The rise of TON (The Open Network) has been spectacular, driven by its seamless integration with Telegram and remarkable price performance, reaching new all-time highs in June 2024. Its native token, Toncoin ($TON), has achieved a market cap of $17 billion and a total value locked (TVL) of over 660 million at the time of writing.
This year, the network has gained tremendous traction, becoming the preferred solution for Web3 integration with Telegram, which reportedly has over 900 million users worldwide.
Key developments fueling TON's rapid adoption include the global launch of TON Space, a self-hosted digital wallet (Telegram Wallet), a strategic partnership with Tencent to create a ‘Super App Eco-platform,’ and the launch of native stablecoin payments. Major investors like Pantera Capital have also highlighted TON’s scalability and extensive user base, comparing its potential to that of Solana or Ethereum and claiming TON as one of the most exciting and unique blockchains in existence today.
Below, we explore some of the most unique innovations within the TON ecosystem. 👇
The Telegram Wallet, introduced in the fall of 2023, is a versatile tool for managing digital currencies directly within the Telegram messaging app. It offers both custodial and non-custodial options, giving users the flexibility to choose between having Telegram manage their keys or maintaining full control themselves.
TON Space, a novel feature within the Telegram Wallet, serves as its non-custodial component. It allows users to store, send, receive, and exchange various cryptocurrencies, including Toncoin, Bitcoin, and stablecoins, all within the app. Users can back up their wallets using Telegram and their email, eliminating the need to remember a seed phrase. Additionally, users can track their portfolio in real-time and receive transaction notifications.
Why this matters:
The key advantage of TON Space is its seamless integration with Telegram, providing easy access to funds, quick transactions with contacts, as well as enhanced security and flexibility for experienced users. Its integration with Telegram bots and services allows for efficient market updates, trading actions, and service payments, all in one place.
TON Space simplifies digital asset management, making it accessible to a broader audience while offering advanced features for experienced users. By combining the convenience of a messaging app with the functionality of a comprehensive wallet, TON Space aims to drive mass adoption of cryptocurrency, potentially increasing the user base to 500 million by 2028.
To understand how to choose the right wallet for your TON assets here, visit: https://www.coingecko.com/learn/top-ton-wallets-jettons-crypto
TON capitalizes on the messaging app's extensive user base to create a network capable of supporting a wide range of applications. Its ecosystem comprises the TON Blockchain, TON Storage, TON DNS, and TON Services, all designed to work seamlessly together.
At the core of TON is its blockchain, built for high performance and scalability. Its dynamic sharding mechanism enables the network to process millions of transactions per second, scaling efficiently as the user base expands.
Dynamic sharding is TON's key feature for achieving high scalability. The ability to shard into individual chains (work chains and shard chains) allows TON to "distribute" transactions, effectively removing the bottleneck of processing transactions on a single blockchain. Learn more about how TON’s dynamic sharding works here.
Why this Matters:
TON’s multifaceted services extend beyond traditional blockchain functionality, aiming to establish a foundational Web3 platform. By integrating various decentralized services within a single ecosystem, TON provides the infrastructure necessary for a decentralized internet, positioning itself as a significant player in the evolution of digital infrastructure. Additionally, TON’s highly scalable blockchain offers an ideal platform for developers looking to deploy applications for a large audience without compromising on speed or security.
Over 360 million users engage monthly with Telegram's “Mini Apps,” including chatbots and mini-games which are easily accessible via the TON Space. These TON-based applications leverage TON’s innovative support for payment channel technology (or Lightning Network) designed for fast off-chain transactions, efficiently handling microtransactions and high-frequency trading.
Why this Matters:
TON’s native support for off-chain scaling and the lightning network design addresses the scalability trilemma more effectively than bolt-on solutions. It allows the blockchain to handle high-frequency, low-value transactions, which are essential for the mainstream adoption of blockchain technology.
Currently, there are over 300 projects on TON, with most building mini-apps accessible via the Telegram Apps Center. Earlier this year, memecoin trading tools like BonkBot leveraging this technology generated millions of dollars in revenue through Telegram’s interface. TON-based applications such as StormTrade now enable users to trade perpetuals, cryptocurrencies, stocks, and equities using the same platform. With StormTrade facilitating over $10 million in daily trading volume, similar TON-native Telegram bots are poised to become the preferred user experience for many traders.
On April 19th, 2024, Tether announced the deployment of a stablecoin, USDt, on the TON blockchain and in Wallet in Telegram. This development represents a significant advancement for the industry, allowing hundreds of millions of users to seamlessly send and receive stablecoins through the Telegram platform, making payments as easy as using Venmo or Apple Cash.
