Ethena’s Resilience and Challenges in a Cooling Crypto Market

Ethena’s Resilience Amid Market Challenges

The crypto yield protocol Ethena, which saw a meteoric rise earlier this year with deposits exceeding $3.6 billion, is now facing significant challenges as the cryptocurrency markets have cooled down. Investors have been withdrawing funds that support its USDe synthetic dollar token, but remarkably, USDe has maintained its stability, holding steady to its $1 peg.

According to DefiLlama data, Ethena has experienced nearly $1 billion in outflows since July, representing a 27% decline in the token’s supply. The governance token of the protocol, ethena (ENA), has suffered a staggering 85% drop from its peak in April. This decline correlates with a sharp decrease in funding rates for crypto perpetual futures, which are a crucial source of yield for USDe, falling to near-zero in recent weeks after reaching annual highs of 40%-70% in March.

Julio Moreno, an analyst at CryptoQuant, explained in an interview with CoinDesk, “Lower funding rates make it less appealing to hold and stake USDe.” USDe is backed by bitcoin (BTC) and ether (ETH), which are paired with an equal-value short perpetual futures position on various exchanges. Typically, perpetual funding rates are positive, allowing Ethena’s USDe to generate revenue from its backing derivative assets.

However, Moreno cautioned, “One of the most significant risks USDe faces is a prolonged period of negative funding rates in the perpetual futures market. In such a scenario, Ethena may have to pay funding fees to maintain its short positions.” The yield associated with USDe has plummeted to 4.4%, down from a peak of over 50% in March. This yield is now lower than safer investment options, such as traditional money-market funds or other Treasury-backed digital token offerings.

Concerns Over Price Stability

Skeptics have raised alarms about Ethena’s operational model, drawing parallels to the failed stablecoin project Terra-Luna. Terra’s algorithmic stablecoin experienced a catastrophic collapse in May 2022 after its subsidized growth strategy exhausted its resources, which triggered a severe downturn in the crypto market.

The current challenging market conditions and the surge in withdrawals have provided Ethena with an opportunity to demonstrate the stability of its protocol. “We are pleased with how Ethena has weathered multiple significant market corrections in recent months,” stated Guy Young, co-founder and CEO of Ethena Labs, the firm behind the protocol. “Stress tests were inevitable, and it has become clear that growing at our previous pace indefinitely is simply not feasible.”

Throughout the outflows, USDe has remained stable at its $1 peg, and the subsequent unwinding of trading positions to accommodate withdrawal demands occurred “in an orderly fashion with no issues affecting the US dollar peg,” Young added.

To ensure its financial stability, Ethena maintains a reserve fund, often referred to as a “rainy day” fund, to cover funding rates as necessary. To mitigate protocol risks, this reserve should ideally be at least 1% of the USDe supply. Currently, according to CryptoQuant’s Moreno, “The reserve fund stands at $45 million, which constitutes approximately 1.6% of the current USDe market capitalization.” He emphasized, “Investors should monitor this critical metric to evaluate Ethena’s risk profile.”