Funding rates turn negative! CryptoQuant analyzes the risks of Ethena's stablecoin USDe

Research institution CryptoQuant studies and analyzes whether the stable currency USDe, which uses ETH as a collateral reserve, can maintain stability. 4/17 Due to the market decline, we have seen that Ethena’s hedging positions have experienced negative annualized returns due to negative funding rates on several exchanges. This makes people wonder whether the huge capital game of nearly 2.4 billion US dollars is in danger?

CryptoQuant analyzes Ethena risks

CryptoQuant stated that Ethena Labs has identified several risk points that may affect the stability of its synthetic U.S. dollar USDe, including funding risk, liquidation risk, custody risk, exchange Failure risk and collateral risk. This article delves into the potential dangers associated with funding risk and how Ethena manages these challenges to maintain exchange rate stability for USDe.

Crisis of Funding Risk

"Funding risk is related to the possibility of continued negative funding rates. Ethena can gain income from the funding rate, but may also need to pay the funding rate. ” explained Ethena Labs. Under standard market conditions, traders in the Ethereum and Bitcoin perpetual futures markets generally tend to go long, resulting in these traders ultimately paying funding rates to short holders, such as Ethena.

Crisis Point: Dramatic Market Adjustment

The key to the problem is that when the market falls severely, a sharp drop in prices may cause the funding interest rate to invert. In this case, traders liquidate their long positions and new short sellers enter the market, potentially pushing funding rates into negative territory. This inversion forces short holders, like Ethena, to pay funding rates to long holders, turning their expected income into expenses.

Ethena Reserve Fund: Is there an obligation to maintain stability?

To protect its operations and USDe’s exchange rate stability, Ethena has established a reserve fund. The fund plays a key role in absorbing financial shocks when Ethena needs to pay negative funding rates, ensuring that USDe holders are not affected.

The pressing question, however, is whether this reserve is sufficient to cover all potential obligations without jeopardizing the stability of their short position.

Assessing the Adequacy of the Reserve Fund

CryptoQuant assesses the sustainability of the Ethena Reserve Fund under extreme market conditions similar to those observed during the Ethereum merger.

Historical data from this period shows that Ethena’s current reserves of $32.7 million are sufficient to support it as long as USDe’s market capitalization remains below $4 billion. But as market capitalization increases, so do the required reserves, requiring significant enhancements to the fund to effectively manage potential obligations at higher market capitalizations.

Risks brought by exchanges

Judging from past cases, shortly after the collapse of the FTX exchange, capital risks increased sharply, further complicating the situation. This event reiterates the need to establish a strong and scalable reserve fund that can adapt to sudden financial pressures and protect the overall health of Ethena's position and USDe.

How to manage risks well?

How Ethena allocates the proportion of total earnings to the reserve fund (retention rate) is an important factor.

This ratio determines how quickly the reserve fund grows and strengthens its buffering capacity during periods of adverse funding rates. The analysis suggests that in order to withstand the severe market downturn experienced during a prolonged bear market, Ethena must maintain a retention rate of at least 32%.

Actively adjusting retention rates and reserve fund allocations will be key to maintaining the stability of synthetic dollars against an unstable cryptocurrency market backdrop.

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