Ethena's Massive Capital Flight: 6.5 billion USD lost in two months, with even more severe tests ahead?

Original Title: “USDe issuance dropped drastically by $6.5 billion, but Ethena is facing even bigger problems”

Original author: Azuma

Source of the original text:

Reprint: Mars Finance

Ethena is experiencing its largest outflow of funds since its inception.

On-chain data shows that the circulating supply of USDe, the main stablecoin product under Ethena, has fallen to 8.395 billion, down about 6.5 billion from its peak of nearly 14.8 billion at the beginning of October. Although it is not quite a 'halving', the drop is already quite remarkable.

Recently, there have been frequent security incidents in DeFi, especially with the two interest-bearing stablecoins Stream Finance (xUSD) and Stable Labs (USDX), which claim to adopt a similar delta-neutral model to Ethena, consecutively facing major collapses. There are rumors that the catalyst for the collapses may have been the disruption of the neutral balance caused by the massacre on October 11, which was forcibly broken by the ADL of CEX. Additionally, there is a profound memory of USDe briefly deviating from its pegged price on Binance at that time, leading to a large-scale wave of FUD surrounding Ethena.

Is USDe still safe?

Considering the current market size of Ethena, if any unexpected events occur, it is very likely to brew a black swan event comparable to that of Terra back in the day… So, has Ethena really encountered any issues? Is the outflow of funds really driven by risk aversion? Can we still confidently deploy funds into USDe and its derivative strategies?

To conclude first, I personally tend to believe that: Ethena's current strategy is still operating normally; the risk aversion sentiment surrounding DeFi has exacerbated Ethena's capital outflow to some extent, but it is not the main reason; the current safety status of USDe is still relatively stable, but it is advisable to avoid circular lending as much as possible.

The main reasons for recognizing Ethena's current operational status are twofold.

Firstly, unlike most yield-bearing stablecoins that do not clearly disclose their position structure, leverage multiples, hedging exchanges, and even clearing risk parameters, Ethena can be considered a benchmark in the industry in terms of transparency. You can clearly see reserve information and proofs, position distribution and proportions, and the status of implemented yields directly on the Ethena official website.

The second point is the issue of the neutral strategy imbalance caused by ADL mentioned earlier. There are rumors that Ethena has signed ADL exemption agreements with some exchanges, but this has never been confirmed, so it will not be mentioned for now. However, even without exemption clauses, it is actually difficult for Ethena to be affected by ADL. This is because, from its public strategy, it can be seen that Ethena basically only selects BTC, ETH, and SOL as hedging assets (with BNB, HYPE, and XRP having a very small proportion). The volatility of these three major assets during the massive crash on October 11 was already relatively low, and the counterparty's carrying capacity is greater. In contrast, ADL is more likely to occur in the altcoin market, which is more volatile and has lower counterparty carrying capacity. Therefore, it is often those protocols that lack transparency that face explosions (possibly due to strategies being overly aggressive compared to their plans, or even completely non-neutral).

As for the main reasons for the outflow of Ethena funds, they can also be attributed to two points. First, as market sentiment has cooled (especially after October 11), the basis arbitrage space between the futures and spot markets has shrunk, causing the protocol yield and the annualized yield of sUSDe (which has fallen to 4.64% as of the publication) to decrease simultaneously. Compared to the base interest rates of mainstream lending markets such as Aave and Spark, it no longer has a significant advantage, leading some funds to choose other income-generating paths; second, the price fluctuations of USDe on Binance on October 11 heightened the market's awareness of the risks associated with circular lending. Additionally, the decline in yields on both off-chain (CEX reducing subsidy efforts) and on-chain ends has resulted in a large amount of funds unwinding circular loans and withdrawing their funds.

Based on the logic above, we believe that Ethena and USDe are still maintaining a relatively stable operating status. Although the recent outflow of funds has exceeded expectations to some extent due to extreme market conditions and security events, the main reason can still be attributed to the decrease in attractiveness caused by the shrinking arbitrage space under a lukewarm market sentiment. This is exactly what is determined by Ethena's design logic—affected by market fluctuations, the protocol's yield and capital attractiveness will also fluctuate in tandem.

A more severe test: scalability

Compared to the periodic outflow of funds, a more serious problem facing Ethena is that the Delta neutral model, which relies on the perpetual contract market for its survival, seems to have encountered a bottleneck in terms of scalability.

On November 6, DeFi giant Mindao commented on the recent explosion of neutral strategy stablecoins, stating: “The long-term returns of these strategies will converge to the level of government bonds (or even lower), with limited liquidity and trading risks fully in the black box of CEX. This model has been completely falsified… They cannot scale, ultimately just being niche financial products, making it even more impossible to compete with fiat stablecoins.”

This is akin to “The Truman Show”; Ethena once thrived in a limited small world, but this small world is constrained by factors such as the position size of the perpetual contract market and the liquidity and infrastructure conditions of trading platforms. Meanwhile, USDT, which Ethena yearns to challenge, exists in the external, unrestricted larger world. This innate difference in growth environments may very well be the biggest challenge Ethena faces.