Original author: Andre Cronje
Translator: Odaily Planet Daily Azuma
*Editor’s note: Ethena Labs officially opened ENA airdrop applications yesterday. In the past few months, with the potential airdrop expectations and the high yields from “spot + contract arbitrage”, the issuance scale of USDe has grown rapidly. As of the time of writing, the minting volume of USDe has exceeded 1.8 billion US dollars. In the decentralized stablecoin track, it has surpassed the pioneers backed by top projects such as FRAX, crvUSD, and GHO, and has a trend of continuing to grow and shake DAI’s top position. *
*However, when USDe’s data is advancing rapidly, a lot of doubts have come to mind in the market. This afternoon, Andre Cronje, the “old king” in the DeFi field, published a long article on his personal account. Although the article did not explicitly mention Ethena Labs and USDe, it strongly questioned the design of the project from a mechanical level. It is even directly compared to the next UST. *
The following is the original content of Andre Cronje, translated by Odaily Planet Daily.
In the cryptocurrency industry, we often see something new.
There are some big things that have happened in the industry that I do wish I had looked at more carefully, but I also admit that some of them took me completely by surprise.
For example, UST, I am very sure that it will fail, because in my opinion its mechanism is illogical, but many people who I think are very smart are opposed to it, and they have been trying to convince me and try to make me Admit that I was wrong; as for FTX, I never thought it would go bankrupt. Whenever someone asked me whether I should withdraw funds from FTX, although I would answer “Okay, why take the risk?”, but this is just my opinion of all The unified view of the exchange is that its collapse was a complete surprise to me.
The reason I bring these things up again is just to make it clear in advance that many times I don’t actually understand the truth.
That said, there is one thing that has caught my attention right now — a new DeFi infrastructure that is rapidly gaining traction, and I’m seeing it being integrated into some protocols that I’ve always thought were low risk. However, according to my understanding (perhaps incorrectly), this new protocol is extremely risky.
I’m not going to point fingers directly, but I do want to ask people smarter than me what is wrong with my understanding. I have reviewed all the available literature and read many external reviews, but I still don’t understand how it eliminates risk.
- Odaily Planet Daily Note: In the full text, Andre Cronje did not directly mention Ethena Labs and USDe, but judging from the market conditions and protocol design he described, the targets of his doubts are Ethena Labs and USDe.
Next, let’s take a look at the architecture of the above protocol.
First up is the perpetual contract. In a normal spot trade, traders are simply buying an asset. To be more precise, traders are actually selling (shorting) one asset and buying (longing) another asset, such as in a BTC/USD trade, you are selling (shorting) USD and buying (longing) BTC, and if BTC appreciates relative to USD, you make money. We call this simple trading model spot trading because you will always have a spot asset, even if BTC depreciates relative to USD, you will always have BTC assets. Perpetual contracts are a trading tool that allows traders to perform similar operations, but without involving any spot assets, so it is actually a bit like gambling rather than trading.
The special thing about perpetual contracts is that both buyers (long sellers) and sellers (short sellers) need to pay a “funding rate”. If the buying demand is significantly greater than the selling demand, the seller’s funding rate will be positive. , the buyer’s funding rate will be negative, thus ensuring that the price of the perpetual contract converges with the spot price. For a trader, to maintain your trading position, all you need to do is provide margin. Margin is essentially collateral to “fund” the funding rate “debt”. If the funding rate turns negative, it will Start gradually eating away at your collateral until your position is closed.
Regarding the collateral (margin), another mechanism of the above agreement is the automatic interest-earning function of the collateral, that is, as long as the collateral is held, the asset will continue to increase in value. In the above projects, the so-called automatic interest-bearing collateral is actually stETH. If I hold 1 stETH, it is essentially equivalent to me being long stETH. Then if I open a short position of 1 stETH through the perpetual contract, position, I can theoretically achieve “delta neutrality” because even if I lose $100 on stETH short, I can still gain $100 on stETH long. Two additional points. First, the only exchange I can find that accepts stETH as margin is ByBit. Second, the “Delta Neutral” discussion here ignores the issue of funding rates.
*Odaily Planet Daily Note: The so-called Delta, in finance, is an indicator used to measure the impact of changes in underlying asset prices on changes in investment portfolios. The value range is “-1 to 1”. The definition of “Delta Neutral” is that if a portfolio consists of related financial products and its value is not affected by small price changes in the underlying assets, such a portfolio is “Delta Neutral”.
Generally speaking, the operating logic of the above protocol is that you can purchase $1,000 of stETH and use it as a deposit to open a short position of $1,000 of stETH, thereby theoretically achieving “Delta neutrality” and continuing to gain stETH’s interest-earning income (about 3%) and bear the capital rate profit and loss.
I am not a professional trader. I only do some exploratory trading to study DeFi. I admit that trading is not my strong point. I tried to compare the above operation logic with the basic financial elements (collateral and debt) that I know. According to my experience, any contract position will eventually have only two outcomes, either it will be closed (that is, “Delta Neutral” will be broken) or it will be liquidated.
So my current ideal for how the protocol works is - “positions will be closed when the market turns”, but that’s like “you just sell when BTC goes up and buy when it goes down” It sounds obvious but is almost impossible to implement in practice.
So even though everything seems to be going well now, this is only because the market is in a bullish sentiment, everyone is happy to hold long positions, and the short funding rate is positive, but the situation will eventually change. When the short funding rate turns negative, the margin (collateral) will begin to be eroded or even liquidated, and at that time there will only be an asset left without any support.
Some people may use the “law of large numbers” to refute, which is very similar to UST’s claim that it had a guarantee fund of $1 billion in BTC - “It is useful until the day it is useless.”
- Odaily Planet Daily Note: By the so-called “law of large numbers”, Andre does not seem to be referring to its classic statistical definition, but rather to the argument that “for short positions, the funding rate is positive most of the time in the long run”.
So I’m hoping some smart people on social media can help me out with this, point out where I’m getting it wrong, or point out what key information I’m missing.
