Recently, a new project called Ethena broke through the noise and attained a high TVL (total value lock, not to be confused with LTV). This post explains what it is, how it works, and where the yield comes from. 

What is Ethena and It Works

Before diving into the Ethena, we must first understand the perpetual future and how it works. 

What is the Perpetual Future

The perpetual future is a derivative product, like forward contracts, that traders can use to gain price exposure for an asset without directly holding it. It allows people to use one asset as collateral and open a position against the collateral. The traders receive more collateral if the price goes as expected (or in quote token). 

For instance, on Binance, there are USD-margined futures markets, where users can use stablecoins like USDT as collateral to open a long (expect price to increase) or short position (expect price to decrease). You receive more USDT if the price goes as planned, and your counterparty receives less. If you want to use non-stablecoin cryptocurrencies like ETH or wBTC as collateral, you must head to the coin-margined futures section. 

How Ethena Works

Ethena allows users to deposit wstETH, a wrapped version of Lido’s staked ETH, on its platform. In return, Ethena mints its USDe stablecoins to end users. 

Under the hood, Ethena uses users’ wstETH as collateral to open short ETH positions on CEX like Binance or OKX. In theory, this combination should be delta-neutral, as the increased value of wstETH should be the same as the decreased value of ETH in USD terms. Additionally, thanks to Ethereum’s proof-of-stake consensus, 1 wstETH should equal more ETH as time passes.    

Once a delta-neutral position is established, Ethena mints a stablecoin known as USDe against the position (not to be confused with USDC.e). 

Where the Yield Comes From

If you check Ethena’s website, you can find that it offers yield on USDe. But where does the yield come from? Is this Luna’s Anchor 2.0? You might wonder. 

As we mentioned, the perpetual future is a derivative product, allowing traders to gain price exposure for an asset without directly holding one. But the problem is, how does the price of this derivative follow that of the underlying? 

Perpetual futures utilize a mechanism known as funding payments to incentivize traders to come in to correct the market. 

It works like this: 
Once every 8 hours, there will be a fee exchange between the traders. If the price on a futures market is higher than that on a spot market, the traders who have held any long position will pay a fee to the ones who have held a short position during the previous 8 hours, and vice versa. This exchange happens automatically, and the payment is subtracted/added from/to the collateral; the further the deviation between spot and futures markets, the greater this fee will be.  

As a rule of thumb, the funding rate is positive during a bull market as more people open long positions. That’s how Ethena can offer such a high rate, as its short positions keep receiving fees from the long position holders.