove challenging. Regulatory concerns may also influence the design separating yield generation from minting.
5. Conclusion
USDe represents a viable attempt at solving the stablecoin trilemma. However, any portrayal as a risk-free, retail-friendly stablecoin should be avoided. Like early digital currency pioneers (eCash, DigiCash, HashCash) whose innovations informed Bitcoin's creation, USDe's features may contribute to future synthetic dollars even if not the ultimate solution itself.
FAQs
What makes USDe different from Terra's UST?
Unlike UST's algorithmic model that depended on unsustainable token mechanics, USDe generates real yield through staking rewards and derivatives trading strategies backed by verifiable collateral.
How secure is USDe's dollar peg?
The peg benefits from staking yields as first-line protection and a reserve fund as secondary backing. While historically stable, prolonged negative funding rates could threaten the peg.
Why does USDe use centralized exchanges?
CEXes provide the liquidity depth needed for USDe's derivative positions to scale effectively, though "off-exchange settlement" providers help mitigate counterparty risks.
What are the main risks of holding USDe?
Primary risks include negative funding rate periods, exchange counterparty risks, collateral devaluation, and operational challenges in maintaining delta-neutral positions.
Who can mint USDe?
Currently only KYC-approved institutions in permitted jurisdictions can mint USDe by depositing approved collateral (LSTs, BTC, USDT).
How does the staking yield work?
Yield is generated on all minted USDe but distributed only to stakers, amplifying returns for participants in the staking pool.