Additionally, as part of the TON network’s scalability plan, straight from Telegram Wallet, users can transfer USDt to i) contacts or other Telegram users; and ii) their own or others’ addresses in the TON blockchain for a very low fee (currently ~0.005 TON), making it a very convenient and competitive platform for small businesses and services.
Why this Matters:
For the TON community, integrating USDt into Wallet in Telegram significantly improves the transaction experience. Users benefit from free transfers within Telegram and only pay network fees when transacting on-chain, using TON space or other self-custodial wallets. USDt on TON also provides an accessible entry point for newcomers to cryptocurrencies, combining the advantages of digital currencies with the stability of traditional fiat currencies.
In fact, the supply of USDT stablecoin on the TON network crossed 500 million after two months of rollout, reflecting a high demand for this use-case.
Even when transacting on-chain, the TON blockchain is relatively cheap. Employing a gas based model, simple transactions’ fee currently averages 0.005 TON, or $0.04 at the time of writing when $TON was priced at $8. At this level, TON positions itself as a potential competitor to Solana - although TON’s scalability has not yet been tested as extensively.
Inflation rate in the protocol is 0.5% per year - considerably small compared to other blockchains. To compensate for that, all network participants are rewarded from both transaction fees and block rewards. As a consequence, users are incentivized to stake their TONcoin to secure the network and directly benefit from network adoption. The biggest advantage lies in keeping assets staked on-chain rather than with external parties offering a fixed APY, e.g. centralized exchanges. As part of a deflationary mechanism, 50% of all TONcoin collected in fees is burnt.
TON relies on the DPoS consensus mechanism with a set of validators who propose and validate new blocks. The validator set is determined by the Elector governance smart contract, which allocates new rounds based on each validator's weight, represented by the amount of tokens delegated to them.
Staking is one of the safest and most predictable ways to earn rewards in the crypto space, as the value originates from the blockchain’s native currency inflation, making it forecastable.
By staking your TON, you help secure the network and earn rewards. Chorus One is the leading enterprise-grade staking platform, enabling institutional customers to stake TON and integrate TON staking functionality into their offerings. We are ready to closely collaborate and contribute to the success of the TON ecosystem, and provide the best staking experience possible.
Reach out to us if you are an institution looking to stake TON with Chorus One.
About Chorus One
Chorus One is one of the biggest institutional staking providers globally, operating infrastructure for 50+ Proof-of-Stake networks, including Ethereum, Cosmos, Solana, Avalanche, and Near, amongst others. Since 2018, we have been at the forefront of the PoS industry and now offer easy enterprise-grade staking solutions, industry-leading research, and also invest in some of the most cutting-edge protocols through Chorus Ventures. We are a team of over 50 passionate individuals spread throughout the globe who believe in the transformative power of blockchain technology.
This article is extracted from the Q1 2024 Quarterly Insights. To read the full report, please visit https://chorus.one/reports-research/quarterly-network-insights-q1-2024
Authors: Michael Moser, Umberto Natale, Gabriella Sofia, Thalita Franklin, Luis Nuñez Clavijo
On PoS networks, the financial aspect of staking is equivalent to the computational power committed on PoW networks. If we were to make an analogy with PoW, shared security could be compared to “merge mining”, a mechanism that allows a miner to mine a block in one blockchain, by solving the cryptographic challenge on another chain.
As a generalization, shared security technologies imply, at least, one security provider chain and, at least, one security consumer chain. To guarantee security, the shared security solution must allow for misbehavior in either the provider or consumer chains to be penalized, and that can be even by slashing the capital used for security of the provider chains. Different approaches are being used to optimize for the specific needs of each ecosystem. We will review the approaches most advanced in terms of development, and highlight the incentives and risks associated with the adoption of those technologies.
Although one may argue that Ethereum has pioneered the concept of shared security with L2s - like Arbitrum and Optimism, other blockchains have been exploring “the appchain thesis” and experimenting with more customized solutions:
The motivation behind shared security is twofold:
Rollups solutions are the main contenders for Layer 2 (“L2”) scalability in the Ethereum (the “L1”) path to modularity. This strategy allows the execution, in terms of computation and memory, to be processed “off the main chain”. The settlement properties of the state are kept on the L1 chain, which pools the security of the ecosystem through its validator base, and “rolled” from the L2 in batches (thus the name “rollup”).
