Arthur Hayes' Vision & The Synthetic Dollar:Ethena's Insights
Colin Wu . 2024-04-02 . Data
The views expressed by the interviewee are personal opinions and do not represent the views of WuBlockchain or constitute any financial advice. Readers are advised to strictly comply with local laws and regulations.

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What is a TLDR of Ethena protocol and why should the industry and crypto degens pay attention to this?

Ethena Protocol is an innovative financial framework that originated from a vision Arthur shared early in 2023 through his blog post titled “Dust on Crust.” His concept involved creating a synthetic, crypto-native dollar by using Bitcoin as collateral and engaging in a short position on perpetual swaps. This method, which predates the advent of stablecoins, leverages derivatives within the cryptocurrency market to bypass traditional financial infrastructures.

Inspired by Arthur’s vision, Guy took the initiative to assemble a team and commence the development of the Ethena Protocol. While retaining the essence of Arthur’s idea, the team decided to begin with staked Ether (stETH) instead of Bitcoin, considering the yield advantages associated with stETH. This strategic choice integrates two significant sources of crypto-native yield — staking and derivatives trading — into a single financial instrument.

Ethena’s innovative approach has significant implications for the cryptocurrency industry. By combining staked Ether and a short Ether position, it generates a synthetic dollar independent of the traditional banking system. This mechanism primarily benefits from the bullish market sentiment, as it captures yield from high funding rates on centralized exchanges by taking short positions against widespread optimism in the market.

The creation of the Ethena synthetic dollar is particularly appealing because it operates entirely within the crypto ecosystem, avoiding the complexities and regulations associated with fiat currencies and traditional stablecoins. Moreover, it offers an attractive yield derived from the derivatives market, a feature that has captivated the interest of both industry insiders and cryptocurrency enthusiasts (“crypto degens”). This unique approach to generating yield and creating a stablecoin alternative highlights Ethena’s potential to revolutionize decentralized finance (DeFi) by offering new avenues for investment and yield generation without reliance on traditional financial systems.

Arthur mentioned the idea of Ethena several times and now he is heavily shilling Ethena and invested in it, what’s the story behind this?

Arthur’s involvement with Ethena and his decision to support and promote the project can be traced back to the initiative taken by the speaker to reach out to Arthur’s family office. Inspired by Arthur’s original concept shared in his blog post, the speaker presented a plan to adapt and implement this idea, leading to discussions with Arthur. These conversations allowed Arthur to evaluate whether the speaker and their team were the appropriate candidates to realize his vision for Ethena.

Convinced of the team’s capability and vision, Arthur became a significant supporter of the Ethena project. His backing was instrumental in garnering the attention and support of major centralized exchanges in the cryptocurrency sector. Arthur’s reputation and achievements in the industry, including his past successes, lent considerable credibility to Ethena. This credibility, combined with his active promotion and investment in the project, facilitated the unprecedented collaboration among leading crypto exchanges — Binance, OKX, and Huobi — to support Ethena. This coalition of support is notable because such collaboration among competitors is rare in the industry, highlighting the unique appeal and potential of the Ethena protocol. Arthur’s role was pivotal in achieving this consensus, underscoring his influence and the respect he commands within the cryptocurrency community.

Why do you call yourself a synthetic dollar? Does it relate to regulatory issues?

The term “synthetic dollar” used by Ethena is chosen deliberately to convey the distinct nature and inherent risks of their financial instrument compared to traditional stablecoins. This decision stems from a commitment to transparency and education following lessons learned from past market cycles, which were marked by deceptive marketing and a lack of clear communication regarding product risks by some entities. By differentiating itself with the term “synthetic dollar,” Ethena aims to highlight the unique financial risks associated with its model, which diverges significantly from those of conventional stablecoins.

Conventional stablecoins, despite their perceived stability, have demonstrated vulnerabilities, as seen when issues like the collapse of SVB caused fluctuations in their value. Ethena’s approach is to be upfront about the different risk profile of their product to foster a better understanding among users.

