Market View
Activity on CME bitcoin and ether futures has picked up sharply in recent weeks alongside the rise in net inflows into spot bitcoin ETFs, suggesting institutional interest in this space is growing. Note that over the last week, we’ve seen the basis between CME futures and spot remain broadly stable near 15% for bitcoin (30-day annualized) and rising slightly to 18% for ether, where there’s currently no available spot ETF alternative for the latter.
The open interest for CME bitcoin futures has risen 58% to $6.8B in February compared to an 86% increase to around $1.1B for CME ether futures. While the absolute figures continue to highlight the differences in market participation and trading activity between these two assets, the trend reveals how ETH has started to catch up to BTC in terms of performance as of late. We’ve previously mentioned in our Monthly Outlook that we believe ETH will continue to close the distance to its peers in 1H24, particularly as we’re seeing a resurgence in decentralized finance (DeFi) activity. Indeed, the total value locked on Ethereum is already up almost 50% to $46.6B from $31.2B at the start of the year, according to DeFiLlama.
Onchain: Ethena
Meanwhile, Ethena Labs has been getting a lot of attention this week for its interest-bearing “synthetic dollar” USDe that launched on Ethereum mainnet on February 19. It has already seen the annualized (variable) rate of return rise to as much as 27% (though that’s since dropped to 15% on February 22 before recovering to 24% as of February 23 9am ET). The total value locked on the protocol has climbed to $418M as of February 23.
In basic terms, the concept behind Ethena is that it tokenizes the “cash and carry” trade between spot and perpetual futures (perps). Specifically, USDe pays earnings from the basis trade structure of long staked ETH (or the equivalent liquid staked tokens) and short ETH perps, which works as long as the combination of funding rates and staked ETH yield stays positive.
That is, USDe holders theoretically earn the (1) staking yield on the staked ETH plus the (2) funding rates received from being short perps. (Note that Ethena has a $10M insurance fund to guard against negative funding rates.) Also, returns are earned only by the proportion of USDe that is staked (similar to sDAI on Gnosis), which enables USDe stakers to receive a higher annualized reward that is greater than the sum of the funding and staking yields.
In our view, Ethena’s earning mechanics are rooted in real value capture despite its high rates. Similar basis trades have long existed in traditional finance to take advantage of the gap between futures and spot markets. That said, the structure embedded in USDe is not risk-free, which Ethena has been transparent with.
Separately, one concern we have for markets as a whole is that should this protocol grow substantially, it could cause a possible imbalance in favor of shorts in the perps market, thus having a disproportionate effect on funding rates. However, funding rates drop when deposits grow significantly, since the funding market compresses as the number of short perp positions increases. This may pose a natural ceiling of sorts on the total value locked in the protocol – albeit this could fluctuate depending on the positioning of other perps market participants. Indeed, depending on that variability, annualized USDe staking returns may find themselves competing with similar rates for deposits in mature lending protocols (e.g. a 10% USDC Aave deposit rate on Base), which may carry lower premiums because they ostensibly have fewer risk vectors in our view.
More broadly, we believe that Ethena is reflective of the central role that real ETH yield will play in novel DeFi innovations this cycle. As more protocols build on Ethereum’s staking and restaking primitives, we think there will continue to be a growing complex of sophisticated products onchain.
Correction: Ethereum’s client centralization risks
Separately, we also want to revisit a statement laid out in the previous weekly that the Geth supermajority risk had been “largely mitigated”. Although there has indeed been significant progress in client diversification in the past month as the ratio of minority known clients has more than doubled from 15% to 32%, there is still much more room for progress before concerns around Geth centralization are fully resolved. Given that 43% of Ethereum validators have not self-reported their execution clients (there are debates around the accuracy of the previously used crawler-based estimate of validator client diversity), a conservative threshold for considering this threat vector sufficiently resolved would be when the proportion of self-reported minority clients exceeds 33% of the entire network – it currently sits at 18%. Commitments by large staking providers such as Coinbase and Lido, which has increasingly diversified their underlying clients, shows that promising progress has been – and continues to be – made in this regard, but we are not out of the woods yet.
