Delta‑neutral synthetic dollars: why the USDe stablecoin matters

In March 2023 published his essay Dust on Crust, in which BitMEX co-founder Arthur Hayes criticised fiat-backed stablecoins. In their place he proposed the Naka Dollar (Satoshi Nakamoto Dollar), a decentralised “stable coin” governed by algorithms.

Hayes envisaged a token pegged to the US dollar but collateralised by bitcoin—more precisely, by short positions in the “digital gold” and inverse perpetual swaps denominated in dollars. Algorithms would keep the peg, as Naka DAO and derivatives exchanges swap assets between themselves. Centralised crypto-exchanges could act as custodians, he argued, because they have the necessary scale, unlike DEX. Such an arrangement, in his view, would avoid pressure from regulators and the banking system.

“The aim is to launch a token worth $1 that does not need the fiat banking system,” concludes Hayes.

Later, a new project called Ethena emerged, embracing the principles set out in that essay. It secured backing not only from major CEX, the Dragon Capital fund and market maker Wintermute, but also from Maelstrom Capital, Hayes’s family office. In February 2024, after a closed test, Ethena Labs opened its platform to the public and attracted about $500m in TVL in its first week.

What, then, has drawn investors to the project? To answer that, first consider the technology Ethena Labs proposes.

Delta neutrality

USDe’s architecture is built on a strategy popular in traditional finance (TradFi): delta‑neutral trading and portfolio management. Such approaches are common in options markets to control risk from moves in the underlying asset.

In TradFi, delta measures the change in an option’s price relative to changes in the price of the underlying. If an option is in the money, its delta is close to 1; if it is out of the money, its delta is close to 0. For options on a non‑dividend‑paying underlying, deltas differ as follows:

• calls have deltas between 0 and 1;
• puts have deltas between -1 and 0.

The goal of a delta‑neutral strategy is to insulate a portfolio from changes in the underlying’s price, allowing traders to earn from volatility rather than the market’s direction.

A “synthetic dollar” and “Internet Bonds”

Building on this hedging approach, Ethena is creating an algorithmic stablecoin, USDe, which the team calls a “synthetic dollar”. The coin runs on an Ethereum‑based protocol.

Ethena proposes not only a mechanism to manage the stablecoin, but also a set of broader changes that fuse TradFi and DeFi. One such instrument is an Internet Bond based on USDe. It will combine staking yield from Ethereum with returns sourced from futures and perpetual‑swap markets. The company hopes it could, in time, serve as a savings instrument for users worldwide.

Ethena also says it is ready to solve the “stablecoin trilemma”, the trade‑off that has forced coins to sacrifice one of three attributes: stability, scalability or censorship resistance. Ethena Labs’ proposed answers are:

• censorship resistance. Separate collateral from the banking system and keep riskier crypto collateral off centralised liquidity venues in transparent (24/7 verifiable) programmatic custodial solutions;
• scalability. Use derivatives so USDe can scale without over‑collateralisation, since posted ETH collateral can be fully hedged with a short of equivalent notional. A stablecoin needs only 1:1 backing;
• stability. Maintain unlevered short perpetual positions, posted as collateral immediately upon mint. That guarantees delta neutrality; USDe will not be issued without a full hedge of the initial notional.

The USDe minting process works as follows:

1. You deposit ETH, USDC or liquid‑staking tokens (stETH), and the protocol converts them into collateral.
2. Ethena stores your tokens off centralised exchanges using a zk‑SNARK mechanism.
3. Ethena opens a short on one of the centralised exchanges.
4. The protocol then maintains neutrality between the short and the stETH staking position.
5. USDe is minted on Ethereum as an ERC‑20 token and made available to you.

In sum:

• USDe is backed by an investment in ETH; the protocol targets parity with roughly 50% in spot stETH and 50% in a short ETH position, keeping the position delta‑neutral to hedge risk;
• the protocol obtains price data via built‑in oracles on major CEXs and also uses the Pyth oracle.

The mechanism may look simple and neat, but where do the returns come from to sustain stability and make the asset attractive? As with a bond, investors expect income. Here is how Ethena generates it.

When income accrues from USDe’s collateral, it is split into two streams:

1. Yield from staking your ETH: inflationary rewards on Ethereum, transaction fees and maximal extractable value (MEV). These are paid in ether.
2. Income from the short ETH position: because most users expect ether to rise over time, those taking the other side (shorts) receive funding payments from the long side.

When all cylinders are firing, staking yield on stETH is roughly 5% per year, while the ETH short has yielded 20–25% annually (a figure that raises concerns). In other words, the value of the reserve collateral increases. Such over‑collateralisation allows the protocol to mint more USDe and distribute it among participants, creating a self‑sustaining income mechanism.

Prospects and risks

Ethena Labs plans to pursue several avenues:

• a stable transactional dollar. USDe is meant to be a censorship‑resistant, scalable and stable form of money that could gradually replace fiat stablecoins in DeFi applications;
• floating‑rate and fixed‑rate bonds. Using dated futures instead of perpetual swaps enables issuance not only of floating‑rate instruments but also constant‑maturity bonds with fixed coupons;
• a crypto yield curve and risk‑free rate. With fixed‑rate, dated‑maturity hedges built on staked ETH and short dated futures, Ethena will try to establish a scalable yield curve and a crypto “risk‑free rate”;
• REPO financing. As with US Treasuries on bank and insurer balance‑sheets, an asset with a stable principal and built‑in yield could serve as collateral in DeFi money markets, allowing leverage on top of base Internet Bonds.

The flip side of high returns is risk. Ethena Labs claims to have planned for adverse scenarios:

1. Funding‑rate risk if rates turn negative, meaning Ethena would pay longs instead of receiving income.

Mitigation: over the long run, funding rates are typically positive. Using stETH as collateral adds a further buffer via its annual yield. Overall protocol income turns negative only if both stETH yield and funding are simultaneously negative.

2. Liquidation risk on exchange short positions.

Mitigation: Ethena can add collateral to protect positions and move margin between exchanges. A reserve fund underpins hedging strategies.

3. Exchange off‑boarding or outages.

Mitigation: Ethena models such scenarios and estimates potential losses, which can be covered by funding income.

Even with robust risk management on paper, there remain dangers linked to unreliable partners and staking platforms failing to honour collateral.

Conclusion

Over‑collateralised stablecoins have historically struggled to scale, as their growth was tied to leverage demand on Ethereum. To expand, they often resorted to injections of centralised stablecoins (USDC or USDT), undermining their decentralised appeal. The catastrophic collapse of Terra’s UST, triggered by problems in the Anchor protocol, put the whole segment on pause for a time.

USDe is unlike other decentralised stablecoins such as DAI, LUSD, crvUSD, FRAX or GHO. If this is to be a new monetary protocol, it must benefit all sides and fix its predecessors’ flaws. Ethena’s business architecture looks innovative in that incentives are aligned for all participants:

• the team earns protocol fees;
• CEXs enjoy deeper liquidity;
• stakers receive yield;
• USDe users get a stablecoin that is hard to block or censor;
• ETH holders benefit if the token’s price rises.

This is a genuine strength—but only if it stands the test of time. In the best case, Ethena’s innovations and Ethereum’s infrastructure will produce a synergistic effect, providing the secure, decentralised environment needed to create and manage synthetic assets.

Text: Sergey Golubenko