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

Research institution CryptoQuant analyzes whether the stablecoin USDe, which is collateralized by ETH, can maintain stability. On April 17th, due to the market downturn, we observed negative annualized returns in Ethena’s hedge position due to negative funding rates on several exchanges. This raises concerns about the $2.4 billion game of capital. Is there any danger?
Contents:
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CryptoQuant analyzes Ethena risk
Crisis of funding risk
Crisis point: severe market adjustment
Ethena reserve fund: obligation to maintain stability?
Assessing 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 may affect the stability of its synthetic USD USDe, including funding risk, liquidation risk, custody risk, exchange failure risk, and collateral risk. This article explores in-depth the potential dangers related to funding risk and how Ethena manages these challenges to maintain the stability of USDe’s exchange rate.
“Funding risk is closely related to the possibility of continuous negative funding rates. Ethena can earn revenue 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 ultimately having to pay funding rates to short holders, such as Ethena.
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The key issue is that in the event of a severe market downturn, a sharp drop in prices may cause funding rates to invert. In this case, traders close their long positions and new short sellers enter the market, potentially pushing funding rates into negative territory. This inversion forces short holders like Ethena to pay funding rates to long holders, turning their expected income into expenses.
To protect its operations and the stability of USDe’s exchange rate, Ethena has established a reserve fund. This fund plays a crucial role in absorbing financial impact when Ethena needs to pay for negative funding rates, ensuring that USDe holders are not affected.
However, the urgent question is whether this reserve is sufficient to meet all potential obligations without jeopardizing the stability of their short position.
CryptoQuant evaluates the sustainability of Ethena’s reserve fund by adopting extreme market conditions observed during a similar Ethereum merger period.
Historical 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. 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 capitalizations.
Looking at past cases, after the collapse of the FTX exchange, funding risk sharply increased, further complicating the situation. This event reaffirms the need to establish a strong and scalable reserve fund that can adapt to sudden financial pressures and safeguard Ethena’s position and the overall health of USDe.
How Ethena allocates the proportion of total revenue to the reserve fund (reserve ratio) is a critical factor.
This ratio determines the growth of the reserve fund and the speed at which it strengthens its ability to buffer against adverse funding rates. The analysis suggests that in order to withstand severe market downturns experienced during prolonged bear markets, Ethena must maintain a reserve ratio of at least 32%.
Actively adjusting the reserve ratio and the allocation of the reserve fund will be crucial in maintaining the stability of synthetic dollars against the backdrop of an unstable cryptocurrency market.
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Further reading
Who is swimming naked when the tide goes out? Cryptocurrency analyst Ignas names CRV, USDe, PAXG
Ethena increases second-quarter airdrop rewards, ENA token reaches a new all-time high.