ethena (not the greek one)
what is the basis
Crypto has been the source of inventions both terrible (UST) and quite innovative (Uniswap), but one of the less discussed projects in the mainstream press and traditional financial spaces, despite its immense success, has been Ethena. Nor have the implications of the structure, as well as the other projects that will build upon the success of the original, been explored.
Much has been made in the mainstream press of the catastrophic failures of centralized financial entities in the crypto space like FTX or Celsius, and many drops of ink have been spilled discussing the unfortunate fate of experimental projects that failed, like Iron Finance or Terraform Labs’ UST. However, significantly less has been written about some of the great successes in the space, and ironically it is those which drive the positive beliefs of many crypto builders, owners, and traders. To that end, if you want to understand those who believe that the crypto space can be a force for financial inclusion, democratization of market structure, and building a more transparent and accessible system overall, Ethena is an excellent project to dig deeper on.
WHAT IS A PERPETUAL FUTURES CONTRACT?
A perpetual futures contract allows traders to speculate on the price of a specific token (e.g. bitcoin) without owning the underlying asset. Unlike traditional futures, it has no expiration date. This means traders can hold their position indefinitely as long as they meet margin requirements. The contract mirrors the spot price through a funding mechanism designed to keep prices aligned: depending on market conditions, traders might pay or receive a funding fee every few hours. These fees are exchanged directly between long and short positions, incentivizing price convergence between the perpetual contract and the actual asset. If the contract trades above the spot price, the long side pays the shorts. If the contract trades below the spot price, the shorts pay the long. The wider the gap, the higher the payments. This structure drives convergence between spot and futures prices over time.
The Basis Trade
Finance and crypto share a similar flaw, which is that they are absolutely garbage at naming things. There are multiple things called a “basis trade” in finance, and so rather than come up with a different name for something, crypto decided that, of all things, they should adopt that as well to describe a specific trade between futures and spot. In fairness, it’s an accurate use of the term. In fairness, it’s also about as creative as painting everything gray in a house. Either way, that’s the name the market picked, so let’s specifically talk about how this trade works in crypto.
Step one is that you own the token outright. In this case, let us use ETH as an example, because this is the primary token that Ethena works on. This is the simple part of the trade, as if you own $1mm of ETH and the price moves 10% in your favor, you now own $1.1mm of ETH. If it were to move 10% against you, you now own $900k of ETH. Simple, right?
Step two is that you also own a futures position. In this case, specifically, you are short the futures position. Thus, given we own $1mm of ETH in our previous position, we will be short $1mm of ETH in the futures market. Therefore, if ETH moves up 10%, we lose money, and if ETH moves down 10%, we make money.
Astute readers will note that if you have both of these positions, you have no price risk (ignoring some other details we will return to later). If ETH goes up, you make money on the token and lose money on the futures contract. If ETH goes down, you make money on the futures contract and lose money on the token. This is academically interesting but kind of silly, so why would you do this?
The answer is the funding leg of the futures trade. Historically in crypto markets, funding has been positive, meaning that longs are paying shorts. In this trade, then, you have no price exposure but you collect the funding rate (if positive) or pay the funding rate (if negative), so your real exposure is just to funding rates. If funding rates are consistently positive, because crypto traders are degenerate gamblers constantly wanting to use leverage, then you are essentially providing that. And you can get paid pretty well for it, as you can see below!
What is Ethena, and Does This Strategy Work?
(The answer is yes, so far)
AUSTIN: This brings us back to Ethena, which is essentially taking the basis trade above and putting it into a package. That package is called USDe, which is the token for the Ethena trade. Again, barring other secondary risk factors, the basis trade itself should always have a notional position worth a stable price plus or minus (usually plus) funding over time. That means Ethena trades like a stablecoin. Ethena then allows you to stake that stablecoin, and pays rewards which are (drumroll please) basically some portion of the returns from the basis trade.