This aggregation of transactions helps to minimize execution costs for each individual transaction. To maintain an ordered control of the state and upcoming transactions, rollups can make use of different architectures: historically we’ve seen a growing trend of optimistic (e.g. Arbitrum, OP, Base) or zero-knowledge (“ZK”, e.g. Starknet, Scroll) rollups, both of which have achieved limited levels of maturity in their proving mechanisms.
New architectures or upgraded versions of past ideas have also taken flight in the past months. Validiums have been brought backto the spotlight with new developments such as X Layer, and a particular flavor deemed “Optimium” (that uses the OP stack) now powers contenders such as Mantle, Mode Network, Metis, etc. The innovation, however, continues to thrive. The idea of “Based rollups” was first introduced in March by lead EF researcher Justin Drake,a simple design that allows L2 sequencing to be defined by L1 validators in their proposed blocks, thus deepening the shared security model between the layers.
It is safe to say that the rollup ecosystem continues to be the leading product in the shared security environment, with a TVL of $45.49 billion (counting canonically bridged, externally bridged, and natively minted tokens). In the last 180 days, transactions per second on the rollups have dwarfed activity on Ethereum mainnet, and the number of active users (considering distinct wallets) has risen meteorically in comparison to the L1.
The idea behind shared security has captured extraordinary attention with EigenLayer, the restaking protocol built on Ethereum that has become a leading narrative within the network’s large staking community. In fact, restaking might as well become a larger sector than even the entire industry of single-asset staking. Driven by growing demand from stakers (seeking increased returns on their investments) and developers (sourcing security), the industry is witnessing an unprecedented shake up with capital flowing to secure multiple chains in aggregate. Concretely, EigenLayer’s TVL has managed to reach the 5 million ETH milestone at the time of writing.
Since we first identified restaking as a fundamental trend in our Q1 2023 edition, we’ve discussed EigenLayer at length and become deeply invested in the future success of the protocol: our research has focused on finding optimal risk-reward baskets for AVSs - total risk is not simply a combination of linear risks, but needs to take correlations into account.
As a result of our experience on the Holesky testnet and as mainnet operators for several AVSs, we publicized our approach to AVS selection. The thesis is straightforward: to identify and onboard the AVSs that have chances of being break-out winners, while filtering out the long tail of AVSs that merely introduce complexity and risk.
Much of what’s left to flesh out has to do with reward mechanisms and slashing conditions in these restaking protocols. As EigenLayer and other shared security models evolve and reach maturity, more information surfaces. Most recently, the Eigen Labs team presented their solution for the slashing dilemma (at least partially): $EIGEN. Current staking tokens have limitations in a model such as the AVS standard, due to the attributable nature of the slashing conditionson Ethereum. In other words, ETH can only secure work thatis provable on-chain. And since AVSs are by definition exogenous to the protocol, they are not attributable to capital on Ethereum.
Enter $EIGEN, the nominal “universal intersubjective work token” that intends to address agreed faults that are not internally provable. The slashing agreements under this classification should not be handled through the ETH restaked pool (as they necessitate a governance mechanism to determine their validity) but this second token, thus fulfilling the dual staking promise that the team had previously outlined. Currently, EigenDA is in its first phase of implementing this dual-quorum solution, and users can restake and delegate both ETH and EIGEN to the EigenDA operators.
Replicated security went live on the Cosmos Hub in March 2023as the initial version of the Interchain Security protocol (“ICS”). Through this system, other Cosmos chains can apply to get the entire security of the Cosmos Hub validator set. This is accomplished by the validator set of the Cosmos Hub running the consumer chain's nodes as well, and being subject to slashing for downtime or double signing. Inter-Blockchain Communication (“IBC”) is utilized to relay updates of validator stake from the provider to the consumer chain so that the consumer chain knows which validators can produce blocks.
Currently, all Cosmos Hub validators secure the consumer chains. Under discussion is the “opt-in security” or ICS v2, an evolution of the above, that allows validators to choose to secure specific consumer chains or not. Another long-awaited feature is the ability for a consumer chain to get security from multiple provider chains. Both, however, introduce security and scaling issues. For example, the validator set of a consumer chain secured by multiple providers can have poor performance, since it will grow too large.
Solving most of the concerns around Replicated Security, Mesh Security was presented by Sunny Agarwal, the co-founder of Osmosis, in September 2022. The main insight is that instead of using the validator set of a provider chain to secure a consumer chain, delegators on one blockchain can be allowed to restake their staked assets to secure another Cosmos chain, and vice versa...
