AC ( Andre Cronje ), a big name in the crypto and founder of Fantom , published a long article on X today to discuss a current hot project. Although he did not specify which one it was, it was obviously Ethena (ENA) that was just launched yesterday. AC believes that the risk of this protocol is very high.
The following content was compiled by Followin :
We often see something new in this space. I often find myself in it for a long time. I feel comfortable with that feeling. That being said, there are events in this industry that I wish I had been more curious about, but there are also events that I definitely did not see coming. UST, which I was very confident in, failed. The mechanisms simply did not make sense to me, but many people who I thought were very smart had been very vocal about it not failing: I was sure "I was wrong". FTX, I did not expect it to fail, and when people asked me if I thought they should withdraw funds from FTX, my default response was "yeah, why risk it", but that is just my default response to all exchanges that hold assets .
That being said, there is a new primitive that is gaining a lot of traction and I see it being integrated into what I consider to be a very low risk protocol, but from my (probably incorrect) understanding, the risk of this new protocol is very high. So rather than naming names or accusations, I would like to ask people smarter than me where I am going wrong in my perspective, I have gone through all the available documentation, I have read other people's assessments, and I still don't know how to mitigate the risk of this project.
First, here are the components of this project;
Perpetual Swaps - In a normal spot trade, you simply buy an asset (more specifically, you sell one asset [short that asset] and buy the corresponding asset [long that asset], e.g. in a BTC/USD trade, you buy ( long) BTC and sell (short) USD. If BTC appreciates against USD, you make a profit. We call these spot trades because you own the underlying asset, even if BTC/USD depreciates, you still own the BTC asset. Perpetual swaps are a tool that allows similar trades, but without the need for any of the assets involved in this trade, kind of like directional gambling instead of trading. A very unique mechanism of perpetual swaps is that buyers (long) and sellers (short) need to pay a “funding rate”. If there is significantly more demand to buy than to sell, sellers will receive “positive funding” and buyers will receive “negative funding”, this is to ensure that the perpetual price tends to its spot price (this mechanism is the same as a loan rate). In order to maintain your position, you need to provide margin, which is actually just collateral to “fund” your “funding rate debt”. If the funding rate turns negative, it will erode your collateral until your position is closed.
Margin/Collateral - The next part of the mechanism is yield-based collateral, i.e. an asset that appreciates in value through holding, in this case stETH. So if I have 1 stETH, I am long stETH, so if I open a 1 stETH short perpetual position, I am (theoretically) “neutral”. Because even if I lost $100 on my stETH short trade, I gained $100 on my stETH long trade. Now I am ignoring that the only place I could find that accepts stETH as margin collateral is ByBit. The above also ignores the funding rate.
Mechanics — The theory here is that you can go “neutral” by buying $1000 of stETH, using that as collateral to open a $1000 short stETH, thereby generating a “stable” $1000, while earning the benefit of the stETH yield (~3%) + whatever amount was paid in the funding rate.
I'm not a trader now, other than doing some exploratory trading to build defi stuff, which is not my area of expertise. I tried to compare these tools to what I know other projects have in common, which is collateral and debt. In my experience, eventually you need to either close your position (no longer neutral) or get liquidated. So now I'm assuming the theory here is, "when the market turns, the position is closed", but that's a bit like saying "buy Bitcoin when it goes up, sell it when it goes down", "which sounds obvious" but is actually almost impossible to achieve.
So, while things are going well now (because the market is positive and short funding rates are positive [because everyone is happy to be long]), eventually things will turn negative, margin/collateral will be liquidated, and you will have unsecured assets.
The opposite of this is the “law of large numbers”, which is pretty much the same thing as UST’s $1 billion BTC fund etc. “It works until it doesn’t”.
So I would like to ask the big Vs in the crypto community to help me understand where I went wrong and what I missed.
@mojitoGMI said JMM wrote a great Medium post outlining that Ethena is essentially anti-reflexive (the opposite of the Luna death spiral) in that negative funding causes fewer people to be interested in short, which also causes people to close out their Ethena positions (which is important because Ethena at a certain scale has a negative impact on funding rates). This naturally rebalances the market and leads to positive funding.
