Risk vs Reward - an Ethenal discussion

The last two weeks were filled with a vicious back and forth on crypto Twitter and forums about Maker’s rapacious embrace of profits via Ethena’s USDe and sUSDe.

After a successful addition of GOV 12.2 to the Atlas, MakerDAO set out to capitalise on a current market inefficiency. The cash & carry trade, as it is known, is yielding above 30% and sometimes as much as 60% APR when going long ETH and funding ETH shorts.

From Investopedia:

“A cash-and-carry trade is an arbitrage strategy that profits off the mispricing between the underlying asset and its corresponding derivative. [It] is usually executed by entering a long position in an asset while simultaneously selling the associated derivative. Specifically, this is done by going short the market via a futures or options contract.”

Large inefficiencies like in the current ETH market are usually not available for a long time, which is why MakerDAO Facilitators decided to use a tokenized version of this trade in the form of Ethena Labs USDe.

From Coinmarketcap:

“Ethena's synthetic dollar, USDe, will provide the first censorship resistant, scalable and stable crypto-native solution for money achieved by delta-hedging staked Ethereum collateral. USDe will be fully backed transparently onchain and free to compose throughout DeFi.

USDe peg stability is ensured through the use of delta hedging derivatives positions against protocol-held collateral alongside a mint and redeem arbitrage mechanism.

The 'Internet Bond' will combine yield derived from staked Ethereum as well as the funding & basis spread from perpetual and futures' markets, to create the first onchain crypto-native 'bond' that can function as a dollar-denominated savings instrument for users in permitted jurisdictions.”

Maker Decided to fund MetaMorpho vaults with different Loan-To-Value ratios via a D3M to Spark, who would then loan DAI to USDe depositors. These depositors usually put the loaned DAI to use by purchasing further USDe and create leverage loops.

An initial $100m was filled within less than one day! You can find the first risk assessment by Monet Supply here:

Capitalizing on the demand, Stability Faciliators approved a maximum of $600m allocation just two days later, with a D3M line at $1bn, so the $600m could be further increased without a further executive poll, if risk assessment was favorable and demand was high enough.

It has long been said that good capitalists wait for a long time until the right opportunity comes a long, and then strike with rapacious fervor. This sudden move upset some of MakerDAOs partners. A Starknet lending protocol removed DAI because they feared a depeg of the relatively young USDe could now cause a depeg of DAI.

But the real drama began when Aave’s Marc Zeller proposed to set the LTV of DAI to 0 and Aave founder Stani proposed to offboard DAI completely.

Apart from insults hurled at Morpho Founders on a Twitter space with Zeller, Rune, and Ethena Labs, the really interesting contribution to the Ethena debate was the thoughful analysis of Ethena risks by Chaos Labs.

[ARFC] Risk Parameters for DAI Update

Summary: Chaos Labs offers analysis concerning the community’s potential strategy to mitigate risk associated with DAI and DAI-c…

governance.aave.com

I can recommend reading it because I think they really understand what Ethena does and also understand the inherent risks. I do not believe their recommendations are 100% correct, and are likely political. But it is important to understand that Ethena’s cash and carry trade will trend to lower yields over time, and that Ethereum funding rates were negative on a few occasions in the past.

We do not know if and how Ethena can redeem USDe at scale, because it never had to.

But I do believe that Steakhouse Finance and BA Labs have deeply understood the risks and set very reasonable parameters overall.

In addition to the post by monet-supply linked above, I highly recommend this post by Steakhouse to understand some of the choices that went into creating the MetaMorpho DAI/USDe and DAI/sUSDe vaults.

Even with this fantastic analysis there are some issue to call out:

• MetaMorpho vaults are linked to a multisig controlled by governance facilitator JanSky. I do not know why this route was chosen, and it seems to introduce unnecessary counterpart risk.

• In addition to the D3M to Spark/Morpho Andromeda is seeking another initial $50m in funding to acquire USDe. I don’t understand why exposure should be even higher and why an arranger with a 2,5% fee and with no exposure to $ENA airdrops was chosen. The airdrop could have gone a long way to offset the fees, most likely.

DAI supply update

There is a very healthy upward trend in DAI supply, which increased 170m since our last newsletter 20 days ago, likely driven by the high DSR of 13%.

Currently almost 1/3 of all DAI is staked in the DSR. A smashing success.

But it’s also clear that unless Maker can aggressively integrate with more chains and protocols and create lasting demand for DAI held this number will not move much. At the same time the competition is definitely not sleeping. Almost every other DAI sees a new stablecoin being born that competes for the same users as DAI.

Voting update

KISS AVC has proposed some clarification around how AVC members can step back and get removed from the pertinent scope language. We hope the poll will pass as it allows AVCs or AVC members a “right to be forgotten”.

There are nine polls in total for your consideration, of which six are Spark related and three are Maker Core governance updates.

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