Ethena: The best choice for synthetic dollars in the encryption ecosystem on-chain.

As winter gives way to spring, I want to revisit the article "Dust on the Crust" published a year ago. In this article, I proposed how to create a fiat stablecoin that exists without relying on traditional banking systems, supported by human intervention. My idea is to combine the perpetual futures contract positions of cryptocurrency bulls and bears to create a synthetic fiat currency unit. I named it "Nakadollar" because I envisioned using Bitcoin and the "perpetual" short futures contract of XBTUSD as a way to create a synthetic dollar. At the end of the article, I committed to doing my best to support a credible team in bringing this idea to fruition.

The changes over a year are really significant. Guy is the founder of Ethena. Before creating Ethena, Guy worked at a hedge fund with a market value of $60 billion, investing in special areas such as credit, private equity, and real estate. Guy discovered issues with digital currencies during the DeFi Summer that started in 2020, and from then on, things spiraled out of control. After reading the book "Dust on Crust," he came up with the idea of launching his own synthetic dollar. But like all great entrepreneurs, he wanted to improve my original idea. He aimed to create a synthetic dollar stablecoin using ETH instead of BTC. At least, that was the plan at the beginning.

The reason Guy chose ETH is that the Ethereum network offers native yield. To provide security and process transactions, Ethereum network validators pay a small amount of ETH for each block directly through the protocol. This is what I mean by ETH staking yield. In addition, because ETH is now a deflationary currency, there is a fundamental reason for the continuous premium of ETH/USD forwards, futures, and perpetual swaps compared to spot. Short perpetual swap holders can capture this premium. By combining physical ETH staking with short positions in ETH/USD perpetual swaps, a high-yield synthetic dollar can be created. As of this week, the annual yield of spot ETH in USD (sUSDe) is about >50%.

Without a capable team to execute, even the best ideas are just empty talk. Guy named his synthetic dollar "Ethena" and has assembled a star team to quickly and safely launch the protocol. In May 2023, Maelstrom became a founding advisor, in exchange for which we received governance tokens. In the past, I have collaborated with many high-quality teams, and the Ethena staff does not take shortcuts, completing tasks exceptionally well. Fast forward 12 months, the Ethena stablecoin USDe is officially launched, and just 3 weeks after going live on the mainnet, the issuance has approached 1 billion coins ( with a TVL of 1 billion dollars; 1 USDe = 1 dollar ).

Let me set aside my knee pads and discuss frankly the future of Ethena and stablecoins. I believe Ethena will surpass Tether to become the largest stablecoin. This prophecy will take many years to realize. However, I would like to explain why Tether is both the best and the worst business in cryptocurrency. It is the best because it may be the financial intermediary that provides the most profit to each employee. It is the worst because Tether exists to please its poorer traditional banking partners. The jealousy of banks and the issues Tether brings to the guardians of America's peaceful financial system could immediately spell disaster for Tether.

To all the misled Tether critics, I want to clarify. Tether is not a financial fraud, nor has it lied about its reserves. Moreover, I have great respect for those who founded and operate Tether. However, if I may speak frankly, Ethena will disrupt Tether.

This article will be divided into two parts. First, I will explain why the Federal Reserve (, the U.S. Treasury, and large U.S. banks with political connections want to destroy Tether. Second, I will delve into Ethena. I will briefly introduce how Ethena is constructed, how it maintains its peg to the U.S. dollar, and its risk factors. Finally, I will provide a valuation model for Ethena's governance token.

After reading this article, you will understand why I believe Ethena is the best choice for providing synthetic dollars in the cryptocurrency ecosystem on-chain.

Note: Physically-backed fiat stablecoins refer to coins where the issuer holds fiat currency in a bank account, such as Tether, Circle, etc. Synthetic-backed fiat stablecoins refer to coins where the issuer holds cryptocurrency that is hedged with short-term derivatives, such as Ethena.

Envy, jealousy, and hatred

Tether) code: USDT( is the maximum stablecoin calculated based on the token circulation. 1 USDT = 1 dollar. USDT is sent between wallets on various public chains, such as Ethereum. To maintain the peg, Tether holds 1 dollar in a bank account for each circulating unit of USDT.

If there is no US dollar bank account, Tether will not be able to fulfill its functions of creating USDT, holding the US dollars that support USDT, and redeeming USDT.

Creation: Without a bank account, USDT cannot be created, as traders have no place to send their dollars.

Dollar Custody: If there is no bank account, there is no place to store the US dollars that support USDT.

Redeem USDT: Without a bank account, you cannot redeem USDT, as there is no bank account to send dollars to the redeemer.

Having a bank account is not enough to ensure success, as not all banks are equal. There are thousands of banks worldwide that can accept USD deposits, but only certain banks have master accounts with the Federal Reserve. Any bank wishing to clear USD through the Federal Reserve to fulfill its USD agency obligations must hold a master account. The Federal Reserve has complete discretion over which banks can obtain a master account.

I will briefly explain how the agency banking business operates.

There are three banks: Bank A and Bank B are headquartered in two non-U.S. jurisdictions. Bank C is a U.S. bank with a master account. Banks A and B wish to transfer U.S. dollars within the fiat financial system. They each apply to use Bank C as their correspondent bank. Bank C assesses the client bases of the two banks and approves them.

