Why Ethena is the Best Choice for Providing Synthetic USD in the Encryption Ecosystem on the Public Chain?

As the footsteps of winter leaving and spring approaching quicken, 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 long and short perpetual futures contract positions of cryptocurrencies 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 synthetic dollars. At the end of the article, I committed to doing my best to support a credible team to bring this idea to fruition.

The changes in a year are truly 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 specialized fields such as credit, private equity, and real estate. Guy discovered the Shitcoin problem during the DeFi Summer that started in 2020, and since then, he has been unable to pull back. 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 on my initial idea. He aims 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 directly pay a small amount of ETH for each block through the protocol. This is what I refer to as the ETH staking yield. Additionally, since ETH is now a deflationary currency, there are fundamental reasons for the continuous premium of ETH/USD forwards, futures, and perpetual swaps compared to spot. Short perpetual swap holders can capture this premium. Combining physical staking of ETH with a short position in ETH/USD perpetual swaps can create a high-yield synthetic dollar. As of this week, the annual yield of spot ETH dollar (sUSDe) is approximately >50%.

Without a capable team to execute, even the best ideas are mere talk. Guy named his synthetic dollar "Ethena" and has assembled a star team to launch the protocol quickly and securely. In May 2023, I became a founding advisor, and in exchange, we received governance tokens. In the past, I have worked with many high-quality teams, and the staff at Ethena do not take shortcuts and excel in completing tasks. Fast forward 12 months, and the Ethena stablecoin USDe was officially launched. Just three weeks after going live on the mainnet, the issuance has approached 1 billion (TVL is $1 billion; 1 USDe = $1).

Let me put aside the knee pads and candidly discuss the future of Ethena and stablecoins. I believe that Ethena will surpass a certain trading platform to become the largest stablecoin. This prophecy will take many years to come to fruition. However, I want to explain why a certain trading platform is both the best and the worst business in cryptocurrency. It is said to be the best because it may be the financial intermediary that profits the most for every employee in both traditional finance and cryptocurrency. It is said to be the worst because the existence of a certain trading platform is to please its poorer traditional financial banking partners. The jealousy of banks and the issues that a certain trading platform brings to the guardians of the peaceful financial system in the U.S. could spell disaster for a certain trading platform almost immediately.

For all those misled FUDsters of a certain trading platform, I want to clarify. The certain trading platform is not a financial fraud, nor has it lied about its reserves. Furthermore, I have great respect for those who founded and operate the certain trading platform. However, if I may say so, Ethena will disrupt the certain trading platform.

This article will be divided into two parts. First, I will explain why the Federal Reserve, the U.S. Department of the Treasury, and large U.S. banks with political connections want to destroy a certain trading platform. Secondly, 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 issued by entities that hold fiat currency in bank accounts, such as certain trading platforms, certain platforms, and certain cryptocurrency platforms. Synthetically-backed fiat stablecoins refer to coins that are hedged by cryptocurrencies held by the issuer and short-term derivatives, such as Ethena.

Envy, Jealousy, Hatred

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

If there is no US dollar bank account, a trading platform cannot fulfill its functions of creating USDT, holding US dollars that support USDT, and redeeming USDT.

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

Dollar Custody: Without a bank account, there is nowhere to hold the US dollars that support USDT.

Redeeming 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 created equal. There are thousands of banks worldwide that can accept dollar deposits, but only certain banks hold master accounts at the Federal Reserve. Any bank wishing to settle dollars through the Federal Reserve to fulfill its obligations as a dollar correspondent 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 proxy 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 an agent bank. Bank C assesses the customer base of both banks and approves them.

Bank A needs to remit 1000 USD to Bank B. The funds flow is 1000 USD transferred 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 an agent, while Bank B will use Bank D as an agent. Now, if Bank A wants to remit $1000 to Bank B, what will happen? The flow of funds is Bank C transferring $1000 from its account at the Federal Reserve to Bank D's account at the Federal Reserve. Bank D will finally deposit the $1000 into Bank B's account.

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

I started getting involved in encryption currency in 2013. In general, the banks that hold fiat currency for encryption currency exchanges are not banks registered in the United States, which means they need to rely on a U.S. bank that has a master account to handle fiat currency deposits and withdrawals. These smaller non-U.S. banks are desperate for deposits and banking business from encryption currency companies, as they can charge high fees without paying any interest on deposits. Globally, banks are usually eager to obtain cheap dollar funding because the dollar is the global reserve currency. However, these smaller foreign banks must interact with their correspondent banks to handle dollar deposits and withdrawals outside their own locations. While correspondent banks tolerate these fiat flows related to encryption currency businesses, for some reason, certain encryption currency clients are sometimes excluded from smaller banks at the request of the correspondent banks. If small banks fail to comply with regulations, they risk losing their correspondent relationships and the ability to transfer dollars internationally. A bank that loses dollar liquidity is like a zombie. Therefore, if the correspondent bank requests it, small banks will always abandon encryption currency clients.

When we analyze the strength of a trading platform's banking partners, the development of this correspondent banking business is crucial.

Bank partners of a certain trading platform:

• 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 conduct open market operations, such as buying and selling bonds. The ability of a trading platform to transfer and hold US dollars is entirely subject to the whims of the intermediary banks. Considering the size of a certain trading platform's investment portfolio in US Treasury securities, I believe their partnership with Cantor is crucial for continued entry into that market.

If the CEOs of these banks did not negotiate to gain equity in a certain trading platform in exchange for banking services, then they are fools. When I later introduce the per capita income metrics of the employees of that trading platform, you will understand the reason.

This covers why the banking partners of a certain trading platform have performed poorly. Next, I want to explain why the Federal Reserve dislikes the business model of a certain trading platform, and why fundamentally, this has nothing to do with encryption, but rather with how the U.S. dollar money market operates.

Full Reserve Banking

From the perspective of traditional finance, a certain trading platform is a full-reserve bank, also known as a narrow bank. A full-reserve bank only accepts deposits and does not issue loans. Its only service is remittances. It pays almost no interest on deposits because depositors do not face any risk. If all depositors request to withdraw their money at the same time, the bank can immediately meet their demands. Therefore, it is called "full reserve." In contrast, the loans of fractional-reserve banks exceed their deposits. If all depositors request a withdrawal from a fractional-reserve bank at the same time, the bank would collapse. Fractional-reserve banks pay interest to attract deposits, but depositors face risks.

A certain trading platform is essentially a full-reserve dollar bank that offers dollar trading services powered by public chains. That's it. No loans, no interesting stuff.

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

Banks collapsed during the 2008 financial crisis because they did not have enough reserves to cover the losses from bad mortgages. Reserves are funds that banks hold at the Federal Reserve. The Federal Reserve monitors the size 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 conducts QE bond purchases worth trillions of dollars, leading to an expansion of bank reserve balances. Great!

Quantitative easing did not cause rampant inflation in a noticeable way like the COVID stimulus checks did, because bank reserves remain with the Federal Reserve. The COVID stimulus measures were given directly to the public for free use. If banks lend out these reserves, the inflation rate would immediately rise post-2008, as this 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 inclined to lend their reserves.