With Mesh Security, operators can choose whether to run a Cosmos chain and enable features to accept staked assets from another Cosmos chain, thereby increasing the economic security of the first one. This approach allows one chain to provide and consume security simultaneously.
BabylonChain uses Bitcoin’s economic value to secure PoS chains. Specifically, Bitcoin has several properties that make it particularly for economic security purposes, prominently its large market cap, and beyond this, the fact that it is unencumbered, less volatile, and generally idle and fairly distributed.
Staking is not a native feature of the Bitcoin blockchain. Babylon implements a remote staking mechanism on top of Bitcoin’s UTXO model, which allows the recipient of a transaction to spend a specific amount of coins specified by the sender. In this way, a staking contract can be generated that allows for four operations: staking, slashing, unbonding, and claiming coins after they have been unbonded.
Blocks are processed natively on the PoS chain using BabylonChain for security first, and then in a second round, validators provide finality by signing again using so-called extractable one-time signatures (EOTS). The central feature of this key type is that whena signer signs two messages using the same private key, it is leaked.
Therefore, if a validator signs two conflicting blocks at the same time, the corresponding private key is leaked, allowing anybody to exit the staked BTC through a burn transaction.
Separately, BabylonChain protects against so-called long-range attacks by timestamping, where the PoS chain’s block hashes are committed to the Bitcoin chain. Such an attacked would occur when a staker unbonds but is still able to vote on blocks, i.e. could attack a chain costlessly. Through timestamping, the set of stakers on Bitcoin is synchronized with the blocks of the PoS chain, precluding a long-range attack.
When exploring the evolution of different solutions to shared security, it becomes clear that it improves one of the dimensions of security in PoS chains - the financial commitment behind a network, resulting in a higher cost of corruption, or the minimum cost incurred by any adversary for successfully executing a safety or liveness attack on the protocols. As a natural challenge to modularity, some networks are born with optimized solutions to how different projects would be able to leverage a validator set. That is the case for Avalanche and Polkadot, for example. On the other side, there are solutions being built as an additional layer on top of existing networks, like EigenLayer and Babylon. And there is the Cosmos ICS, which leverages IBC, and is modular enough to not form part of either of the previous two groups.
In the set of analyzed projects, two categories emerged: restaking and checkpointing. The former aims to unlock liquidity in the ecosystems, while the latter works as an additional layer of security to a protocol, without directly changing the dynamics for stakers nor node operators. In the end, those projects also have secondary effects on the networks. For example, restaking reduces the need for scaling the validator set in the Cosmos, while checkpointing has the potential to minimize the unbonding period for stakers.
Shared security can also change the economic incentives to operate a network. Particularly related to restaking, the final rewards for validating multiple networks are expected to be higher than validating only one. However, as always, return scales with risk. Shared security can compromise on the decentralization dimension of security, opening the doors to higher levels of contagiousness during stress scenarios, and it also adds new implementation and smart contract risk.
In the context of decentralized networks, shared security is the idea of increasing the economic security of a blockchain through the use of resources from another - one or multiple - networks.
Shared security can also change the economic incentives to operate a network. Particularly related to restaking, the final rewards for validating multiple networks are expected to be higher than validating only one. However, as always, return scales with risk. Shared security can compromise on the decentralization dimension of security, opening the doors to higher levels of contagiousness during stress scenarios, and it also adds new implementation and smart contract risk.
About Chorus One
Chorus One is one of the biggest institutional staking providers globally, operating infrastructure for 50+ Proof-of-Stake networks, including Ethereum, Cosmos, Solana, Avalanche, and Near, amongst others. Since 2018, we have been at the forefront of the PoS industry and now offer easy enterprise-grade staking solutions, industry-leading research, and also invest in some of the most cutting-edge protocols through Chorus Ventures. We are a team of over 50 passionate individuals spread throughout the globe who believe in the transformative power of blockchain technology.
Restaking Summer has arrived.
The staking revolution on Ethereum and other proof-of-stake blockchains has been one of the biggest developments in crypto over the past few years. First came staking pools and services that allowed users to earn rewards by contributing their crypto assets to help secure these networks. Then liquid staking derivatives like stETH unlocked composability and liquidity - holders could put their staked assets to work earning yield in DeFi while still earning staking rewards.
The first half of 2024 has seen the rise of restaking - protocols that allow staked assets like stETH, wETH, osETH and more to be recursively staked to earn compounding rewards. EigenLayer took restaking mainstream, locking nearly $20B in TVL (at the time of writing) as users flocked to maximize their yields. But restaking has been limited to a single asset like ETH so far.
