The Real Risks of Etna’s Stablecoin Model (Not What You Think)

Etena Labs' new stablecoin has topped $2 billion in market cap, more than any other dollar-denominated asset in crypto history. But the USD's meteoric rise has raised concerns that it could repeat the high-profile collapse of other stablecoins.

While its attractive yield of 17.2% has drawn frequent comparisons to Terraform Labs's disastrous stablecoin UST, it's nothing like UST, which had its own token, algorithm, and a few hopes and prayers of circular support.

Athena differentiated itself from its predecessors by marketing the stablecoin as a “synthetic dollar.”

To generate USDE synthetic dollars, users deposit Bitcoin, Ether, Staked Ether (stETH) or USDT into the protocol, which is used to open short perpetual positions or derivatives with no expiration date.

If the value of the asset goes down, he will offset his 1:1 futures position, reducing losses. If the container appreciates, it will be resisted by the price falling in the short position.

This design, often referred to as “delta-neutral”, has been battle-tested for decades by traditional finance's differences in cash and carry trades, says Justin D'Anetan, head of APAC business development at Keyrock. It is considered safe in favorable market conditions.

But what happens when the pendulum swings the other way?

Experts share with the magazine the challenges Athena must overcome to ensure its resilience in the face of market stress.

Negative cash flow risk

Etena has been able to offer high yields due to the hot current in the crypto market.

Few investors are willing to bet on a rise in crypto prices, allowing short futures investors like Ethena to cash regular checks from long contracts and pay USDe yield.

Funding prices in perpetual futures equate contract prices with the spot price of the underlying asset, eliminating significant differences.

In bull markets, high demand for long positions can push prices above the spot, which leads to positive financial support. Long holders then make payments to short holders, adjusting for this increase and adjusting prices to the position.

Conversely, in the event that short positions cost more than the spot price, the funding rate will be negative, and short holders will pay off long holders, reducing shorts and driving up the price of the spot.

Traders with high funding need to determine whether the potential gains justify the costs. If not, closing their position will help to stabilize the contract prices with the position.

Athena's strategy “grows” in a bullish environment, explained Julia Palamarchuk, co-founder of Ton Network's Aqua Protocol, which has its own stablecoin backed by Liquid Staking Token (LST).

The tables turn into a bear market as Athena is forced to pay large amounts of cash to long holders.

“Short spaces [become] It's expensive to maintain, which could lead to a deviation from the $1 peg if costs become prohibitive, Palamarchuk told the magazine.

Athena will be able to pay the fee with the product received from LST in Collateral State – Ether-Peg IOU token that will be issued to people using the Lido DeFi protocol.

According to Etena's website, stETH accounts for 16 percent of its holdings, the lowest share of the list of four that includes Ether, Bitcoin and stablecoin USDT.

Only stETH yield, which currently has an annual percentage of 3.3%, may not be enough to cover the entire project in the face of sustained negative funding.

As markets tumbled over the weekend over Iran's attack on Israel, the currency turned sharply negative. USDe had briefly raised its stake to $0.995 on April 13, but Seraphim Chaker, Athena's head of growth, said the next day: “So far so good: USDe has passed the first stress test.”

Athena does not expect to experience long-term negative cash flows.

Citing internal analysis, Athena founder Guy Young told Cointelegraph in a February interview. In 2022, a leap year, the average funding was zero. He added that the worst times included a one-week period of negative funding, down 3%.

“If interest rates are too low, the market is telling us that the supply of USDe is too high to leverage demand in the system, and that means we need to taper off,” Yang said.

The invisible hand of the market can also play a role in keeping the USD pegged during market crises. In order to protect themselves, users must redeem their USD, which will lift the shorts, which will contribute to the replenishment of the currency.

Etena maintains an insurance fund of $32 million.

“There is no such thing as zero-risk in any traditional financial markets, and certainly not in decentralized financial markets,” says Keiroc d'Anetan.

“The difference [of the cash-and-carry trade] The product used by Athena should be meaningful and ensure stability, and the production will vary according to the desired derivatives, so it may not be at the current level, but it should not cause serious problems.

centralized collateral risks

A string of cryptocurrency exchanges have decided to freeze or go bankrupt in recent years, which means USDe's reliance on centralized exchanges for its derivatives model raises serious concerns.

Etena mitigates this risk in part by tapping settlement guards outside of the exchange.

These businesses keep Ethena's investors' assets in their vaults and use it to open a perpetual position on a central exchange on their behalf.

In the event of centralized exchange bankruptcy or other risks, Athena's perpetual position would be closed, but the collateral assets themselves should be safe because they were not originally on the exchange.

But this is only half of the battle: if the starting point is not transferred to another exchange, it may cause a risk to the statcoin's peg.