Bank A needs to transfer 1000 dollars to Bank B. The funds flow is 1000 dollars from Bank A's account at Bank C to Bank B's account at Bank C.

Let's make a slight modification to the example by adding Bank D, which is also a U.S. bank with a master account. Bank A will use Bank C as the correspondent bank, while Bank B will use Bank D as the correspondent bank. Now, what happens if Bank A wants to transfer $1000 to Bank B? The flow of funds is that Bank C transfers $1000 from its account at the Federal Reserve to Bank D's account at the Federal Reserve. Bank D will ultimately deposit the $1000 into Bank B's account.

Typically, banks outside the United States use correspondent banks to wire transfer US dollars globally. This is because when dollars move between different jurisdictions, they must be cleared directly through the Federal Reserve.

I started getting involved in encryption currency in 2013. Usually, the banks where encryption currency exchanges hold fiat currency are not banks registered in the United States, which means they need to rely on a U.S. bank with a master account to handle the deposits and withdrawals of fiat currency. These smaller non-U.S. banks are eager for deposits and banking business from encryption currency companies because they can charge high fees without paying any interest on deposits. Globally, banks are typically eager to obtain cheap dollar funding because the dollar is the world's reserve currency. However, these smaller foreign banks must interact with their correspondent banks to handle dollar deposits and withdrawals outside their location. While correspondent banks tolerate these fiat flows related to encryption currency business, for whatever reason, sometimes certain encryption currency clients are dropped from small banks at the request of the correspondent banks. If small banks do not comply with regulations, they risk losing their correspondent bank relationships and their ability to transfer dollars internationally. Banks that lose dollar liquidity are like walking dead. Therefore, if requested by the correspondent bank, small banks will always abandon encryption currency clients.

When we analyze the strength of Tether's banking partners, the development of this agency banking business is crucial.

Tether's banking partners:

• Britannia Bank & Trust
• Cantor Fitzgerald
• Capital Union
• Ansbacher
• Deltec Bank and Trust

Among the five listed banks, only Cantor Fitzgerald is a bank registered in the United States. However, none of these five banks have a Federal Reserve master account. Cantor Fitzgerald is a primary dealer that helps the Federal Reserve execute open market operations, such as buying and selling bonds. Tether's ability to transfer and hold US dollars is entirely subject to the whims of its correspondent banks. Given the size of Tether's U.S. Treasury investment portfolio, I believe their partnership with Cantor is crucial for continuing to access that market.

If the CEOs of these banks did not secure equity in Tether in exchange for banking services through negotiation, then they are fools. When I later introduce the per capita income metrics of Tether's employees, you will understand the reasons behind it.

This covers why Tether's banking partners have performed poorly. Next, I want to explain why the Federal Reserve dislikes Tether's business model and why fundamentally, this is related not to encryption but to how the U.S. dollar money market operates.

Full Reserve Banking

From the perspective of traditional finance, Tether is a full-reserve bank, also known as a narrow bank. A full-reserve bank only accepts deposits and does not issue loans. The only service it provides is remittance. It pays almost no interest on deposits because depositors face no risk. If all depositors request to withdraw their money at the same time, the bank can immediately fulfill their requests. Therefore, it is called "full-reserve". In contrast, the loans of fractional-reserve banks exceed the amount of deposits. If all depositors simultaneously request withdrawals from a fractional-reserve bank, the bank will fail. Fractional-reserve banks pay interest to attract deposits, but depositors face risk.

Tether is essentially a bank fully backed by reserves of US dollars, providing dollar transaction services driven by public chains. That's it. No loans, no funny business.

The Federal Reserve does not dislike full-reserve banks because of who their customers are, but because of how these banks handle their deposits. To understand why the Federal Reserve detests the full-reserve banking model, I must discuss the mechanisms of quantitative easing ) QE ( and its impacts.

Banks collapsed during the 2008 financial crisis because they did not have enough reserves to cover the losses from bad mortgages. Reserves are the funds that banks hold at the Federal Reserve. The Federal Reserve monitors the scale of bank reserves based on the total amount of outstanding loans. After 2008, the Federal Reserve ensured that banks would never lack reserves. The Federal Reserve achieved this by implementing QE.

QE is the process by which the Federal Reserve purchases bonds from banks and credits the reserves held by the Federal Reserve to the banks. The Federal Reserve's QE bond purchases, worth trillions of dollars, have led to an expansion of bank reserve balances. Great!

Quantitative easing did not cause rampant inflation in such a clear way as the COVID stimulus checks, because bank reserves stayed at the Federal Reserve. The COVID stimulus measures were given directly to the public for discretionary use. If banks lend out these reserves, the inflation rate would rise immediately after 2008, as that money would be in the hands of businesses and individuals.

The existence of fractional reserve banks is to issue loans; if banks do not issue loans, they cannot make money. Therefore, under the same conditions, fractional reserve banks are more willing to lend reserves to paying customers rather than keep them at the Federal Reserve. The Federal Reserve faces a problem. How do they ensure that the banking system has nearly unlimited reserves while not causing inflation? The Federal Reserve chooses to "bribe" the banking industry instead of lending.

Bribing banks to ask the Federal Reserve to pay interest on excess reserves in the banking system. To calculate the amount of the bribe, you can multiply the total amount of bank reserves held by the Federal Reserve by the interest on reserve balances ).