Now, a new protocol called Symbiotic is aiming to push restaking into its next phase - a permissionless, asset-agnostic restaking layer for all of crypto.
Symbiotic is a generalized shared security protocol that serves as a thin coordination layer. It empowers network builders to source operators and scale economic security for their decentralized network.
At its core, Symbiotic separates the concepts of staking capital ("collateral") and validator infrastructure. This allows networks to tap into pools of staked assets as economic bandwidth, while giving stakeholders full flexibility in delegating to the operators of their choice.
The Symbiotic protocol has a modular design with five core components that work together to provide a flexible and efficient ecosystem for decentralized networks.
Symbiotic leverages a flexible model with specific characteristics that offer distinct advantages to each stakeholder:
For Operators:
For Restakers:
For Networks:
The protocol opened for deposits on June 11th, and it was met with much fanfare and demand: within a mere 5 hours of going live, a whopping 41,000 staked wETH had already been deposited into the protocol - smashing through the initial cap! New crypto assets and higher caps will be added as the protocol onboards more networks and operators.
Symbiotic sets itself apart with a permissionless and modular framework, providing enhanced flexibility and control. Key features include:
EigenLayer employs a more managed and centralized strategy, concentrating on utilizing the security provided by ETH stakers to back various decentralized applications (AVSs):
Symbiotic has collaborated extensively with Mellow Protocol, its "native flagship" liquid restaking solution. This partnership empowers node operators and other curators to create their own composable LRTs, allowing them to manage risks by choosing networks that align with their specific requirements, rather than having these decisions imposed by restaking protocols.
Mellow provides the ability for anyone, including hedge funds and node operators, to deploy a Liquid Restaking Token. This will likely lead to a significant increase in the number of LRTs, complicating their integration with DeFi protocols and affecting liquidity. Despite these challenges, Mellow offers several advantages:
We’re proud to share that we have integrated Symbiotic restaking into our staking dApp, OPUS Pool.
OPUS users can now seamlessly tap into Symbiotic's restaking capabilities with just a few clicks on our dApp. When the cap is relifted, simply deposit your assets to start earning Symbiotic points, which can soon be delegated to operators like Chorus One to earn rewards.
Not only is the process incredibly user-friendly, but it's fully secure and censorship-resistant - restaking as it was meant to be.
Start restaking today at: https://opus.chorus.one/pool/restake
Resources:
Symbiotic Website: https://symbiotic.fi/
Docs: https://docs.symbiotic.fi/
Twitter:https://x.com/symbioticfi
About Chorus One
Chorus One is one of the biggest institutional staking providers globally, operating infrastructure for 50+ Proof-of-Stake networks, including Ethereum, Cosmos, Solana, Avalanche, and Near, amongst others. Since 2018, we have been at the forefront of the PoS industry and now offer easy enterprise-grade staking solutions, industry-leading research, and also invest in some of the most cutting-edge protocols through Chorus Ventures. We are a team of over 50 passionate individuals spread throughout the globe who believe in the transformative power of blockchain technology.
This article is extracted from the Q1 2024 Quarterly Insights. To read the full report, please visit https://chorus.one/reports-research/quarterly-network-insights-q1-2024
Ethena is a project that has recently captured significant attention, driven not only by their fundraising announcement in February but also by the early April launch of their governance token, $ENA. However, it is their product called USDe, that lies at the heart of ongoing debates and discussions. Described by the Ethena team as a 'synthetic dollar', a concept originally proposed by Bitmex, USDe has emerged as a focal point of discussion within the crypto community. While USDe may indeed be perceived as an innovative product, it's essential to acknowledge that all innovation carries inherent risks that must be carefully evaluated. This piece aims to explain how Ethena operates, including the mechanisms behind USDe and sUSDe, while also examining market dynamics and potential vulnerabilities in the case of black swan scenarios. The goal is to provide readers with comprehensive insights to better understand Ethena’s mechanisms.
When reviewing the official documentation, one will find the following passages:
Ethena is a synthetic dollar protocol built on Ethereum that provides a crypto-native solution for money not reliant on traditional banking system infrastructure, alongside a globally accessible dollar denominated instrument - the 'Internet Bond'.
and
Ethena's synthetic dollar, USDe, provides the crypto-native, scalable solution for money achieved by delta-hedging Ethereum and Bitcoin collateral. USDe is fully-backed (subject to the discussion in the Risks section regarding events potentially resulting in loss of backing) and free to compose throughout DeFi.
Understanding USDe isn't necessarily straightforward for everyone, as it necessitates some basic understanding of trading strategies and derivative products. What Ethena is doing with USDe is a cash and carry trade, which is a concept very well known in TradFi.
