As people deposit large amounts of their crypto assets into Ethena, a new decentralized finance protocol, discussions around its flagship product USDe has intensified among proponents, critics, and those in-between. 

USDe is Ethena’s cryptocurrency that aims to be a dollar-denominated savings instrument or “synthetic dollar” (Ethena has moved away from calling it a stablecoin). Since the beginning of 2024, USDe’s market cap, which is the same as the number of USDe tokens circulating, has increased nearly fourfold from $91.32 million on Jan. 1 to $352.45 million at presstime, data from blockchain analytics firm DefiLlama shows

An increase in the number of USDe tokens circulating corresponds to more crypto denizens depositing various types of cryptocurrencies – USDT, USDC, DAI, crvUSD, FRAX and mkUSD – into the Ethena protocol in exchange for the synthetic dollar, as specified by the project’s documents. 

Read More: How Ethena’s USDe Challenges Traditional Stablecoin Models

The Appetite For Additional Yield

The inflows into Ethena, in part, stems from people’s appetite for yield, as crypto investors who decide to stake their USDe after minting the token get an annual percentage yield of 27.64%, per the protocol’s staking portal. According to onchain intelligence firm Nansen, over 174.38 million USDe, about half of the supply, currently sits in Ethena’s smart contract for staking.

Ethena’s staking yield, according to Ethena’s documents, comes from two sources: the rewards from staked ETH securing the Ethereum blockchain, and the funding rate from shorting ETH futures on derivatives exchanges. 

“When minters provide assets in the process of minting USDe, Ethena Labs opens corresponding short derivatives to hedge the delta of the received assets,” per the project’s documents. “Historically due to the mismatch between demand & supply for exposure to digital assets, there has been a positive funding rate & basis spread earned by participants who are short this delta exposure.” 

“Delta” refers to the sensitivity of the derivative’s value to changes in the value of the underlying asset. 

Read More: What Is an Algorithmic Stablecoin? The Experiment That Triggered a Market Collapse

The surge in inflows comes as Ethena’s co-founder Guy Young announced on X two days ago that the protocol raised a $14 million seed extension round led by venture capital firm Dragonfly and Maelstrom, an early-stage investment fund run by the family office of Arthur Hayes. 

Questions Arise 

Despite the recent funding announcement and the major inflows of crypto assets into Ethena, the synthetic dollar protocol has raised eyebrows for how it generates yield via its USDe staking mechanism.

For example, Circle’s chief economist Gordon Liao and CEO Jeremy Allaire criticized the protocol without directly mentioning it by name. In a long-form tweet, Liao discussed the constraints and risks of “some high-yield liability stabilized in fiat value through trading some commodities or any asset with a liquid derivative market,” an uncharitable reference to USDe, according to some Ethena supporters.

Liao describes a scenario where markets become more volatile, leading to the potential of a futures exchange collapsing or the exchange’s other counterparties defaulting. 

Read More: What Is Depegging in Crypto and Why Does It Occur?

Allaire then quoted Liao’s tweet saying, “And it’s completely decentralized! Not.” Circle is the firm behind USDC, the second-lagest stablecoin by market cap, behind Tether

However, one Ethena investor on X noted how he was glad to see individuals questioning the design of Ethena, inquiring how the protocol can offer yields of over 20% and exploring what the underlying risks are. Anthony Sassano, who is an investor in Ethena, wrote ​​on X. “This is very different to last cycle where people questioning things were the minority and were just told that they were ‘coping’ over not making money on ponzis.”