Furthermore, Ethena differentiates itself through its technical infrastructure. While the on-chain component of Ethena, visible and auditable through its open-source code, is relatively straightforward, the bulk of its complexity lies in the off-chain hedging infrastructure. This aspect is not open source, adding a layer of complexity and exclusivity to the Ethena model. This approach not only makes replication difficult but also emphasizes the importance of the partnerships with centralized exchanges.

The relationship with centralized exchanges is crucial, not only from an operational standpoint but also as a strategic moat. Given the potential systemic risks involved, centralized exchanges are selective about entities like Ethena operating at scale on their platforms. Ethena’s partnerships with these exchanges serve as a vote of confidence in its operations and a deterrent against competing projects attempting to replicate its model. This exclusivity, bolstered by the backing of centralized exchanges, is highlighted as a significant competitive advantage for Ethena, underpinning its unique position in the market.

Do you see Tether as a competitor? What’s the end game of Ethena?

It’s difficult to rival the scale of Tether, primarily because its growth is tied to the derivative market within the cryptocurrency sector. This market can expand significantly, as seen in various cycles, but Tether’s capacity to scale through Treasury bills poses a constant challenge in matching its size. However, this doesn’t imply that we cannot achieve substantial growth. Presently, I believe the market could well support a size north of $10 billion for USDe, while still maintaining safety.

In my perspective, stablecoins are indispensable in the crypto ecosystem, dominating trading volumes and representing one of the most practical innovations to date. Yet, the absence of a crypto-native variant means we’re still dependent on traditional banking systems — the very entities we aim to disrupt. We envision ourselves as a neutral infrastructure, aspiring to become a pivotal element within both decentralized finance (DeFi) and centralized finance (CeFi). Our goal is to offer a scalable dollar alternative that integrates seamlessly within our ecosystem, serving as a counterbalance to the reliance on centralized stablecoins.

What’s next for USDe to keep users in Ethena?

For USDe, the next step to maintain user engagement within Ethena hinges on enhancing the product’s utility. A crucial aspect often overlooked with stablecoins is the necessity to create a tangible demand, beyond just offering supply infrastructure. With our established connections to centralized exchanges, we see a significant opportunity in positioning USDe as a primary currency for both trading pairs and as collateral for leveraging positions. The intriguing prospect of using USDe to margin Bitcoin and other assets offers a potential to offset some funding costs, thereby driving its demand even if yields are lower.

It’s important to understand that lower yields are acceptable as they reflect a market-determined interest rate. The error with fixed interest rates, as exemplified by the Anchor protocol, lies in their rigidity, preventing market forces from adjusting the stablecoin’s supply adequately. If yields decrease, it signifies an oversupply, necessitating a contraction of our market presence. This contraction, in turn, facilitates a rise in short positions and rejuvenates funding rates.

Our approach embraces the natural market cycles of expansion and contraction, recognizing these fluctuations as integral to a market-driven product. We don’t aim to control interest rates directly; instead, our role is to provide the mechanisms that allow USDe to adjust its market footprint as needed, ensuring its long-term viability and utility.

What do you think are the biggest risks of USDe?

I believe the most significant risk associated with USDe revolves not around funding, which many might assume, but rather liquidity. The concern isn’t about funding rates dipping low or even turning negative, as these situations are self-correcting; participants tend to withdraw, allowing the system to stabilize. My primary worry lies with the liquidity aspect, specifically the costs associated with entering and exiting USDe positions. These transactions necessitate executing or unwinding hedges, which, especially at large volumes, can lead to slippage costs that are passed directly onto the users. In scenarios where many are trying to exit simultaneously, the costs could surge from a minimal 5 or 10 basis points to a substantial 50 or 100 basis points.

It’s crucial to understand that this issue doesn’t pose a systemic risk to the asset’s solvency but rather represents the inherent cost of liquidity, a burden that unavoidably falls on the users. The most challenging situations arise when there’s a mass exodus, leading to elevated slippage costs. Ensuring adequate liquidity to facilitate redemptions without significant losses for users is essential.

However, it’s important to evaluate these risks within the context of the returns generated. For instance, if a user earns a yield of 30, 40, 50, or even 60% and incurs a slippage of 50 basis points upon exit, the net outcome is still favorable compared to holding assets like USDC with negligible returns but similar liquidity risks. Hence, the comparison shouldn’t be between USDe and another stablecoin in isolation but should consider the overall yield and how it compensates for potential exit costs. This perspective encourages a more nuanced understanding of risk versus return, emphasizing the importance of considering the overall performance rather than focusing solely on liquidity constraints.