Important note: that doesn’t mean Ethena is a stablecoin. Much like many products in traditional finance that are approximately stable or have secondary risk factors that can be exposed unexpectedly at moments like the 2008 crisis, there are a wide range of things that vary from “stable-ish” to “almost certainly stable barring systemic collapse”. I would personally put Ethena in the former category, which is not an insult, as it also has significantly more upside through the exposure to funding rates. The latter category is really things like regulated stablecoins that hold only t-bills in the background, as for one of those to lose the dollar peg, something pretty terrible likely happened to the US Treasury or the custodian banks, both of which are going to be existential for the financial system, not just the stablecoin. And if you don’t believe me on this, notice the Ethena team themselves calls their product a synthetic dollar and they have an extensive risk disclosure section on their own website.
What does it mean for Ethena to be doing things in this way? It means that, instead of the basis trade being the domain of crypto market makers and hedge funds, where the Ken Griffin types make all the money in the end, you can now essentially facilitate for everyone who wants to contribute money running the basis trade themselves. At the time of writing, there’s about $5.3B of money being run through the Ethena platform to do this trade, making them one of the larger projects in the crypto space. At a ~10% rate of return for funding, that means $500mm of profits coming out of the pockets of the professional market making class and into the pockets of, well, whoever wants to buy and stake USDe.
For all of the malingering about crypto being financial nihilists, scammers, and ideological lunatics (and trust me, there are plenty of those), do you know what this reminds me of? Vanguard and Stone Ridge. For those who are unfamiliar with Vanguard, they essentially created some of the most boring products known to man that took advantage of diversification, made them cheaper and accessible, and then just… did that. Forever. Vanguard still operates with a business model very similar to when John Bogle founded the firm. I’ve worked with them before - they were one of my largest clients when I was a trader at JPM, and let me tell you, they were BORING in all caps. I mean that as a high compliment, as well. Where many other people contorted themselves into pretzels to justify higher fees on the basis of “alpha” or high returns (which usually ended with them underperforming index funds), Vanguard just did their thing and cranked out average returns at fair prices.
Stone Ridge, where I used to work, essentially expanded that idea into strategies that were previously only for hedge funds. I used to manage a 1940 act daily liquid mutual fund that was filled with catastrophe bonds for RIAs. This was stuff that, back when I started in Reinsurance, was a private high net worth hedge fund game only. You’d have folks in the space like extreme specialists (Fermat) or hedge funds (Magnetar) or the most aggressive of the asset managers in their extremely opportunistic funds when things went wrong (PIMCO). What you never saw was these assets in the portfolios of the average person, even though cat bonds are positive returning on average over time, largely uncorrelated from stocks or bonds (you hear this story a lot, but let me assure you that hurricanes and earthquakes don’t pay much attention to the market). Adding a small amount of them to the average portfolio was strictly good, yet nobody was doing this, at least not until 2012 when someone had the idea to found a firm to do literally this, and ended up with a multi-billion dollar asset manager distributing alternative assets.
Ethena is essentially some related version of this concept in crypto. The project has democratized the ETH basis trade (and maybe a little bit more than that, now) in relatively boring fashion, where now you don’t have to be an expert trader or managing positions all day, nor do you need to individually have the bankroll of a market making firm or hedge fund to do this meaningfully. Instead, they created a wrapper using a token, and did what crypto is good at: distribute it.
Staking Yield & DEFI
Or, What is the “internet bond”
DAVID: For my money, the most interesting thing about USDe is the source of the yield: a mix of funding rate revenue from exchange perp positions, and staking yield from spot long Ethereum that is “staked” in Ethereum’s consensus/settlement system. Readers indoctrinated in the past ten years of “crypto is all a scam” rhetoric are going to get their wigs blown back, because the staking portion of the yield comes out of actual Ethereum system revenue, rather than inflationary printing.
“Proof of Stake” is a blockchain security mechanism that keeps transaction processors honest, and has largely supplanted “Proof of Work,” though PoW still backs Bitcoin and other legacy tokens like Dogecoin. Those Proof of Work systems emit inflationary rewards to validators running energy-intensive mining rigs.
