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Ethena Labs' High Yield Strategy Draws Parallels to Terra, Stirs Debate Among Crypto Traders

High returns with high risks: Ethena's approach sparks controversy  

Ethena Labs' new yield strategy with USDe stablecoin revives discussions about high-risk returns similar to Terra.

Key takeaways:

  • Ethena's yield strategy echoes the high-risk approach that led to Terra's downfall.
  • Experts debate the sustainability of Ethena's financial techniques in volatile markets.

Ethena Labs has recently captured the attention of the cryptocurrency world with its USDe stablecoin, promising an annualized yield of 37% for stakeholders. Since its public debut in February, the value locked in the protocol has surged from $178 million to $2.3 billion, marking a significant upturn within just two months. However, this high yield strategy is reminiscent of the high-risk approach that contributed to the catastrophic collapse of the Terra ecosystem in 2021.

"A lot of things can go wrong," cautioned Mike van Rossum, CEO of Folkvang, reflecting on the potential risks associated with Ethena's strategy. Unlike traditional asset-backed stablecoins, USDe operates as a synthetic stablecoin, maintaining its peg through a cash-and-carry trade, which mitigates directional risk but is not devoid of other potential complications. 

"The trade itself is very safe and well understood, many folks (including Folkvang) have been running trades like this for years," 

Van Rossum explained in an X post, adding: 

"But keep in mind it’s only risk-free when talking about delta. There are a lot of things that can go wrong here."

The mechanics behind Ethena's yield generation

To generate its attractive yields, Ethena requires users to mint USDe tokens by depositing stablecoins such as USDT, DAI, and USDC, which are then staked for returns. The protocol leverages the cash-and-carry trade involving Bitcoin and Ether perpetuals, which currently yield positive returns as long positions pay shorts. However, the sustainability of this yield is questionable, particularly if the cryptocurrency market shifts into a bearish phase.

Jeff Dorman, chief investment officer at Arca, highlighted the inherent risks tied to market cycles. 

Dorman noted in an interview:

"The risks to Ethena is that the yield goes away due to natural market forces, or that they have a counterparty blow up, not the collateral itself," 

He also pointed out that while the basis trade strategy employed by Ethena is a well-established tactic in traditional markets, it increases risk by reducing the time needed for individual investors to replicate these trades independently.

Future Prospects and Market Adaptations

Despite the high stakes involved, Ethena Labs continues to attract significant interest, evidenced by substantial withdrawals of ENA, its governance token, for staking purposes. The protocol's founder, Guy Young, defended the strategy in an interview with Laura Shin on the Unchained podcast, emphasizing the robust backing of USDe compared to the flawed model of Terra's UST. 

Young argued, underscoring the full collateralization behind USDe:

"It is a really weak, surface-level argument to compare what Ethena is doing to Luna," 

Young also acknowledged the potential need to adapt Ethena's strategy in response to changing market conditions. "This is something that we're okay with," he stated, considering the dynamic nature of market demand and interest rates. 

"It's just something that is responding to market dynamics, and if there is less leverage demand to be long as the interest rate is lower, we're going to adjust to a smaller size."