Ethena Protocol Insights: Challenges and Strategy Optimization of Funding Rate

Ethena is a stablecoin protocol built on the Ethereum blockchain that provides a "synthetic dollar" USDe through a Delta neutral strategy. The way it works is that users deposit stETH into the protocol to mint an equivalent amount of USDe, and Ethena utilizes an OTC settlement scheme to map the stETH balance to the exchange as collateral, shorting an equal amount of ETH perpetual contracts. This portfolio achieves Delta neutrality, theoretically keeping the value of USDe stable.

Users can stake USDe in the protocol to mint sUSDe and earn returns generated from the funding rate. As of May 9, 2024, the yield for holding sUSDe is 15.3%, with a total issuance of USDe reaching $2.29 billion, accounting for approximately 1.43% of the total market value of stablecoins, ranking fifth.

The revenue sources of the Ethena protocol are spot staking yields and funding rate earnings from short positions. In the current bull market, the bullish sentiment is significantly higher than the bearish sentiment, and the funding rate has remained at a high level for a long time. This is the reason why the Ethena protocol generates risk-free high returns.

Recently, Ethena allows users to collateralize BTC to mint USDe. As of May 9, BTC collateral accounted for 41% of total collateral. Although BTC does not have native staking rewards, introducing BTC as collateral can quickly enhance the short-term expansion capacity of USDe. However, in the long term, the growth rate of the total open interest of BTC and ETH will limit the growth of USDe.

Currently, the sUSDe yield has rapidly declined from over 30% to around 10%, influenced by the overall market sentiment and the impact of a large number of short positions caused by the expansion of USDe on the market. As a stablecoin, USDe is still extremely lacking in application scenarios, and the primary purpose of the vast majority of holders is to obtain high APY and participate in airdrop activities.

The insurance fund mechanism of Ethena is activated when the negative interest rate is integrated, but currently, the size of the insurance fund is severely insufficient compared to the issuance of USDe, accounting for only 1.66%. An inadequate insurance fund may lead to a lack of user confidence, a gradual decrease in the project’s TVL, or force the project party to increase the withdrawal rate of the insurance fund, further reducing user returns.

When the funding rate drops significantly, USDe may face the risk of a bank run. However, Ethena's unique mechanism seems to have a natural advantage in responding to bank runs. When a bank run occurs, the expenditure of the insurance fund decreases as short positions decrease, while the long liquidity in a negative funding rate market is sufficient, which is beneficial for closing short positions.

In the future, the total amount of open contracts in the market will continue to constrain the issuance of USDe. The massive short positions generated by Ethena have already caused some disturbances in the contract market, and further expansion of the USDe scale may face liquidity issues. The best way to solve this problem is to increase more high-quality collateral, raise the USDe supply limit, and diversify risks.

In summary, the Ethena protocol demonstrates a unique stablecoin mechanism and a sensitive response to market dynamics. Despite facing numerous challenges, Ethena maintains its market competitiveness through innovative over-the-counter settlement mechanisms and diversified collateral types. In the future, Ethena needs to continuously optimize its strategies and enhance its risk management capabilities to ensure sufficient insurance fund and stable liquidity. For investors and users, it is crucial to have a deep understanding of the protocol's operational mechanisms, sources of income, and potential risks.