How do the shards work?(airdrop)

The shard airdrop was conceived as a strategic initiative to incentivize users to actively engage with USDe across various sectors of the decentralized finance (DeFi) ecosystem. The goal was to not just have holders of USDe, but active participants who would use USDe in diverse DeFi applications. We aimed to encourage users to deploy USDe in Automated Market Makers (AMMs) like Curve for swapping, in money markets such as Aave or Morpho for lending and borrowing, and in leveraging verticals like Gearbox. Additionally, we sought to explore its use in yield trading platforms like Pendle, fostering a dynamic engagement with the currency across multiple DeFi services.

This strategy was also about kickstarting partnerships and integrations within the DeFi space, making USDe a more integrated and utilized asset. The shard program, however, is not intended to expand indefinitely. It is set to run until April 1st, with announcements planned around that time regarding the future direction of our initiatives.

Do you foresee any regulatory pressures, how are you mitigating them?

Certainly, addressing potential regulatory pressures is a crucial aspect of our operations. We are proactively ensuring that we do not engage U.S. users within our application, nor allow them to interact with our staking contracts. To enforce this, we conduct TRM checks and possess the capability to blacklist addresses flagged within the staking contract. This measure is primarily in place to swiftly respond to any regulatory demands.

Taking a broader perspective, navigating the innovative frontiers often means operating without a clear regulatory playbook. Our strategy involves understanding current regulations and developing a flexible framework that can adapt to these rules. This flexibility is key, allowing Athena to adjust to fundamental changes if required.

The regulatory landscape, particularly concerning stablecoins and their interaction with central bank digital currencies (CBDCs) and other assets, is a focal point for regulators, especially in the U.S. This area is expected to undergo significant developments over the next 12 to 24 months.

Is there any interaction with traditional financial system?

Yes, we do interact with the traditional financial system. A key advantage is the ability to cover some funding costs with collateral. Notably, traditional financial institutions like Franklin Templeton and Fidelity have shown interest and have invested in Athena.

Our aim is to develop a dollar-denominated instrument that can smoothly transition from the crypto space to traditional finance (TradFi), offering safety and attractive yields. This has proven to be highly appealing to TradFi participants, exceeding our initial expectations. Their interest underscores our direction as aligning with market demands, especially regarding high-yield dollar assets. This interaction is not only an opportunity for expansion within the crypto sphere but also serves as a significant pathway into traditional financial sectors.

USDe’s Tradfi attractiveness, what is it like to talk to the big Tradfi guys like Fidelity, interesting takeaways?

Engaging with the major players in traditional finance (TradFi), such as Fidelity, has been surprisingly positive, especially regarding their openness to exploring the crypto space. Coming from a background in TradFi myself, I’ve been able to share perspectives on how I previously viewed the industry versus how these institutions are currently approaching it. We’ve found common ground and are able to communicate effectively.

I’m genuinely impressed by their eagerness to learn about new and innovative developments within crypto. Their interest extends beyond basic B2C services and even ETFs; they’re aiming to be at the forefront of innovation. This engagement has been extremely encouraging. Initially, I was concerned that their participation might be limited to launching ETFs as a means to merely capitalize on the industry without true involvement. However, my experience has shown that this is not the case. These institutions are genuinely interested in engaging with and contributing to the crypto ecosystem, which is a promising sign for the industry’s growth and integration with traditional finance.

Any final message to our viewers?

To our viewers, I might not be the quintessential source for advice in this domain, yet if there’s one insight I can offer, it’s drawn from my own hesitations in 2020 and 2021. Back then, I harbored the idea of embarking on a venture akin to what we’re discussing today but lacked the push to actualize it. The core of my message is simple: if you’re tuning in with ambitions to pursue something bold, innovative, and challenging, know that there’s intrinsic value in taking action. The world tends to favor those who dare to step forward and bring their ideas to fruition. So, if you find yourself wavering, my earnest advice is to seize the initiative. Embrace your ambition and make your move.

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