Old DeFi celebrity Andre Cronje comments on Ethena: Mechanism nearly impossible to implement

Former DeFi celebrity Andre Cronje has expressed concerns about the emergence of a "new stablecoin," as the timing and theme coincide with the launch of Ethena's coin, which the community believes is the stablecoin project Ethena strongly supported by BitMEX founder Arthur Hayes in recent times.

Ethena's token ENA airdrop is now open! MakerDAO proposal invests six billion in USDe

Ethena's token ENA is positioned as a governance token, but so far, it has not demonstrated any practical utility. However, the token's price has continued to rise since its listing, surprising many.

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Here is his thoughts:

"This New Protocol Carries Very High Risks"

Every now and then, new things emerge in this space. I often find myself in a broad curve for a long time. I am comfortable here. However, some events in this industry make me wish I were more curious about them, and there are events that I absolutely did not anticipate.

I am very certain that UST will fail, its mechanism makes no sense to me. However, many smart people I know are very firm in saying that it won't fail, which makes me believe "I am wrong." As for FTX, I did not expect it to collapse. When people ask me if they should withdraw their funds, my default response is "yes, why take the risk," but that is my default response to holding assets on any exchange. I did not anticipate the FTX event. I added this preamble to say that often I have no clue.

Nevertheless, there is a new original concept that is gaining a lot of attention. I see it being integrated into protocols that I consider to have very low risk, but based on my understanding, which may be incorrect, this new protocol carries very high risks.

So, I don't want to name names. I want to ask those smarter than me where I went wrong. I have gone through all visible documents, read others' assessments, but I still can't see how its risks are mitigated.

Unreasonable Aspects of the Ethena Mechanism

First, the components of this mechanism;

Perpetual Contracts -

In a normal spot trade, you simply buy an asset. More specifically, you sell one asset short and buy the corresponding asset long, for example in a BTC/USD trade, you are buying long BTC and selling short USD.

If the value of BTC against USD rises, you profit. We call these spot trades because even if the value of BTC/USD drops, you still own the BTC asset.

Perpetual trading is a tool that achieves similar trades but without involving any assets in the trade, it's more like directional gambling than trading.

A very unique mechanism in perpetual trading is that buyers (longs) and sellers (shorts) have to pay a "funding rate." If the demand to buy significantly exceeds the demand to sell, sellers receive a "positive funding rate" while buyers receive a "negative funding rate," this is to ensure that the perpetual price converges towards its spot price, this mechanism is akin to lending rates.

To keep your position open, you need to provide collateral, the collateral essentially funds your "funding rate debt." If the funding rate goes negative, it gradually eats into your collateral until your position is liquidated.

Margin/Collateral -

The next part of this mechanism is collateral based on appreciating assets, assets that hold value, in this case, stETH.

So if I have 1 stETH, I am long stETH, so if I open a short perpetual position of 1 stETH, theoretically I am "neutral." Because even if I lose $100 on the short stETH, I gain $100 on the long stETH. This overlooks the fact that the only place I could find that accepts stETH as collateral is ByBit. This also overlooks the funding rate.

Mechanism - Almost Impossible to Achieve

The theory here is that you can buy $1000 worth of stETH and use that as collateral to open a $1000 short stETH position, achieving "neutrality," while earning stETH returns of around 3% + any funding rate paid.

I am not a trader, apart from some experimental trades to build DeFi products, I admit this is not my area of expertise. I am trying to compare these tools with the commonalities I know, collateral and debt.

In my experience, eventually you need to close positions, they are no longer neutral, or they get liquidated. So now I assume the theory here is, "these positions will only be closed when the market turns," but that's a bit like saying "only buy when BTC goes up, sell when it goes down," why does this sound like a joke, because "it sounds simple," but in reality, almost impossible to achieve.

So, when everything is going well because the market is positive, and the funding rate for shorts is positive [because everyone is willing to go long], eventually the tables turn, the funding goes negative, collateral is liquidated, and you end up with an unsupported asset.

The rebuttal to this is the "law of large numbers," almost akin to the $1 billion BTC fund for UST, "it works until it doesn't."

So, I want to ask the greater wisdom out there to help me understand where I am mistaken and what I have missed.