DeFi "King of the Old" Andre Cronje Questioned Ethena (USDe) in a Long Post: The Next UST?

Original article by Andre Cronje, co-creator of Fantom Foundation

Original compilation: Azuma, Odaily

Editor’s note: Ethena Labs officially opened applications for ENA’s airdrop yesterday. Over the past few months, USDe issuance has grown rapidly in anticipation of potential airdrops and high yields from “spot + contract arbitrage”. As of this writing, USDe has exceeded $1.8 billion minted, surpassing FRAX, crvUSD, GHO and other pioneers in the decentralized stablecoin track, and has a tendency to continue to grow and shake the top spot of DAI. However, while USDe’s data is soaring, there are also a lot of doubts in the market. This afternoon, Andre Cronje, the “” in the DeFi space, posted a long article on his personal account, in which Ethena Labs and USDe were not explicitly mentioned, but he strongly questioned the design of the project from a mechanical level, and even compared it directly to the next UST.

The following is an original article by Andre Cronje, compiled by Odaily:

In the cryptocurrency industry, we see something new from time to time.

I do wish I had taken a closer look at some of the big things that have happened in the industry, but I also admit that some of them were completely unexpected.

For example, UST, I’m pretty sure it’s going to fail, because it doesn’t seem logical to me, but a lot of people who think I’m very smart are against it, and they’ve been trying to convince me to admit that I’m wrong, and as for FTX, I never thought it would go bankrupt, and whenever someone asks me if I should withdraw from FTX, I always say “yes, why take the risk”, but that’s just my unanimous view of all exchanges, and its collapse was a complete surprise to me.

The reason why I bring these things up again is just to explain in advance, and many times I don’t know the truth.

That said, one thing does catch my attention at the moment – an emerging DeFi infrastructure is fast gaining traction, and I’m seeing it integrated into some protocols that I’ve traditionally considered to be low-risk. However, as I understand it (and perhaps wrongly), the risks of this new agreement are extremely high.

I’m not going to point fingers directly, but I do want to ask people who are smarter than me, what is wrong with my understanding? I’ve consulted all the available literature and read a lot of reviews from the outside world, but I still don’t understand how it eliminates the risk.

Odaily Note: In the full text, Andre Cronje does not directly mention Ethena Labs and USDe, but from the market conditions he describes and the design of the protocol, his skepticism is aimed at Ethena Labs and USDe.

Next, let’s take a look at the architecture of the above protocol.

The first is perpetual contracts. In normal spot trading, a trader is simply buying an asset. To put it more precisely, a trader is actually selling (shorting) one asset and buying (longing) another, for example, in BTC/USD trading, you are selling (shorting) USD and buying (longing) BTC, if BTC appreciates relative to USD, you make money. We call this simple trading model spot trading because you will always own some kind of spot asset, even if BTC depreciates against USD, you will always own BTC assets. Perpetual contracts are a trading tool that allows traders to perform similar actions without involving any spot assets, so it’s a bit of a gamble rather than a trade.

The peculiarity of perpetual contracts is that both buyers (longs) and sellers (shorts) need to pay a “funding rate”, if the buying demand is clearly greater than the selling demand, the seller’s funding rate will be positive, and the buyer’s funding rate will be negative, so as to ensure that the price of the perpetual contract converges with the spot price. For traders, what you need to do to maintain your trading position is to provide margin, which is essentially collateral to “finance” the funding rate “debt”, and if the funding rate turns negative, it will start to gradually eat away at your collateral until your position is closed.

With regard to collateral (margin), another mechanism of the above agreement is the automatic interest-bearing function of the collateral, i.e. as long as the collateral is held, the asset will continue to increase. In the above project, the so-called auto-interest-bearing collateral is actually stETH, if I hold 1 stETH, which is essentially equivalent to I am long stETH, then if I open a short position of 1 stETH through the perpetual contract, I can theoretically achieve “Delta neutrality”, because even if I lose $100 on stETH short, I can also gain $100 on stETH long. To add two points, one is that the only exchange I can find that can accept stETH as margin is ByBit, and the other is that the “delta neutral” discussion here ignores the issue of funding rates.

• Odaily Note: In finance, Delta is an indicator used to measure the impact of changes in the price of underlying assets on the change of investment portfolio, with values ranging from “-1 to 1”. “Delta Neutral” is defined as a “Delta Neutral” portfolio if it consists of underlying financial products whose value is not affected by small price changes in the underlying asset.

In general, the logic of the above protocol is that you can buy $1,000 of stETH and use it as margin to open a short village of $1,000 of stETH, so as to theoretically achieve “Delta neutrality”, and continue to obtain interest-bearing income on stETH (about 3%) and bear the profit and loss of the funding rate.

I’m not a professional trader and only do some exploratory trading for the sake of DeFi, and I admit that trading is not my forte. I’ve tried to compare the above operating logic with what I know about the underlying financial elements (collateral and debt). In my experience, any contract position will only end up with two outcomes, either it will be closed (i.e. the “delta neutral” will be broken) or it will have to be liquidated.

So, my current ideal assumption about how the protocol works is that “when the market turns, positions will be closed”, but this statement is like a meme of “you just need to sell when BTC goes up and buy when it goes down”, which sounds obvious, but in practice it is almost impossible to execute.

So although it seems that everything is going well now, this is only because the market is in a bullish mood, everyone is happy to hold long positions, and the funding rate for short is positive, but the situation will eventually change, and when the funding rate for short turns negative, the margin (collateral) will start to be cannibalized or even liquidated, and then there will only be one asset left without any support.

Some may refute it with the “law of large numbers”, which is much like UST’s claim to have $1 billion in BTC — “useful until the day it was useless.”

• Odaily Note: The so-called “law of large numbers”, Andre does not seem to be referring to the classical definition of statistics, but to the argument that “for short positions, the funding rate is the majority in the long run”.

So I’m hoping that smart people on social media can help me answer these questions so that I can point out where I’m misunderstanding or what I’m missing out on key information.