In this specific scenario, Ethena's objective in executing a cash and carry trade is to use spot assets as collateral to open a short position with a perpetual futures contract linked to the same underlying assets. That way, the position is delta-hedged and Ethena capitalizes on positive funding rates, ultimately distributing profits between USDe stakers (those who hold sUSDe tokens) and an insurance fund.
For those not familiar with the concept of perpetual futures contracts and delta hedging/delta neutral strategies, let’s define the concepts.
Perpetual futures contracts were popularized by BitMEX and are crypto derivatives that allow users to trade long or short positions with leverage if they want to. The concept is similar to traditional Futures Contracts but without an expiration date or settlement. Traders can maintain their positions indefinitely, with a funding mechanism ensuring that the contract's price stays closely tied to the spot price of the underlying asset.
A Delta Neutral strategy is a strategy that aims to minimize directional risk by keeping a position's delta at zero. To achieve delta neutrality, traders typically offset the delta of one position with the delta of another position in such a way that any gains or losses from price movements are balanced out.
This strategy is popular among professional traders and market makers to hedge against market direction. Ethena uses this strategy to keep USDe stable around $1 without being affected by market movements.
Let’s take a look at a concrete example:
Let’s take the example of stETH. We assume stETH is trading at par(1 stETH = 1 ETH) with the price of ETH at $3000. If the price of ETH increases by 10% from $3000 to $3300, here's what will happen:
Note: If the stETH/ETH pair experiences a depeg, it could potentially result in a liquidation event, which may cause USDe to no longer be backed by $1 worth of collateral.
Therefore, the total P&L of the position would be:
Total P&L = $300 + staking yield - 300 + funding rate
The generalized formula would be:
Total P&L = (Δa+Σ pk) + (Гb+ f)
Δ = rate of change of position a
a = collateral
p = additional parameters related to asset a (example: staking yield)
Г = rate of change of position
bf = funding rate
To conclude this part, we can argue that USDe is not a stablecoin. Ethena’s USDe represents a tokenized, delta-hedged strategy. It’s a pioneering concept that offers decentralized access to a hedge fund’s strategy.
A. The USDe total supply
There are exclusively two ways to acquire USDe, depending on whether one is a whitelisted participant (a market maker for example) or not. The methods vary as follows:
1) Minting: A whitelisted entity decides to mint USDe by selecting a backing asset (like stETH) and entering the amount to use for minting. Then, the backing asset is swapped against the agreed amount of USDe that is newly minted.
Note: This method is exclusively available for whitelisted entities.
2) Buying though a liquidity pool: A user decides to buy USDe via the Ethena dApp and can exchange different sorts of stablecoins for USDe, which are available in liquidity pools from protocols such as Curve. This transaction done via the Ethena UI, is routed using MEV protection through CowSwap.
At the time of writing, the total supply of USDe is 2,317,686,500 USDe in circulation. The evolution of the cumulative supply can be seen on the dashboard below:
As we can see, USDe has experienced steady growth from February until early April, and then has stagnated for most of the months of April and May.
The largest daily inflow occurred on April 2nd, with 232,176,843 USDe minted. This corresponds to the launch of the $ENA governance token and its associated airdrop.
On the contrary, the largest outflow occurred on April 13th, with 19,514,466 USDe removed from circulation. This happened during a sell-off triggered by the Bitcoin halving and the fact that funding turned negative during that short period of time.
To redeem USDe, only addresses whitelisted by the Ethena Protocol are eligible. These whitelisted addresses typically belong to entities such as market makers or arbitrageurs. For non-whitelisted addresses, the only way to exit is by selling USDe in liquidity pools, which can lead to a depegging event, similar to what occurred mid-April 2024 and May 2024.
In these specific scenarios, whitelisted addresses capitalize on this arbitrage opportunity by buying USDe on-chain and redeeming the collateral to realize profits.
B. Ethena’s collateral
Whitelisted addresses have the ability to generate USDe by providing a range of collateral options, including BTC, ETH, ETH LSTs, or USDT. Below is the current allocation of collateral held by Ethena:
This allocation is split between CEXs for executing a cash and carry trade, with some portion remaining unallocated.
The purpose of USDT is to purchase collateral and establish a delta-hedged position. However, there is currently a lack of publicly available information regarding the frequency of swaps, the trading process, and allocation specifics. Similar to a traditional hedge fund, this aspect appears to be at the discretion of the team, which makes this process opaque.
