Understanding of Ethen Stablecoin

Author: Daoshuo Blockchain

In this round of bear market, there are not many bright spots in the DeFi track, and the stablecoin project Ethena is one of them.

Speaking of stablecoins, the most familiar ones are USDT, USDC and DAI. Although they have been used in the crypto ecosystem for a long time and have occupied a near-monopoly position, people have always expected to find a more ideal stablecoin.

On the one hand, these mainstream stablecoins currently have obvious weaknesses: for example, USDT is questioned in terms of credit, USDC does not have the ability to resist censorship, and DAI does not have sufficient liquidity.

On the other hand, stablecoins are the basis of all transactions in the crypto ecosystem and a bridge connecting the crypto ecosystem and the real society. Whichever project can become the king of stablecoins will strangle the throat of the entire crypto ecosystem. Obviously, these existing stablecoin projects are not regarded as the king because of obvious problems, so there are always teams that are persevering in making new attempts.

Ethena is such a new stablecoin project.

Its introduction uses a series of financial terms to describe its operating principle. Its fundamental logic is to use algorithms to simulate a stablecoin pegged to the US dollar at a 1:1 ratio.

Its characteristics can be summarized in three points:

It does not use excess collateral, so it releases liquidity as much as possible, which is better than DAI;

The issuance of currency is generated by users pledging crypto assets, so it has the ability to withstand censorship, which is better than USDC;

It uses a series of hedging transactions to try to maintain the currency value against the US dollar to obtain credit, which is better than USDT.

In my opinion, the most important and fundamental of these three characteristics is the third one: maintaining the stability of the currency value through a series of hedging transactions. It is the fundamental guarantee for maintaining the stable operation of the entire system.

But it is precisely on the third point that it has to introduce centralized exchanges in order to hedge the risk of exchange rate fluctuations, thus introducing the risk of centralization.

To eliminate this risk, the decentralized derivatives exchange in the future can only match the centralized exchange in liquidity and performance.

In addition, the operating mechanism of this system seems too complicated. Any system, as long as it is too complicated, will definitely expose too many weaknesses, and it is easy for the system to be disturbed by external forces.

In terms of design concept, its idea is to hope to achieve exchange rate stability through pure algorithms, but the implementation and execution of algorithms are engineering problems. It is often difficult to match the actual execution with the ideal of algorithm construction.

Essentially, Ethena's operation still follows the rules of the traditional financial system.

In this case, we can refer to a very good stable currency reference: Hong Kong dollar.

The Hong Kong dollar uses a linked exchange rate against the US dollar, and its exchange rate fluctuation is controlled between 1 US dollar and 7.75 to 7.85 Hong Kong dollars. Its issuance adopts the simplest mortgage model: for every 1 US dollar mortgaged, the corresponding Hong Kong dollar is issued according to the exchange rate.

When the Hong Kong dollar is out of the linked exchange rate, the Hong Kong government will maintain the exchange rate through open market buying and selling.

In this process, the key to maintaining exchange rate stability is that the Hong Kong government must have sufficient liquidity reserves, especially US dollar liquidity.

During the 1997 financial crisis, the Hong Kong dollar was attacked because international speculators believed that the liquidity of the Hong Kong government was not enough to maintain the Hong Kong dollar exchange rate. In the end, the key to Hong Kong's survival was that the Hong Kong government obtained sufficient US dollar guarantees through various channels.

Compared with the Hong Kong dollar model, Ethena is more complicated and more inseparable from the guarantee of liquidity. However, the exchange that provides exchange rate guarantees for Ethena cannot be compared with the Hong Kong government in terms of size and credit.

So I think it will be more complicated and challenging to maintain the exchange rate of Ethena.

I am only interested in this project, not too interested in buying. I only have the coins I got from the wool, and I will not consider buying coins for the time being.