Compute power expenditure is effectively a kind of ‘collateral’ that keeps PoW miners honest, but Proof of Stake replaces that with actual financial collateral, in the form of each PoS system’s native token (a switch that massively reduces electricity costs and carbon impacts). PoS transaction processors (validators) who aren’t honest or accurate can be ‘slashed,’ losing their underlying stake. But nodes that do their jobs correctly earn yield that has settled at around 3% annualized. ETH holders who don’t have the skills or infrastructure to run a validator can “delegate” stake to validators, in exchange for a fee, usually a portion of staking yield.
There’s another key distinction here between Bitcoin’s Proof of Work and Ethereum’s Proof of Stake. Bitcoin famously has a capped supply of 21 million coins, and mining rewards are cut in half every four years, creating a steadily declining inflation rate. But after the August 2021 implementation of Ethereum Improvement Proposal (EIP) 1559, Ethereum has moved towards a non-inflationary model. EIP-1559 changed Ethereum’s fee structure so that a large portion of transaction fees on the network are burned, or destroyed, rather than going to validators. These two functions largely cancel each other out, and the annualized inflation of the ETH supply has generally been under 5 basis points since the 2022 Proof of Stake transition. The overall ETH supply has actually declined so far in 2025.
This means the roughly 3% in staking yield isn’t simply newly-printed ETH – it’s not just being inflated out from under you. Instead, staking yield is effectively a mix of revenue from fee-paying users and an inflation tax on unstaked holders, redistributed to the decentralized swarm of validators that run the system, and the stakers that fund them.
This makes ETH staking yield, whether packaged into Ethena, Lido’s stETH (“Staked ETH”) or other wrappers, a strikingly novel financial primitive, representing aggregate economic growth in decentralized financial networks. The existence of competing systems like Solana mean it’s not a perfect analogue, but you could describe staking yield as the base rate of the on-chain economy.
(One note of caution: “Staking” has increasingly been used imprecisely, to refer to any token that you can “lock” in a smart contract in exchange for some amount of yield incentive. But many of these functions have nothing to do with security, so calling them ‘staking’ is misleading. In practice, the point of many such programs is simply to offer an unsustainable bribe for holders to keep liquidity off the market.)
Risk, Results, and Revelations
(Ethena will not destroy the financial system)
“So does any of this work? Is this another UST that will break? Isn’t this just super levered and going to explode?”
Those are the comments I most frequently get from those outside the crypto space, which reveals to me that we continue to have a cripplingly poor exchange of information from traditional finance into decentralized finance and vice-versa, with both sides having important information and lessons that are completely, totally missed by the other side through some combination of arrogance, lack of interest, and lack of ability to respect the other.
It’s truly incredible to witness.
However, now I’m going to put back on my tradfi trader hat, with the added understanding of the mechanics of Ethena, and talk about what the real risks are here, as well as dispense with the two above. In fact, we can start there: Ethena is not UST. The core problem with UST was that the LUNA token could be turned into UST, which could be turned into the LUNA token. It was self-referential, and as it collapsed, all of it collapsed because neither had a value proposition independent of each other. USDe, on the other hand, has a giant pile of ETH under it, as well as a perpetual position. That… is not self-referential. That’s similar to a structured note, in traditional finance, with a long treasury and short futures position. There’s an actual asset with value independent of Ethena (ETH) and a hedge (the futures position) in there. You don’t have the death spiral problem, because ETH doesn’t derive its value from USDe.
The other one is the leverage question. Here, the theoretical risk is that the spot price of ETH and the futures price of ETH diverge significantly, and thus Ethena is “forced” out of a position. The good news about this is that they have a significant buffer here. Ethena, in particular, uses the actual underlying ETH (well, staked ETH) as collateral in many cases, meaning they are not taking on additional leverage and thus the level of divergence between spot and futures price would have to be catastrophic to be forced out. Obviously a strategy with more leverage could be very damaged with smaller divergences (see, for the tradfi crowd, something like LTCM level leverage or perhaps Archegos), but a $1 spot and $1 perp per $1 capital position is very unlevered. If we are having $1000 spot ETH and $2000 ETH perp prices, there are much bigger problems with crypto markets and product structure than Ethena, in short.
