Can Ethena’s USDe withstand the negative interest rate on funds?

Research institution CryptoQuant has conducted an analysis on whether the stablecoin USDe, which is collateralized by ETH, can maintain stability. On April 17, due to the market downturn, CryptoQuant observed that Ethena’s hedge position had a negative annualized return due to negative funding rates on several exchanges. This raises concerns about the potential risks of the massive $2.4 billion game.
Contents:
Toggle
CryptoQuant analyzes Ethena risks
The crisis of funding risks
Crisis point: Severe market adjustment
Ethena reserve fund: Obligation to maintain stability?
Evaluation of the adequacy of the reserve fund
Risks brought by exchanges
How to manage risks effectively?
CryptoQuant states that Ethena Labs has identified several risk points that could affect the stability of its synthetic USD, USDe. These include funding risk, liquidation risk, custody risk, exchange failure risk, and collateral risk. This article delves into the potential dangers related to funding risk and how Ethena manages these challenges to maintain the exchange rate stability of USDe.
“Funding risk is related to the possibility of continuous negative funding rates. Ethena can generate income from funding rates, but it may also need to pay funding rates,” explains Ethena Labs. Under normal market conditions, traders in the Ethereum and Bitcoin perpetual futures markets tend to be long, resulting in these traders eventually having to pay funding rates to the short holders, such as Ethena.
Advertisement – Continue reading below
The key issue is that in the event of a severe market downturn, a rapid price drop may invert the funding rates. In this scenario, long positions are closed by traders, and new short sellers enter the market, potentially pushing the funding rates into negative territory. This inversion forces the short holders, like Ethena, to pay funding rates to the long holders, turning their expected income into expenses.
To protect its operations and the exchange rate stability of USDe, Ethena has established a reserve fund. This fund plays a critical role in absorbing the financial impact when Ethena needs to pay the costs of negative funding rates, ensuring that USDe holders are not affected.
However, the pressing question is whether this reserve is sufficient to meet all potential obligations without jeopardizing the stability of their short positions.
CryptoQuant assesses the sustainability of Ethena’s reserve fund by employing historical data from a period of extreme market conditions similar to the Ethereum merger.
Data from this period shows that as long as the market capitalization of USDe remains below $4 billion, Ethena’s current reserve of $32.7 million is sufficient to support it. However, as the market capitalization increases, the required reserve will also increase, necessitating significant enhancements to the fund to effectively manage potential obligations at higher market values.
Looking at past cases, shortly after the collapse of the FTX exchange, funding risks sharply increased, further complicating the situation. This event emphasizes the necessity of establishing a robust and scalable reserve fund that can withstand sudden financial pressures and safeguard Ethena’s positions and the overall health of USDe.
The proportion of total revenue allocated to the reserve fund (reserve ratio) by Ethena is an important factor.
This ratio determines the growth of the reserve fund and the speed at which it strengthens its ability to buffer against adverse funding rate periods. The analysis suggests that to withstand a prolonged bear market period characterized by severe market downturns, Ethena must maintain a reserve ratio of at least 32%.
Actively adjusting the reserve ratio and the allocation of the reserve fund will be key to maintaining the stability of the synthetic USD against the backdrop of an unstable cryptocurrency market.
CryptoQuant
ENA
Ethena
USDe
Extended Reading
Who is swimming naked when the tide goes out? Crypto analyst Ignas mentions CRV, USDe, PAXG
Ethena increases second-quarter airdrop rewards, ENA coin price reaches a historic high