How Ethena's DeFi Platform Offers 27% Annualized Rewards by Shorting Ether

Ethena, a decentralized finance (DeFi) platform, has made waves in the crypto community by offering a staggering 27% annualized yield to holders of its USDe stablecoins. This article explores how Ethena generates these rewards, the mechanics behind its model, and the challenges it may face.

Ethena's Yield Generation Mechanism

Ethena generates its impressive yield mainly by shorting ether futures. Users can deposit stablecoins like tether (USDT), frax (FRAX), dai (DAI), Curve USD (crvUSD), and mkUSD to receive Ethena’s USDe tokens, which can then be staked. The yield is calculated on a rolling seven-day basis and is subject to change.

Staking Ether to a Validator

One source of yield for Ethena is staking ether to a validator and earning 5% on the capital. This process involves locking up ether to secure the network and validate transactions, earning rewards in return.

Shorting Ether Futures

Ethena also generates yield by shorting ether futures to capture the funding rate. The funding rate, estimated to be above 20%, is based on historical modeling. This futures mechanism is similar to a “cash and carry" trade, where a trader takes a long position in an asset while concurrently selling the underlying derivative.

Ethena's USDe Stablecoin

Ethena's USDe stablecoin is designed to mimic an algorithmic stablecoin, with a target peg of $1. The tokens are minted as ether tokens are deposited to the platform, ensuring a stable value proposition.

Community Response and Challenges

While Ethena has seen significant inflows, some in the crypto community remain skeptical. Past attempts at similar models have failed due to yield inversions, where the yield becomes negative, leading to losses.

Risk Management

Managing risk is a critical challenge for Ethena. The platform has allocated a significant portion of its funding round towards an initial insurance fund to mitigate risks associated with funding rates.

Addressing Concerns

Ethena's head of research, Conor Ryder, has addressed some concerns regarding risk management. He stated that the protocol's parameters were based on historical testing, minimizing far-fetched risks.