Ethena, an Ethereum-based synthetic dollar protocol, has recently caught the attention of investors with its native token ENA doubling in value since its launch in early April 2024. The project, which mimics a typical hedge fund strategy, is attracting massive investments due to its impressive 37% staking yields. However, this eye-popping yield has raised questions about its sustainability.

Ethena and Its USDe Stablecoin

Ethena's USDe stablecoin operates on a cryptocurrency strategy similar to the basis trade, exploiting price differences between spot and futures markets. This strategy, known as a cash-and-carry trade, has been profitable recently due to soaring token prices and high funding rates.

Traders generate USDe tokens by depositing stETH, a derivative of Ether, and other approved tokens into an automated system. Ethena Labs, the entity behind USDe, then initiates short positions via Ether futures and perpetual swaps across various crypto exchanges, including Binance. These short positions enable holders of sUSDe, a derivative of USDe locked within the project, to capitalize on high funding rates, which have surpassed 100% on an annualized basis this year.

Managing Risk-Reward

While Ethena offers attractive yields, they come with elevated risks. Investors must be cautious, as demonstrated by the Terra ecosystem collapse, where the massive yields on TerraUSD proved unsustainable. Although Ethena is not identical to TerraUSD, investors must identify potential risks associated with the asset class.

Robert Leshner, partner at Robot Ventures, describes Ethena as a "tokenized hedge fund" with a complex trading strategy across multiple exchange venues. The worst-case scenario is that the hedge fund's performance may not align with the implied funding rates on various crypto exchanges for various reasons.

Ethena aims to create a centralized crypto that offers attractive yields while maintaining a stable value, primarily relying on stETH for backing. However, the project's performance has only been tested in a bullish market environment.

Ethena acknowledges several risks associated with USDe on its website, including funding risk, exchange risk, custodial risk, and collateral risk. Funding risk involves potential losses if funding rates turn negative for an extended period. Exchange risk arises from uncertainties in the post-FTX crypto market.

Custodial risk is a concern due to the project's dependence on third-party partners to safeguard customers' assets. Collateral risk is also a factor, as Ethena uses 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.