Former DeFi Icon Andre Cronje Reviews Ethena: Mechanism Practically Impossible to Implement
Former DeFi celebrity Andre Cronje expressed concerns about the emergence of “new stablecoins” due to the timing and subject matter coinciding with the issuance of Ethena tokens, a stablecoin project strongly supported by BitMEX founder Arthur Hayes, as perceived by the community.
(Ethena token ENA airdrop begins! MakerDAO proposes to invest 600 million in USDe)
The ENA token of Ethena is positioned as a governance token, but so far, it has not fulfilled any practical function. However, the token’s price has continuously risen since its listing, surprising many people.
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Here are his thoughts:
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“This new protocol carries a very high risk.”
Unreasonable aspects of the Ethena mechanism
Perpetual contracts –
Collateral/margin –
Mechanism – Almost impossible to achieve
In this field, new things often emerge. I often find myself in a long period within a broad curve. I feel comfortable here. Nevertheless, some events in this industry that I wish I could be more curious about, and some events that I absolutely did not expect, happened.
I am very certain that UST will fail, as its mechanism does not make sense to me. However, many people I consider very intelligent are firmly convinced that it will not fail, which makes me believe “I am wrong.” As for FTX, I did not expect it to collapse. When people ask me if I think they should withdraw, my default response is “yes, why take the risk,” but that is my default response to any exchange holding assets. I did not anticipate the occurrence of the FTX incident. I added this preamble to say that often I simply do not know.
Nevertheless, there is a new original concept that is gaining a lot of attention. I see it being integrated into protocols that I perceive to carry very low risk, but according to my understanding (which may be incorrect), this new protocol carries a very high risk.
So, I don’t want to name names. I want to ask those smarter than me where I misunderstood. I have gone through all visible documents, read other people’s assessments, but I still cannot see how its risk is mitigated.
Firstly, the composition of this mechanism:
In a normal spot transaction, you simply buy an asset. (To be more specific, you sell one asset (short) and buy the corresponding asset (long), for example, in a BTC/USD transaction, you are buying (going long) BTC and selling (going short) USD.)
If the value of BTC to USD rises, you make a profit. We call these spot transactions because even if the value of BTC/USD declines, you still hold the BTC asset.
Perpetual trading is a tool that achieves similar transactions without involving any assets, somewhat like directional gambling rather than trading.
A very unique mechanism of perpetual trading is that buyers (longs) and sellers (shorts) need to pay a “funding rate.” If buying demand significantly exceeds selling demand, sellers will receive a positive funding rate, while buyers will receive a negative funding rate, to ensure that the perpetual price converges to its spot price (this mechanism is the same as loan interest rates).
To maintain your position, you need to provide collateral, which is essentially the “collateral” for your “funding rate debt.” If the funding rate becomes negative, it gradually depletes your collateral until your position is closed.
The next part of this mechanism is based on income-generating collateral, which is an appreciating asset, in this case, stETH.
So if I have 1 stETH, I am long stETH. Therefore, if I open a short perpetual position of 1 stETH, I am theoretically “neutral.” Because even if I incur a $100 loss on the short of stETH, I make a $100 profit on the long of stETH. The above statement ignores the fact that the only place where stETH can be accepted as collateral is ByBit. It also ignores the funding rate.
The theory here is that you can buy $1,000 worth of stETH and use that as collateral to open a $1,000 short stETH position, achieving “neutrality” while earning stETH returns (about 3%) + any funding rate paid.
I am not a trader, except for some experimental trading to build DeFi products, I admit this is not my area of expertise. I try to compare these tools with the commonalities I know, namely collateral and debt.
Based on my experience, eventually, you need to close positions (no longer neutral) or be liquidated. So now I assume the theory here is that “these positions will only be closed when the market turns,” but this is a bit like saying “buy when BTC rises and sell when it falls,” why does this sound like a joke? Because “it sounds simple,” but in reality, it is almost impossible to achieve.
So, when everything is going well (because the market is positive and the funding rate for shorts is positive [because everyone is willing to go long]), the situation will eventually change, funds will turn negative, collateral/margin will be liquidated, and you will end up with an unsupported asset.
The counterargument to this is the “law of large numbers,” which is almost the same as the $1 billion BTC fund of UST, etc. “It will be useful until it is no longer useful.”
So, I want to ask the larger community of wisdom to help me understand where I went wrong and what I missed.
Andre Cronje
ENA
Ethena
Further reading
ENA token ENA airdrop begins! MakerDAO proposes to invest 600 million in USDe
Binance Launchpool project Ethena (ENA) to start tomorrow, BNB back above $600.