“Etena's current centralized operating model, which involves centralized wallets for fund management, introduces significant security risks and goes against DeFi's decentralized ethos,” says Palamarchuk.

Jaewoo Cho, an assistant professor of social sciences at South Korea's Hansung University, analyzed the movement of armed Ether (wETH) from the Athena Mint and the chain's return of addresses to its custodians, “directly to exchange large amounts of money.”

According to Cho's analysis, 11,417 Ether went directly into ByBit from Etena Mint and Redemption contracts.

” Saying [Ethena] Guardianship may claim to reduce risk, but in reality, the issue of trust cannot be avoided,” Cho told the newspaper.

An Athena spokesperson told the magazine that the transactions seen by Cho were part of a pre-launch phase that tests address flow before launch.

“After going live with the public network, support assets that came into Etena have all been moved directly to the Exchange solution,” Etena says.

Cho adds that most of USDT's follow-up goes down to a single tutor.

“It makes it look like the risk is not well distributed,” says Cho.

Athena released its depository receipt on Monday, reporting the location of collateral assets backing the $2.359 billion supply: copper holds $1.28 billion, Sefu holds $1.07 billion and Cobo holds $4.87 million.

Ethena Derivatives model may limit availability.

USDe is the fastest growing stablecoin to date. But there are some limitations that keep it from catching up with its centralized counterparts like Tether, which has a market capitalization of more than $100 billion and often outpaces Bitcoin in daily trading volume.

“The size of the market and the high open interest limits may overshadow USDe's growth potential, which cannot outpace the popularity of fiat-backed stablecoins,” says Palamarchuk.

Ethena's growth, like the synthetic dollar, hinges on sustainable market size.

A rising USD market value increases short positions in derivatives as such contracts open to mint USDe, increasing negative liquidity. In theory, this reduction in profits will prompt investors to close shorts and pay USDe.

If the USDe rate is too large to stabilize the funding rate for long positions, Athena's expansion may be blocked.

Ethereum open interest is estimated at $9.75 billion as of April 11, and 12 percent will help stabilize the USDe, according to Etena.

If accepted by USDe, introduced the concept of “synthetic” dollar last March, according to Arthur Hayes, it could lead to a “great growth” in the representatives of the open interest.

Aetna addresses volume constraints by expanding bond assets, most recently adding Bitcoin.

Bitcoin's open interest market is larger than Ethereum's, with $37 billion on major exchanges, according to CoinGlass data.

But this in itself brings new challenges.

Unlike stETH, Bitcoin does not offer native staking returns. The other collateral assets, USDT and Ether do not.

Thanks to an equally short hedge of positions in delta-neutral positions when spot prices fall, the lack of accumulated yield means the cushion to cushion the damage from negative liquidity is slim compared to other collateralized assets like stETH.

This may force Etena into the insurance fund.

The project's reserve funds are largely financed by the proceeds of the USDe holders holding the property to obtain production.

Of the $32 million in insurance reserves, Athena holds $6.1 million, of which $5.1 million is in USDT and $1 million in its own dollar wallet. It also has $15 million in sDAI at Maker and $11.3 million worth of USDe and USDT on Uniswap.

Having DAI in a reserve fund doesn't directly threaten the USDe itself, but it does pose insurance cost risks. This is because MakerDAO recently passed its debt ceiling to $1 billion to invest in USD, creating an awkward situation where both stablecoins need to protect each other in catastrophic situations.

MakerDAO received heavy criticism for its move, including from DeFi protocol Aave, which decided to reduce its DAI collateral.

“With Athena using DAI as its insurance fund, and with both Athena and MakerDAO facing a market downturn, the overlap could indeed pose risks,” he said.

She added that DAI's overclocking provides a buffer for the additional assets needed to maintain the image.

A different issue is that stETH may lose its peg with Ether as it did in 2022. However, they agree that the State Division deviation is not a realistic threat to Athena USDA.

“If STETH loses the peg because they've set up positions, it should neutralize the delta, so there shouldn't be much of an impact,” Cho says.

As the new kid on the block, Etna will have to carry the heavy baggage of past stable coin failures, but experts say the chances of a dip are slim.

“Besides operational errors or execution errors, the business itself is risk-free,” D'Anetan said.

He said users should balance existing risks, such as retention risks and market conditions, with the “convenience and appeal” of stablecoin and its product.

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John Yun

Yohan Yun is a multimedia journalist who has been reporting on blockchain since 2017. He has contributed as an editor to crypto media outlet Forkast and covered Asian technology stories as an assistant reporter for Bloomberg BNA and Forbes. He spends his free time cooking and experimenting with new recipes.