So, if those two are either non-risks or very remote risks, what are the real risks around Ethena?
One is that they use staked ETH, so if something happens to their staking provider (esp. the liquid staking providers), they have a problem. Crypto, like it or not, has been known to have hacks, exploits, and other such things happen with some regularity in the ecosystem, so something of this sort happening to the ETH side of the balance sheet would be damaging.
Two is that they also use a custodial arrangement at times for the ETH or stETH. This is good in one way, but it always introduces risk. The good news is that the sophisticated custodians and key holding arrangements (e.g. Copper, Fireblocks, DFNS, etc.) have not historically been exploited. The bad news is that it doesn’t mean they never will be. Because ETH is a crypto-native token and the blockchain has shown it is unwilling to revert even large hacks (see Bybit), this is a risk.
Three is counterparty credit risk. Bybit is also a good example of this: because Ethena has a third-party custodian (Copper) who was holding the actual collateral, their specific funds were not at risk in the Bybit hack. But do you know what was at risk? Any PNL they had unrealized on the exchange. Funding PNL, anything in the futures trades, even if you are sweeping it periodically, will be at risk at the moment of compromise. In this case, the risk was non-zero but not extreme, and having a belt-and-suspenders setup with an insurance fund, diversification, and more would all be extremely helpful, but the reality is that there’s no way around the fact that if you are running perps positions, you are exposed in some way to the perps provider.
Fourth is funding rates. With either lack of demand for leverage or increasing scale, it’s entirely possible that Ethena finds itself in the position of the basis trade no longer being profitable. While there are other things they can do with the money (tokenized MMFs, for instance), they aren’t as profitable as the basis trade and it would, over time, lead to the product shrinking down to zero (or at least small). This is not the same critical risk as blowing up, but it should be noted. Likewise, periods of extreme negative rates that happen quickly could cause small losses, but there are limits to this so long as it’s being monitored and a team just doesn’t stay in a negative yielding trade forever.
Fifth is unwind risk. Specifically, unwinding the stETH part of the trade. The futures are relatively liquid over a reasonable amount of time, but truly large unwinds on the ETH side of the trade could cause either losses or significant delays in returning funds as Ethena itself may be stuck waiting for either liquidity or unstaking of the underlying derivative. Again, this is not “break the buck” style risk, but it is downside risk on a structured product.
To my eye, those capture the real risks of Ethena, and probably the most critical (and certainly most prevalent) would be hacks and exploits. That has been the downfall of other crypto projects in the past, and does not require a financial or economic problem, rather merely a technological one. To that end, this is where I say “this is why it’s not a stablecoin”, as in the case of something like USDC being exploited, well, they can always take a snapshot of the ledger at a point in time and then give everyone the actual dollars into bank accounts. That kind of thing is not particularly possible if you lose all the ETH. As we saw with Bybit, it’s just gone. Very different than with real assets, and drives home the difference in risk profile and consumer protection between these products.
So if you are a tradfi person, you come to an ironic place with Ethena: it’s actually pretty well-designed economically, and while there are risks there, they are not extreme, but tradfi over-focuses on them because it is what they know and understand. It’s actually the novel technological risk that is the biggest problem, which is not a traditional concern.
Austin’s Take
I like it
Honestly, I think Ethena is pretty cool. This is exactly the sort of positive experiment that crypto has been engaging in which gives me faith it could have major impacts on the traditional financial markets over time. Here, we essentially have a funding trade that also can serve as an asset used as the base layer for other trades; that is the definition of composable. The risks are understandable, and the most severe one (hacks) is something that will improve over time if the space is going to go big.
The rest, for once, is not an over-levered hedge fund style blow up waiting to happen. Instead, it’s a pretty banal alternative lending type of exposure, exactly the sort of thing that it has been hard for retail to access historically, but very accretive for portfolios when they do it.
