Ethena Labs Founder Stablecoins need to focus on liquidity rather than decentralization

Ethena Labs Founder Stablecoins should prioritize liquidity over decentralization

Author: DARREN KLEINE, Blockworks; Translation: Song Xue, LianGuai

Lido and its liquidity staking token stETH dominate the Ethereum staking service market – Guy Young, the founder of Ethena Labs, says that this may not be a bad thing.

Young says that if you were to ask: in periods of market volatility, which is more important, liquidity or decentralization, exchanges are more concerned about liquidity.

According to the company’s website, Ethena “provides derivative infrastructure to transform Ethereum into the first crypto-native interest stablecoin not reliant on the banking system: USDe [Unified Stable Dollar Ecosystem].”

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The website explains that stablecoins achieve price stability through “delta-neutral hedging processes across both centralized and decentralized venues.” In the 0xResearch podcast (Spotify/Apple), Ethena Labs founder Guy Young and research director Conor Ryder discussed the dilemma of liquidity and decentralization.

“We just need to consider our users,” Young said. “What went wrong on our end? That’s liquidity.” Young states that in periods of market turmoil, centralization is unlikely to be the main reason for the failure of USDe.

“The biggest risk of what we’re doing is ensuring that the collateral is liquid,” he said. “We’re focused on different things compared to other liquidity staking token providers that focus more on the decentralization aspect.”

Ryder added that users may not necessarily reduce risk by adopting Ethereum staking in a competitive form. “Lido’s dominance right now is not what I’m really concerned about. There’s a reason why it’s dominant,” he said.

Ryder said that Lido’s staking platform and liquidity staking token Lido Staked Ether (stETH) have the “best set of validators” and have been “battle-tested” and enjoy “very good market attractiveness.”

“These smaller, highly liquid staking tokens currently don’t have that kind of market attractiveness. It’s not about diversifying by getting 10% stETH, 10% Rocketpool ETH (rETH), 10% anything else,” Ryder said, such a strategy only adds more risk.

Stablecoin Solvency

Another major issue regarding stablecoin risks is solvency, Young says it’s actually a matter of time. “If every user wants to withdraw all their money at the same time, this would force you to face realized losses when withdrawing because you have to take away the collateral and return it to the users, which doesn’t mean they think they invested dollars.”

“The same risk exists in bonds that you saw in the real world last year, are you really redeeming them with realized losses on their market value?”

“In reality, the same risk exists there,” he said. “The question is just how to manage the duration risk.”

Young explained that one way to reduce solvency risk is to establish an insurance fund. “The system will have more than one effective collateral, as stablecoins are essentially backed by a pool of US dollars.”

He said that the insurance fund can act as the “lender of last resort” to ensure stability during times of “chaos” in prices.

“You can prove in real time that the whole thing is solvent because you have collateral that you can read and show to users, and you have derivative positions that you can read again and show to users,” Young said.

Youg gave an example: when the trading price of USDe on Curve is $0.95, the insurance fund can act as a bidder in the open market for USDe, “sharing these profits among the token holders on the other side.”

Youg acknowledged that market panic is inevitable, “but I think the insurance fund can play an interesting role, basically offering the opportunity to share these profits with token holders afterward.”

“You can only do this when you can prove that the system is actually collateralized and programmable.”

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