C. USDe, sUSDe and Insurance Fund
USDe could be seen as a claim over Ethena’s collateral. Users provide collateral (BTC, ETH, etc.) and receive USDe in exchange, while Ethena delta hedges the collateral to ensure that 1 USDe should be worth $1 of Ethena collateral (factoring the execution costs). Therefore, USDe could be seen as a notice debt, in which if you decide to reclaim the collateral, users should be able to redeem it. USDe could be seen as a claim over Ethena’s collateral, users provide a collateral (BTC, ETH etc), and receive in exchange USDe which delta collateral the collateral to ensure that 1 USDe should be worth $1 of Ethena collateral (magnus execution cost). Therefore, USDe could be seen as a debt or a 'repayment commitment' from Ethena Labs, wherein USDe holders can redeem Ethena’s collateral.
However, even if considered a debt, holding USDe does not offer any yield. To earn yield on USDe, users can either:
In the second case, USDe has to be staked in order to receive the yield which comes from two sources:
Yield is not paid directly to sUSDe holders; rather, it accumulates within the staking contract, resulting in the "value" of sUSDe rising over time. The relationship between sUSDe and USDe is as follows:
sUSDe:USDe ratio = Total sUSDe supply / Total USDe staked + total protocol yield deposited
At the time of writing, 1 sUSDE = 1.058 USDe
What is surprising is when we look at the data, it seems like only a few portion of USDe holders are staking their USDe to earn a yield.
The portion of 370,127,486 sUSDe represents 391,594,880 USDe with a ratio of 1.058.
Out of the 2,317,686,500 USDe in circulation, only 391,594,880 are staked and generating yield. This represents only 16.8% of the supply that is staked and generates yield.Why wouldn't the remaining 83.2% stake to get the yield? This is because of the Sats Campaign.
Ethena is currently running a SATS campaign that incentivizes USDe holders not to stake by giving them SATS, which would result in additional incentives in ENA by locking USDe, holding it, or providing USDe liquidity into diverse protocols.
Therefore, Ethena is using the ENA tokens as incentives to prevent USDe holders from staking it. Why is that? Because of the Insurance Fund.
The Insurance Fund is a safety measure created by the Ethena team to have a reserve for use in case of events such as negative funding rates (which we will discuss later in this article). The Insurance Fund can be track in the following address.
Which represents a total of more than $39 million. Part of Ethena’s strategy is to use ENA to incentivize USDe holders not to stake in order to fill in the insurance fund and prepare in case of a bad scenario. This sets the stage for the next part, in which we will discuss some of the intrinsic risks related to the protocol.
Note: Since the publication of this article, the number of sUSDe in circulation has significantly increased. This is due to the fact that the insurance fund now has a fairly large treasury, as well as the increase in the caps for sUSDe on Pendle.
A. Negative funding rates
One of the most well-known risks of Ethena’s architecture is probably the risk of funding rates turning negative. As explained in the first part, Ethena is taking a short perpetual position to delta-hedge the spot collateral. If the funding rates turn negative (indicating more people are on the short side than the long side), there is a risk that the protocol starts losing money.
There are two mechanisms in place to mitigate losses coming from negative funding rates:
The Insurance Fund steps in when the negative funding rate > the collateral yield.
Based on Ethena’s analysis, there has only been one quarter in the last 3 years where the average sum yield was negative, and this data was polluted by the ETH PoW arbitrage period, which was a one-off event that dragged funding deeply negative.
However, it’s important to mention that past data is not necessarily a representation of the future. As of May 13, 2024, Ethena represents 14% of the total Open Interest on ETH, and approximately 5% of the total open interest on BTC.
If Ethena continues to grow, there is a chance that it will start representing too significant a portion of the total open interest to be known to be on the short side, leading to a natural decrease in funding rates and potentially experiencing negative funding rates more often due to the protocol becoming too large for the market.
If this scenario happens, Ethena will be forced at some point to cap USDe supply in order to adapt to the total open interest. Otherwise, Ethena would shoot itself in the foot.
B. The Liquidity Crunch
This is somewhat related to the negative funding rates mentioned earlier. When negative funding rates occur, there is a sell-off, as shown here:
We can notice that funding rates started to be more frequent on some specific exchanges between mid-April and mid-May. This has been translated into some periods of USDe depegs, with an inflow of USDe probably explained by whitelisted entities taking advantage of that depeg, and a USDe total supply not really growing.