I also think it’s good the Ethena team did not call it a stablecoin, and that they’ve been transparent about the risks. Their conduct around the Bybit hack was surprisingly transparent, they managed their risk, and nothing exploded. If you were grading them as a bank regulator, you wouldn’t be angry. Given that regulators only have two states of being (angry and not yet angry), that’s a big win.
So it’s cool, and I’m glad it exists. Could it break someday? Yes. Will those risks have been disclosed and hopefully understood? It appears that answer is also yes. Are those disclosures sufficient and do people understand? That’s a somewhat different topic and I think one that should be answered with regulation, not putting ad hoc burdens on everyone individually.
It’s hard to ask for more in reasonable terms of financial experimentation (without requiring everyone to just become JPM to do anything). If we’d had more of this conduct, we’d have had a lot less of UST or FTX, at least.
David’s Take
Guarded Optimism?
Allow me a moment to flex here, on the subject of stability and economic design. In April of 2022 I wrote this deep dive into why Luna/UST’s design was financially nonsensical. Two weeks later, it blew up. Which should be way less impressive than it apparently is, because if you can’t spot a perpetual motion machine with endogenous collateral, you might be in the wrong line of work.
My concerns with Ethena are far, far milder. Not even in the same category, really. The most obvious is the reliance on off-chain perp positions, which create both counterparty and regulatory risk. This makes Ethena vulnerable to regulatory action and exchange instability, which rubs my cypherpunk soul wrong. We saw this unfold back in February with the ByBit hack. Ethena stood to lose $30m of PnL on ByBit, but said at the time that was “less than half” of a reserve fund meant for such incidents. Frankly, that’s still a bit much for comfort, but it’s there (and ByBit wound up making users whole anyway).
My other concern is more conceptual: When is a dollar not a dollar, and when is that okay? It’s responsible of Ethena to lean away from “stablecoin” language, but they still call the thing “USDe,” so the distinction would likely be lost on retail, creating unrecognized risk. This may be par for the course, for instance, for money market funds, but the terminological ambiguity might need more regulatory clarification.
Small Bites 1:
Genius progresses
We discussed the Genius Act in our previous newsletter, but this week it is expected to receive a vote in the House, which it is overwhelmingly likely to pass, and then move on to President Trump’s desk.
What is notable here is that this marks the first time that Congress has taken on financial regulation in a pre-emptive, rather than reactive, manner in quite a while. This is potentially a positive sign for the entire crypto space moving forward, as while Clarity is going to face a much rockier road in terms of passing in this legislative session, Congress moving forward with stablecoin legislation alone will be a significant and powerful unlock for financial markets over time.
AUSTIN: I’ve probably gotten more phone calls on stablecoins in the last week than I have in the past two years combined. By the way, if you’re a bank, asset manager, or payments company and you don’t already have a plan you feel really good about? You’re behind the curve. If only someone had started an advisory firm which could help people who find themselves in that situation…
DAVID: What’s most tantalizing for me here is what comes next. Starting with stablecoin regs is strategically sublime, because it’s much harder to argue against a censorable token than more adventurous stuff like DeFi. But GENIUS will in turn stoke demand for market structure and other clarifying regulations.
Small Bites 2:
Pump.fun Token
On the absolute opposite side of crypto from regulated stablecoins would probably be memecoins. They are not backed by anything other than, well, a collective agreement that they are worth something. They range from the venerable and original memecoin, Doge, all the way to the small army of tokens being launched daily from the commercial behemoth that is Pump.fun, which can best be described as some combination of sports gambling, a casino, and a reality TV level of presentation all welded together into a horrific machine of profit generation and user destruction. This is probably a future topic for this newsletter, so for now, it will be left there.
