Austin Campbell: Ethena is an interesting financial experiment, but USDe is just a structured bond.
Author: Austin Campbell, Founder and Managing Partner of Zero Knowledge Consulting, Professor at Columbia Business School
Translator: Babywhale, Foresight News
In July of this year, Ethena, inspired by Arthur Hayes' article on creating decentralized stablecoins based on Bitcoin, secured a $6 million investment led by Dragonfly. Ethena's decentralized stablecoin, USDe, is created by converting users' collateral into Ethereum and pledging it through perpetual contracts to hedge against the collateral's price decline.
On one hand, the pledged Ethereum can earn collateral income, and the short position can also earn funding rate income (in the long run, most of the time the funding rate for perpetual contracts on centralized exchanges is positive). Moreover, the hedge between the two can offset the collateral value loss caused by Ethereum price drops.
This seems to be a good decentralized stablecoin solution, where the collateral's value is not greatly affected by price fluctuations, and users minting USDe can also earn returns through the mechanism. However, Austin Campbell, a scholar of stablecoins and the Founder and Managing Partner of Zero Knowledge Consulting, as well as a professor at Columbia Business School, expressed that USDe cannot be called a stablecoin, but is merely a structured note:
In traditional stablecoins backed by cryptocurrencies, collateral is required, and this collateral is used to support the value of the stablecoin. To make the stablecoin "safe," the collateral price needs to be much higher than the stablecoin itself. The good news is: as long as the market does not experience a crash, you can liquidate in an orderly manner (this has been effective until events like the 2008 crisis occurred, the subprime crisis was a painful lesson for TradFi). The bad news is: this method is not very capital efficient, as the locked capital is much higher than the capital released by using stablecoins, and it also depends on the potential demand for leverage.
What sets Ethena apart? The model here attempts to eliminate the price instability of underlying cryptocurrency collateral by holding long positions in ETH and short positions in ETH perpetual contracts. Therefore, every price change in ETH is hedged.
As a structured financial product, I think this is a very interesting attempt. What I oppose is calling it a stablecoin and marketing it as such, or promising any degree of safety. Why?
Essentially, what they are doing is replacing price risk with credit risk. In particular, Ethena now faces the following risks:
Regardless of the method used for ETH collateral. If they run their own validators, is the security and continuous operation of the validators guaranteed? If they are outsourced, then the risk is borne by the supplier. If they use a liquid staking protocol, then the risk comes from the protocol, there is no free lunch here. This is not to say that the risk is always present, and in most cases, there will be no problems, but once there is a problem, the consequences could be unimaginable.
The centralized exchange or DEX where the contract positions are located. It is obvious that diversifying over time is a requirement, but at the same time, these things are not invulnerable, you will leave collateral, and therefore face risks. As for CEX, it is mainly credit risk. As for DEX, given the frequent hacking incidents in this field, credit risk may be smaller, but security/protocol risk is greater. In other words, what if the position is on FTX?
Availability risk. Another lesson learned from 2008 is: the protocol assumes that there will be enough depth for short-term trading when the price is stable. In special periods, this is not always the case. Prices will gap, liquidity will dry up, and one of the problems you will encounter is that there is simply not enough liquidity to go short. Of course, this problem is related to the issues mentioned in 2.
Interest rate risk. One interesting assumption is that the net value of collateral income and perpetual contract funding rate income is a positive number. Maybe not! Unfortunately, it is common to incur losses to maintain hedging over time, and this is fatal for stablecoins.
What I want to say is that these are not the reasons why I predict that this project will fail immediately.
It is indeed an interesting experiment, but I am concerned that, like many structured notes built by think tanks in the past, this is just an interesting experiment and does not have a core economic purpose.
Do I expect it to be stable in the long term? Maybe, maybe not. Compared to the volatile algo stablecoins, the key flaw of this design is certainly less, but from the perspective of price stability, its risks are much greater than using stablecoins backed by fiat currencies with reasonable designs. Among the issues I mentioned, one will eventually arise and undermine this "stable" coin. In a long enough time frame, this stablecoin will inevitably become unanchored.
Therefore, if you know what it is, fully understand its risks, and believe it is better than using something like PYUSD, then use it, I do not oppose them doing so.
I just oppose calling it a stablecoin, it is not.
What is issued here (Ethena) is a structured note, and its risk characteristics are similar to many notes. Are they useful? Sometimes they work, but sometimes they don't.
Would I call them "stable" or let others price them as a fixed $1 net asset on a trading platform? Absolutely not. As a buyer and issuer, truly managing the risks is also very complex.
Austin Campbell's evaluation is incisive
Compared to many people discussing how to keep over-collateralized stablecoins "stable," Austin Campbell's questions are more "soul-searching": What exactly is being issued by collateralizing crypto assets?
Whether it's MakerDAO's DAI, Curve's crvUSD, or Aave's GHO, regardless of the mechanism, the essence is: collateralizing assets to release purchasing power, and the most fundamental thing is leveraging. So, whether the issued stablecoin is pegged to the dollar or the euro, it doesn't really matter, the protocol can define the newly issued tokens as anchored to any stable and powerful currency or commodity, because it is not the so-called "stablecoin," but a structured bond.
Currently, there are many decentralized over-collateralized stablecoins in the market, which increase the trading depth between them and traditional stablecoins like USDT and USDC through liquidity incentives. On one hand, this allows many idle traditional stablecoins to earn higher returns; on the other hand, by increasing trading depth, users who collateralize their assets to mint over-collateralized stablecoins can exchange them for traditional stablecoins for secondary investment to increase purchasing power.
Although the logic is sound, once external funds stop flowing in and internal fund flows cannot support interest payments or price stability, then a market downturn will lead to a chain reaction. The cascading liquidations triggered by the mid-2021 price declines of Bitcoin and Ethereum, as well as the bankruptcy of many centralized institutions in the second half of 2022, were all caused by excessive leverage.
So, whether it's innovative collateral hedging mechanisms like Ethena or the hot collateralized LST issuance stablecoins in the market, you can call it a financial experiment, perhaps allowing some who understand the rules of the game to triumph in a stock market battle, or even call it "decentralized stablecoin," but you need to understand in your heart that fundamentally, it is just borrowing, and what is minted is just a "bond."
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