In early 2023, Arthur Hayes, co-founder of BitMEX, released an essay, Dust on Crust, in which he criticized steiblcoins backed by traditional fiat dollars. He proposed an alternative vision – a decentralized Naka Dollar (or Satoshi Nakamoto Dollar) steiblcoin that would be backed by algorithms and pegged to the dollar exchange rate. Bitcoins would be used as collateral, and the price would be managed through short positions and inverse perpetual swaps.

The essence of Hayes’ approach is to create a token that does not need the support of the banking system, protecting itself from regulatory pressure. Hayes suggested that decentralized exchanges are not large enough for such operations, so the best candidates for the role of custodians would be centralized platforms. This was to reduce risks and preserve the decentralized nature of the project.

In 2024, a new project called Ethena, which embodies the principles described by Hayes, has attracted attention and has been backed by major players including Dragon Capital and market maker Wintermute. Ethena Labs opened access to its platform in February and raised about $500 million in assets in its first week.

What is delta-neutrality?

USDe, a stablecoin developed by Ethena Labs, is based on the concept of a delta-neutral strategy popular in traditional finance. It is used to manage the risks associated with asset price volatility. In the world of finance, delta refers to the change in the value of an option when the price of the underlying asset changes. The goal of this strategy is to eliminate the risks associated with price volatility so that returns depend on volatility rather than market direction.

In the context of USDe, Ethena Labs has adapted the strategy to provide a secure peg to the dollar. The mechanism of operation is as follows: investors deposit ETH or other tokens, which are then used to hedge positions. Half of the collateral is invested in stETH, generating income from the staking, and the other half is used to short positions in ETH.

“Synthetic dollar” and new opportunities

USDe is an algorithmic stablecoin that runs on Ethereum and hedges risk through a clever approach. Ethena Labs has also proposed a new financial instrument called “Internet Bond,” a bond that would combine the returns from Ethereum steaking with the collateralization of futures and swap markets. This innovation could be an alternative to fiat stackcoins, offering a new paradigm in DeFi.

The key task, according to the developers, is to solve the so-called trilemma of stablecoins: to find a balance between resistance to censorship, scalability and stability. To this end, the Ethena team has developed mechanisms to avoid compromises, such as:

– Censorship resilience: using decentralized solutions to store assets.

– Scalability: derivatives allow the coin to grow without the need for over-collateralization.

– Stability: hedging risks through short positions and collateral in stETH.

How does it work?

To issue (mint) USDe, a user deposits tokens, which are turned into collateral. Ethena’s algorithms then manage this collateral by maintaining delta-neutral positions and distributing revenue to network participants. In doing so, the system uses data from oracles to maintain a fair exchange rate.

Sources of income

To maintain sustainability, Ethena generates revenue from two main streams:

1. ETH staking revenues, including transaction fees and inflationary awards.

2. Revenue from short positions: when traders counting on ETH growth pay funding fees, Ethena makes a profit.

Potential risks and protection

The Ethena project takes into account multiple risks such as negative funding rates, the possibility of liquidation and threats from exchanges. Protection mechanisms include the use of a reserve fund and asset reallocation to minimize losses.

However, the project remains a high-risk endeavor. For example, negative returns can become a problem if financing rates suddenly change in an unfavorable direction. However, the developers are confident in the reliability of their solutions.

USDe is an innovative approach to creating a decentralized stablecoin that avoids the limitations of traditional finance. If the Ethena project lives up to expectations, it could fundamentally change the DeFi landscape by offering a sustainable and profitable alternative to existing stablecoins. However, time will tell how sustainable this model is in the face of real cryptocurrency market volatility.