Encryption Native Structured Stablecoin USDe and Its Ecosystem

Recently, an innovative crypto-native synthetic USD stablecoin has attracted market attention. This stablecoin adopts a structured passive income product design that lies between centralized and decentralized structures, securing assets on-chain while earning yields through a Delta-neutral strategy to maintain stability.

The background of the birth of this stablecoin is the dominance of centralized stablecoins such as USDT and USDC in the market, the collateral of decentralized stablecoins like DAI tending towards centralization, and the collapse of the algorithmic stablecoin LUNA/UST, which aims to seek a balance between the DeFi and CeFi markets.

This new type of stablecoin utilizes off-chain settlement services provided by institutions to custody assets on-chain and maps funds to margin provided by the exchange. This retains the characteristic of DeFi that isolates on-chain funds from exchanges, reducing risks such as the misappropriation of funds by exchanges, while also preserving the advantages of sufficient liquidity in CeFi.

The underlying returns mainly come from Ethereum staking rewards and the funding fee income obtained from opening hedge positions on exchanges, which can be considered a structured public funding fee arbitrage product. Currently, the project is incentivizing liquidity through a points system.

Ecological assets include:

• USDe: stablecoin, minted by depositing stETH
• sUSDe: Certificate token obtained by staking USDe
• ENA: Protocol governance token, which can be obtained through points redemption.

The Minting and Redemption Mechanism of USDe

Users can deposit stETH into the protocol to mint USDe at a 1:1 ratio. The deposited stETH will be sent to a third-party custodian, which will map the balance to the exchange through the OES method. The protocol will then open a perpetual short position in ETH on the exchange to ensure that the collateral value remains delta neutral.

Ordinary users can obtain USDe from external liquidity pools. Whitelisted institutions that have completed KYC/KYB can directly mint and redeem USDe through contracts. Assets are always kept on-chain in a transparent custody address, without relying on traditional banking infrastructure, thus avoiding risks such as fund misappropriation by exchanges.

OES: New Custody Model for ceDeFi Funds

OES( off-chain settlement ) is a custody method that balances on-chain transparency and the use of funds in centralized exchanges:

• Use MPC technology to build custodial addresses, store user assets on-chain, and maintain transparency and decentralization.
• Users and custodial institutions jointly manage addresses, eliminating counterparty risk in exchange transactions.
• OES providers collaborate with exchanges to allow the mapping of custodial assets to exchanges for trading.

This allows the protocol to custody funds outside of the exchange while using those funds to provide collateral for Delta hedging derivative positions on the exchange.

Profit Model

The profits of this agreement mainly come from two aspects:

1. Ethereum staking rewards brought by ETH liquidity derivatives

2. The funding fee earnings from opening a short position on the exchange and the basis trading earnings.

The funding rate is the payment made periodically based on the price difference between the spot and perpetual contract markets. When the funding rate is positive, longs pay shorts; conversely, shorts pay longs.

The basis refers to the deviation between spot and futures prices. As the futures contract approaches expiration, the price typically tends to converge towards the spot price.

The protocol formulates different arbitrage strategies by utilizing funds mapped to the exchange, providing diversified returns for USDe holders.

Yield and Sustainability

Recently, the annualized yield of this protocol has reached as high as 35%, with the yield allocated to sUSDe reaching up to 62%. This difference arises because not all USDe is converted to sUSDe. In fact, the application scenarios for USDe include entering DeFi protocols such as Curve and Pendle, which not only meet different needs but also enhance the potential yield of sUSDe.

However, as the market cools down, the long positions in the exchange decrease, and the funding rate income declines. Since April, the overall yield has significantly decreased, and the protocol yield has dropped to 2%, while the sUSDe yield has fallen to 4%.

Therefore, the yield of USDe is more dependent on the situation of centralized exchange futures contract markets and is also constrained by the scale of the futures market. When the issuance of USDe exceeds the capacity of the corresponding futures market, it will limit its continued expansion.

Scalability Analysis

The scalability of stablecoins is crucial, referring to the conditions and possibilities for increasing supply. Unlike over-collateralized stablecoins such as Maker, the scalability of this protocol is mainly constrained by the open interest of the ETH perpetual market (.

The total value of the open positions in ETH perpetual contracts on centralized exchanges is approximately 12 billion USD ) as of April 2024 (. Since the beginning of the year, ETH Open Interest has increased from 8 billion to 12 billion, and the protocol has also added support for the BTC market ) with an Open Interest of about 30 billion (. The current issuance of USD is approximately 2.3 billion, and its scalability is closely related to the size of the perpetual market.

This also explains why the protocol chose to collaborate with centralized exchanges. Previously, the UXD Protocol on the Solana chain, which adopted a similar delta-neutral strategy, faced liquidity constraints after the stablecoin issuance increased due to its choice to execute hedging strategies on decentralized exchanges, ultimately leading to the project's failure.

USDe currently ranks 5th in market capitalization among stablecoins, surpassing most decentralized stablecoins, with a gap of 3 billion USD from DAI. However, ETH and BTC Open Interest have approached or reached historic highs, presenting challenges for the continued expansion of USDe. Over-issuance may drive funding rates down or even negative, affecting yields.

In the long run, the theoretical capacity of USDe will fluctuate with market sentiment. The capacity increases during a bull market and decreases during a bear market. Overall, USDe may become a high-yield, short-term limited-scale stablecoin that follows the market in the long term.

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Risk Analysis

1. Funding Rate Risk: Insufficient market bulls or excessive issuance of USD may lead to negative funding rates. Although historical data shows that it is positive most of the time, and the stETH staking yield can provide an additional safety margin, similar projects in the past have failed due to yield inversion.

2. Custody Risk: Fund custody relies on OES and centralized institutions. Exchange bankruptcy may lead to losses of unsettled profits, and OES institutional bankruptcy may delay fund acquisition. Despite the implementation of security measures such as MPC, there remains a theoretical risk of fund theft.

3. Liquidity risk: Large amounts of funds may face insufficient liquidity during market stress. The protocol attempts to alleviate this issue by collaborating with exchanges, but it also introduces centralized risks.

4. Asset anchoring risk: stETH is theoretically anchored 1:1 with ETH, but has historically experienced brief decoupling. Future Ethereum liquidity derivatives may carry unknown risks, and asset decoupling could also trigger exchange liquidation.

To address these risks, the protocol has established an insurance fund, with funding sourced from a portion of the revenue allocated from each protocol period.

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