ByBit insolvency rumors highlight Ethena’s centralization

Rumors of problems with Ethena’s $2.5 billion so-called stablecoin USDe have been fueled this week by reports that giant exchange ByBit — where Ethena trades some of its assets — is experiencing financial problems, possibly even insolvency.

Some claim that the rumors were attributable to a dashboard error at Arkham while others believed them to be true. Observers noted a small amount of exchange outflows relative to ByBit’s total assets.

ByBit itself has since refuted any claims of insolvency.

Protos reached out to the exchange for comment but at time of publication has not received a response. Over the last seven days, neither the price of Ethena’s proprietary token ENA nor its stablecoin USDe have declined in price.

For its part, Ethena claims to hold all of its collateral off-exchange at third-party custodians like Copper or Cobo. Although it clears trades via crypto exchanges, it claims to hold the collateral backing its positions, including ByBit perpetual futures, off-exchange.

Give us money, we trade it, earn 37% APY

Ethena’s marketing pitch is simple. It accepts capital, executes trades on various exchanges using this capital, and pays out a stratospheric yield above 37%. It also incentivizes extra deposits with an airdrop of its proprietary token ENA — a classic crypto marketing ploy.

Its hook is only slightly new. Ethena crafted a scheme that would take Ethereum’s 3.4% and add complexity and lots of leverage. It would also supposedly allow investors to earn the staking yield from Ethereum without subjecting themselves to the price fluctuations of ETH, via its USDe.

Ethena claimed to accomplish this feat by establishing a leveraged delta-neutral ETH trade. Its leaders would also control the private keys and exchange login credentials to hold most of the protocol’s assets. It would call itself the ‘internet bond,’ its proprietary token a ‘synthetic dollar,’ and its unsustainable 37% APY an ‘internet native yield.’

Delta neutrality is a way to invest so that the value of a portfolio usually doesn’t decrease when small changes occur in the value of the underlying asset. A trader hedges ‘delta,’ a greek financial term meaning ‘sensitivity to changes in the price of the underlying,’ by buying an equal amount of long and short positions simultaneously.

In a perfect world, this delta neutrality allows a trader to preserve the USD value of a position, regardless of whether the price of an asset like ETH declines. If ETH declines, the short position gains in value to compensate.

No free lunch on Wall Street

Of course, there’s no free lunch in finance, and holding delta neutrality in order to capture Ethereum’s staking yield carries significant risks. The two most important risks are Ethena leadership’s control of keys and funds, as well as the risk of crypto exchanges going under.

Ethena has both risks in spades. By its founding backer’s own admission, “Ethena is not decentralized, nor is it trying to be.”

Ethena backs each USDe, which is supposed to be worth $1, with two major assets. First, it buys a staked ETH (stETH) position from LidoDAO, Ethereum’s largest liquid staking protocol. Second, it collateralizes perpetual futures short contracts on crypto exchanges, including ByBit. Lido pays out most of Ethereum’s staking yield to Ethena, which Ethena then eventually leverages and passes along to USDe tokenholders who stake their USDe.

With the USD price of ETH hedged against a decline thanks to its perp shorts, as long as management and custodians don’t steal or lose the money, Ethena hopefully stays delta-neutral.

Ethena aimed to differentiate itself from failed stablecoins like Charles Hoskinson’s BitUSD, Mark Cuban’s Iron Titanium, Mark Lamb’s flexUSD, Huobi’s HUSD, or Do Kwon’s Terra and Basis Cash. Its marketing campaign worked. It rebranded itself away from ‘algorithmic’ stablecoin — a tarnished word after the multi-billion dollar collapse of Do Kwon’s algorithmic stablecoin Terra — and instead claims that USDe is a ‘synthetic dollar.’

Synthetic is, of course, different from algorithmic.

Arthur Hayes is Ethena’s biggest cheerleader

Arthur Hayes, who made millions by trading against his own customers at BitMEX and later pleaded guilty to federal crimes, is the main cheerleader for Ethena. Hayes predicts that USDe
“}[=, which has a market capitalization of $2.6 billion today, will one day grow larger than its $111 billion stablecoin competitor, Tether (USDT).

“Combining physical staked ETH plus a short ETH/USD perp swap position creates a high-yielding synthetic USD,” Hayes wrote glowingly. He also assured his fanbase that despite similar, nose bleeding-high interest rates above 30% advertised for both USDe and UST during their respective launch phases, “USDe generates yield in a completely different fashion than UST.”

Read more: Two years after blowing up his own fund, Zhu Su offers advice to $2B Ethena

Ethena investors won’t be critics

Ethena also gained significant support from crypto influencers who might have otherwise criticized the project. Influencers like Cobie, Andrew Kang, Dovey Wan, and the founders of three DeFi protocols are backers. Ethena’s own fundraise was financially supported by the crypto exchanges that process trades using its collateral.

On Ethena’s own cap table are ByBit, Deribit, OKX Ventures, Binance Labs, Gemini, and Kraken. Meltem Demirors likened USDe’s 37% yield to USDC’s 5% yield, as though the two are comparable. The founders of two competing stablecoins, Synthetix and Frax, are backers of Ethena.

Delphi Digital — which invested in the now-collapsed Terra Luna scheme, heavily broadcast Terra to wealthy New York traders, and charges over $5,000 per year for so-called research — employed an author who owns Ethena assets USDe and ENA to write a glowing, nine-chapter report.

Coincidentally, that Delphi author concluded that Ethena is “democratizing access to the delta-neutral basis trade and allowing it to seamlessly compose with the rest of DeFi.” Incredibly, Delphi alluded to a Bloomberg article about “the closest thing to a risk-free bet in the cryptocurrency market” as though Bloomberg analysts were referencing Ethena’s delta-neutral trade. They were not.

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