How Ethena Fee Switch Could Shake Up DeFi

With hopes that the return of Donald Trump to the White House will lead to clearer legal frameworks and a friendlier regulatory climate for crypto, investors are looking into DeFi tokens like UNI that could soon "turn on" their fee switch, basically allowing token holders to start accruing returns just by holding the token.

Perhaps the most buzzy protocol triggering this interest is Ethena. The occasionally controversial growth monster has been making waves in the stablecoin space, and holders of its ENA token could see significant returns from stablecoin yields.

Let's take a deeper look at what Ethena is up to and why its community is considering this move for ENA. 👇

Ethena's Opportunity

Ethena is a decentralized stablecoin project offering a synthetic dollar for DeFi and Web3 users.

While Tether and Circle back their centralized stablecoins with cash-equivalent assets like short-term T-Bills, ensuring each token is fully collateralized, they retain the yield from these assets, which benefits the issuers, not the stablecoin holders. This arrangement leaves stablecoin holders bearing the risk of a depeg event, while issuers profit from the underlying asset yields. Ethena, however, is seizing this opportunity with a new approach.

When a user mints USDe, Ethena creates a delta-neutral position to back it. Ethena does this by opening a long position, buying tokens like stETH, ETH, or BTC, and matching that with a short perpetual position of the same size. This strategy helps ensure that the value of USDe remains stable.

Additionally, if the futures price of ETH or BTC is higher than the spot price, Ethena’s short position collects funding payments from traders holding long positions. Although stETH yield is moderate at around 3-4%, the primary source of return is the funding generated from shorting futures. 

With the crypto market heating up and growing bullish sentiment, the gap between futures and spot prices has widened and funding rates have increased as well. This would mean even greater yields from Ethena’s short positions, potentially adding value for ENA holders if the fee switch is activated.

The "Money Printer"

Tether reported a whopping $2.5 billion net profit in Q3, bringing its yearly total to $7.7 billion, largely from holding T-Bills. USDT holders, however, have no way to get in on these profits. Ethena’s model, by contrast, allows stablecoin holders to benefit from generated yield, unlocking new earning avenues for USDe and potentially ENA holders.

Through Ethena’s approach, they capture not only the yield from the staked assets but also profits from funding and basis spreads via its delta-hedged derivatives positions. Additionally, Ethena holds stablecoins like USDC and USDS, with its USDC holdings earning approximately 5% APY through Coinbase and USDS earning about 6% APY through Sky (formerly Maker).

Thanks to this approach, Ethena generates about $250 million annually (based on current numbers). 80% of this amount is directed to sUSDe holders, who earn a competitive 12% APY on their stablecoin holdings, while the remaining 20% supports Ethena’s reserve fund.

With sUSDe’s substantial yield, ENA holders are eager to get in on this yield. A recent forum post on the Ethena Foundation sparked discussion around activating the fee switch. The post raises important points, such as clarifying revenue amounts, the impact of a fee switch on sUSDe rates, and average protocol revenue.

If ENA holders were to join the yield distribution, sUSDe holders might see a slight reduction in APY, but still a highly competitive return compared to other stablecoins. For example, adjusting the split so that sUSDe holders receive 60% and sENA holders receive 20% would still yield sUSDe holders a solid 9% APY and sENA holders about 7% APY, derived from real yield rather than token emissions.

As Ethena actively pursues integrations to expand USDe, the stablecoin's growth potential is promising. Should the fee switch activate, sENA holders could experience substantial returns.

Switch Incentives

If Ethena’s ENA token holders decide to activate the fee switch, allowing sENA holders to earn a share of the yield from USDe positions. ENA holders might then push for a larger portion of the yield, reducing the amount allocated to the reserve fund or sUSDe holders.

Ethena then might not be able to give enough yield to sUSDe holders. This could shift the risk-reward balance, making sUSDe less attractive and potentially driving users to alternative stablecoins.

Additionally, let’s say there’s a situation where the funding rate is negative so Ethena has to pay the funding rate in the futures market. This would force Ethena to fund long-position holders, drawing from its reserve fund.

While the reserve fund is a safeguard and funding rates have historically been positive, the crypto market is no stranger to downturns. With fluctuating rates, it’s uncertain how long the reserve could sustain these payouts if negative funding rates persist in the future.

DeFi Outlook

Ethena aims to revolutionize a billion-dollar industry that has yet to return value to token holders. The potential fee switch offers ENA holders a unique opportunity for both token appreciation and yield from real revenue.

Ethena presents an interesting case study to watch, as it may offer insights for Uniswap, Blur, and others about balancing stakeholder incentives when activating a fee switch. It will also be intriguing to see how well token holders’ long-term interests align with Ethena’s goals, and how Ethena’s team may respond if ENA holders demand too much of the yield.