Ethena’s Tokenized Hedge Fund Offers Eye-Popping 37% Yield, Can It Sustain?

Ethereum-based synthetic dollar protocol Ethena has been in the news recently with its native token ENA gaining a staggering 100% since launch in early April 2024. Amid the widespread buzz in the market, Ethena, which replicates a common hedge-fund trade, is attracting massive investments. However, the staking yields offered by Ethena, have surged to a staggering 37% raising questions about its sustainability rate.

Ethena and Its USDe Stablecoin

Ethena, along with its synthetic dollar USDe token achieves its objective through a cryptocurrency strategy akin to the basis trade, exploiting price differentials between spot and futures markets. This strategy, known in the crypto sphere as a cash-and-carry trade, has demonstrated significant profitability recently amidst soaring token prices and funding rates.

Here’s the mechanism: Traders generate USDe tokens using an automated system by depositing stETH, a derivative of Ether, along with other approved tokens. Subsequently, Ethena Labs, the entity behind USDe, initiates short positions via Ether futures and perpetual swaps, a type of crypto futures contract that remains open indefinitely. These short positions are established across various crypto exchanges, including Binance.

These short positions enable holders of sUSDe, a derivative of USDe locked within the project, to capitalize on remarkably high funding rates, which have surpassed 100% on an annualized basis during this year’s bullish market.

Managing Risk-Reward

Obviously, the staggering high yields offered by Ethena come along with some elevated risks. However, looking back to the Terra ecosystem collapse, the massive yields on the TerraUSD token proved too good to be true.

Obviously, Ethena by design is not similar to TerraUSD, however, the challenge among investors is to identify what could go wrong with the asset class. Robert Leshner, partner at fintech venture fund Robot Ventures, said:

“It’s essentially a tokenized hedge fund where the hedge fund is managing a somewhat complex trading strategy across many different exchange venues .The worst-case scenario is that the hedge fund doesn’t perform in-line with the implied funding rate on all of these different crypto exchanges for any number of reasons.”

With the entire mechanism surrounding the USDe token as mentioned above, Ethena’s efforts seek to build a centralized crypto that pays attractive yields while simultaneously maintaining stable value. The DeFi market depends majorly on centralized stablecoins like USDT and USDC. In contrast to these tokens backed by tangible assets, USDe primarily relies on stETH for its backing.

One concern is that Ethena’s performance has only demonstrated the strategy’s effectiveness in a bullish market environment.

Ethena has acknowledged various risks associated with USDe on its website. These include funding risk, which entails potential losses if funding rates turn negative for an extended period. Exchange risk is also highlighted, given the uncertainties in the post-FTX crypto market.

Additionally, custodial risk is mentioned, as the project depends on third-party partners to safeguard customers’ assets. Collateral risk is another factor, with Ethena using stETH as collateral for its derivatives positions. If the value of stETH significantly declines compared to Ether, it could pose challenges. Ether has experienced a resurgence in crypto markets this year, rallying approximately 50% so far in 2024.