The only way for non-whitelisted people to exit from USDe is to sell on the market, which will create a depeg. This will be captured by the whitelisted entities. If a depeg happens, whitelisted entities will buy USDe at a discount to redeem collateral by giving back USDe, therefore reducing the USDe circulating supply and capturing the profits.
This is an easy way for whitelisted entities to capture profits.
Example:
With negative funding rates, some people decide to exit USDe and sell on a DEX. USDe is now trading at $0.8. Whitelisted actors will buy USDe at $0.8 and redeem USDe against BTC or ETH for $1 worth of assets, then sell the collateral to capture $0.2 of profits (factoring the execution cost).
Things become more complex when they have to deal with ETH LSTs; this is where the liquidity crunch can happen. Ethena currently has 14% of its total collateral in ETH LSTs, which at the time of writing, represents around $324 million. It is not detailed which assets are held within the LSTs category, therefore we will assume it’s mostly stETH.
Let’s now imagine a scenario where all native assets such as ETH and BTC have been redeemed by whitelisted actors, and Ethena now only has ETH LSTs as collateral.
Funding rates turn negative again, there is a sell-off of USDe, and whitelisted actors start redeeming USDe against ETH LSTs. Different scenarios can happen, we will present three main scenarios below:
Scenario 1: Whitelisted entities are directly selling the ETH LSTs on the market, capturing some profits but also reducing the arbitrage opportunity if more and more actors do so, as the ETH/ETH LSTs pair will start depegging.
This scenario can happen initially, and some traders will take advantage of the ETH/stETH depeg to buy stETH at a discount and unstake to get ETH. This will start impacting the exit/unstaking queue, leading to negative consequences in other scenarios.
Scenario 2: Whitelisted entities decide to unstake the ETH LSTs to get ETH and simultaneously open a short perp position on ETH to delta hedge and mitigate the risk associated with the token price.
They then wait for the exit queue to end, get the native ETH, close the short perp position, and profit.
If the funding rates are negative, the whitelisted actor might not engage in this arbitrage and redeem the collateral because it depends on how negative the funding rates are and how long the exit queue is.
If the exit queue is too long and funding rates are too negative to make that trade profitable, then actors who don’t want exposure to the asset price won’t take that trade. This would leave USDe depegged and trigger a bank run, with more and more people selling their USDe on the market.
If USDe starts depegging and remains that way, Ethena’s insurance fund will also take a significant hit, mostly due to the negative funding rates and the fact that a portion of the insurance fund is in USDe.
Of course, all these scenarios would only occur in a situation of a very extreme event. However, if such a scenario were to happen, non-whitelisted USDe holders would suffer the most, as their only way of exit would be to sell USDe. At least, changing this model by offering the redemption feature to everyone could improve the situation. In any case, if Ethena were to become big enough, this could lead to significant unstaking events, thereby impacting Ethereum's economic security.
If an attacker sees that most of Ethena's collateral is in ETH LSTs, they can choose to borrow USDe, sell it heavily on liquidity pools to break the peg, allow the first whitelisted actors to arbitrage and begin increasing the unstaking queue, and then keep selling massively USDe to start a bank run.
That's why it's important for Ethena not to grow too large and to ensure that the collateral in ETH LSTs is also capped.
C. The Execution risk
Holding USDe also involves trusting the Ethena team to execute the cash and carry trade effectively. Unfortunately, there isn't much information available about how this trade is executed. After reviewing the official documentation, there is no information provided about the trading team or how frequently this trade occurs. For example, there is currently $109.5 million of unallocated collateral in USDT, which will be used for the cash and carry trade, but no information on when those trades will be executed.
This is a review of the hidden risks associated with Ethena that users should be aware of. Of course, there are many more traditional risks related to the protocol, such as smart contract risks, custodial risks, or exchange risks. The Ethena team has done a great job of mentioning these traditional risks here.
In conclusion, the goal of this article was to explain what Ethena is, show the various mechanisms behind the protocol and its innovations, while also outlining the associated risks. Users of a protocol should be aware of their exposures and act accordingly, there is no free lunch in the market, and Ethena presents multiple risks that should be taken into account before engaging with the protocol.
About Chorus One
Chorus One is one of the biggest institutional staking providers globally, operating infrastructure for 50+ Proof-of-Stake networks, including Ethereum, Cosmos, Solana, Avalanche, and Near, amongst others. Since 2018, we have been at the forefront of the PoS industry and now offer easy enterprise-grade staking solutions, industry-leading research, and also invest in some of the most cutting-edge protocols through Chorus Ventures. We are a team of over 50 passionate individuals spread throughout the globe who believe in the transformative power of blockchain technology.