It’s going to launch a token. What will this token do? Well, it’s going to launch a token. In typical crypto fashion, the rumors are swirling around how much will be sold (15% of supply) at what prices (4c?) and at what valuation (high?). Either way, the ephemeral value of tokens as things that kind of sort of look like equity but also are totally not equity is a subject of much debate, so it will be interesting to see exactly what happens with the madhouse casino meme platform launching one. Note: interesting is not always good.
AUSTIN: I’ve always had a viscerally negative reaction to pump.fun in particular, simply because with such poor structure around a casino-like product, it seems inevitable that it will extract money from users while returning almost nothing to anyone who is not an insider or running the casino itself. The evidence seems to suggest that as well, with the overwhelming supermajority (e.g. >90%) of “traders” (e.g. marks) on pump.fun losing money. It serves as a magnet for some of the worst behavior out there, and David has written about many of these trends in crypto, so I’m sure he’s going to have thoughts beyond my vague disgust for the entire thing. Overall, though, this would be the kind of thing begging for regulation (along with things like sports betting) if Congress wants to keep looking at things in the space.
DAVID: Can we swear in this newsletter? (Austin: Fuck yes we can.) Because I fucking hate this. Pump.fun both exploits and worsens the broad transition of asset speculation into pure gambling. “Meme stocks” like AMC, BBB and their ilk are part of the same trend, itself broadly linked to both the democratization of investment and, at the same time, increasing mass precarity among American “investors” in particular. That mix of cynicism and despair came up a lot when I talked to Memecoin traders for an upcoming feature in Use Case Magazine.
That said, I have absolutely no clue how to deal with a problem like Pump, whether in regulatory or ideological terms. Decentralization makes this sort of thing hard to stop in practical terms. The Trump SEC has specifically declared that memecoins are not securities, which is obviously self-serving $Trumpism, materially debatable … and very, very bad for average people. ICOs were meant to democratize investing, and some of those actually worked. But with regulations that literally boil down to “it’s more legal to launch a token that explicitly does nothing than to try and create a solid investment structure that doesn’t line up with the way the stock market works,” this is where you end up.
I used to be much more optimistic about financial education as a way to tamp down self-destructive degenerate behavior, but that optimism is fading. Human brains like to gamble, and if you let them, people will destroy themselves with it.
WHAT ARE WE UP TO?
First of all, sign up for our newsletter if you haven’t already. It’s literally the short form of this, mainlined to your inbox, and will also bring you here if you like the longer pieces.
AUSTIN: On the topic of Ethena and basis trades, I’m actually an advisor to a company called XSY, which is slowly but surely working on some yield-optimizing versions of the perpetual basis trade, perhaps on some tokens that will be quite unexpected. It just goes to show that when a successful idea emerges in crypto, it doesn’t descend into the sort of financial monopoly that we are used to in traditional finance, but rather people start iterating, riffing, and adopting ideas from successful projects to iterate and experiment in real-time. To me, that’s one of the best aspects of the space: we are doing it live. Competition lives.
Likewise, if you’re interested in new, interesting, or unexpected implementations of the basis trade, keep an eye on XSY… as things happen, I’ll share more, but for now, all I can really say is keep your eye on this space.
DAVID: Please check out my other newsletter, Dark Markets, which is focused on financial malfeasance, crypto, and technology investment fraud. We do a weekly news roundup and regular deep dives, recently including this analysis of Apple’s explosive recent paper on the limits of reasoning in Large Language Models like ChatGPT.
Second, I’m about to dive headfirst into covering the trial of Roman Storm, one of the developers of Ethereum anonymizing protocol Tornado Cash. The questions at stake in the trial are huge: Storm is charged with money laundering and conspiracy, but claims that he and codevelopers never interacted with the North Korean users at the center of the charges. Critics of the prosecution argue that Storm is being prosecuted for writing code, which would have serious First Amendment implications. Coverage will be appearing at The Rage, with frequent updates from court to The Rage’s X account.
Finally, my book “Stealing the Future: Sam Bankman-Fried, Elite Fraud, and the Cult of Techno-Utopia” is coming November 11th from Repeater Books. Preorders should be live soon.
