Why is Ethena the best choice for providing synthetic dollars in the on-chain encryption ecosystem?

As the end of the Hokkaido skiing season approaches, I would like to reflect on the article "Dust on the Crust" published last year. In that article, I proposed how to create a fiat-backed stablecoin that does not rely on the TradFi banking system. My idea was to combine the long and short positions of perpetual futures contracts in cryptocurrencies to create a synthetic fiat currency unit. I named it "Nakadollar" because I envisioned using Bitcoin and XBTUSD's perpetual short futures contracts as a way to create a synthetic dollar.

A year later, there was a huge change in the situation. Guy, the founder of Ethena, came up with the idea of launching his own synthetic dollar after reading my article. He wanted to improve on my original idea and create a synthetic dollar stablecoin using ETH instead of BTC.

The reason Guy chose ETH is that the Ethereum network offers native yields. To provide security and process transactions, Ethereum network validators directly pay a small amount of ETH for each block through the protocol. This is the ETH staking yield. Additionally, since ETH is now a deflationary currency, the fundamental reason for the continuous premium of ETH/USD forwards, futures, and perpetual swaps compared to spot is clear. 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 dollars (sUSDe) is approximately >50%.

Without an executable team, even the best ideas are just 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, received governance tokens. In the past, I have worked with many high-quality teams, and the Ethena staff do not take shortcuts and complete tasks excellently. Fast forward 12 months, Ethena stablecoin USDe officially launched, and within just 3 weeks of going live on the mainnet, the issuance has approached 1 billion ( with a TVL of 1 billion dollars; 1 USDe = 1 dollar ).

Let me honestly discuss the future of Ethena and stablecoins. I believe that Ethena will surpass Tether to become the largest stablecoin. This prophecy will take many years to achieve. However, I would like to explain why Tether is both the best and the worst business in cryptocurrency. It is said to be the best because it is probably the financial intermediary that allows the most employees in TradFi and cryptocurrency to profit. It is considered the worst because Tether's existence is to please its poorer TradFi banking partners. The jealousy of banks and the issues that Tether brings to the guardians of America's peaceful financial system could immediately spell disaster for Tether.

For all those misled Tether FUDsters, I want to make it clear. Tether is not a financial fraud, nor has it lied about its reserves. Furthermore, I have great respect for those who founded and operate Tether. However, I must say that 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 American banks with political connections want to destroy Tether. 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.

Envy, jealousy, hatred

Tether) code: USDT( is the maximum 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, Tether holds 1 dollar in bank accounts for each circulating unit of USDT.

If there is no US dollar bank account, Tether cannot fulfill its functions of creating USDT, holding the 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: If you don't have a bank account, there is nowhere to store the USD that supports 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 around the world that can accept dollar deposits, but only certain banks have master accounts with the Federal Reserve. Any bank wishing to settle dollars through the Federal Reserve to fulfill its dollar correspondent banking 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 agency banking works.

There are three banks: Bank A and Bank B have their headquarters in two non-U.S. jurisdictions. Bank C is a U.S. bank with a master account. Banks A and B want to transfer U.S. dollars in the fiat financial system. They each apply to use Bank C as their agent bank. Bank C evaluates the client base of the two banks and grants approval.

Bank A needs to remit 1000 USD to Bank B. The funds flow is 1000 USD 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 designate Bank C as the correspondent bank, while Bank B will designate Bank D as the correspondent bank. Now, what happens if Bank A wants to remit $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. Finally, Bank D deposits 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 US dollars flow between different jurisdictions, they must be settled directly through the Federal Reserve.

I started getting involved in cryptocurrency in 2013. Typically, the banks that hold fiat currency for cryptocurrency exchanges are not registered banks in the United States. This means they need to rely on a U.S. bank that has a master account to handle fiat deposits and withdrawals. These smaller non-U.S. banks are eager for deposits and banking business from cryptocurrency companies because they can charge high fees while paying no interest on deposits. Globally, banks are usually eager to obtain cheap dollar funding since 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 location. While correspondent banks tolerate these fiat flows associated with cryptocurrency businesses, for whatever reason, sometimes certain cryptocurrency clients will be dropped from small banks at the request of the correspondent banks. If small banks do not comply with regulations, they will lose their correspondent relationships and their ability to transfer dollars internationally. Banks that lose dollar liquidity are like zombies. Therefore, if the correspondent banks demand it, small banks will always abandon cryptocurrency 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. The ability of Tether to transfer and hold US dollars is entirely subject to the whims of its correspondent banks. Given Tether's portfolio of US Treasury securities, I believe their partnership with Cantor is crucial for continuing to enter this market.

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

This covers the reasons why Tether's banking partners have performed poorly. Next, I would like to explain why the Federal Reserve does not like Tether's business model and why, fundamentally, this is not related to encryption but to the way the US dollar money market operates.

Full Reserve Banking

From the perspective of TradFi, 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 funds at the same time, the bank can immediately meet their demands. Therefore, it is called "full reserve." In contrast, fractional reserve banks have loan amounts greater than their deposits. If all depositors simultaneously request withdrawals from a fractional reserve bank, the bank will collapse. Fractional reserve banks pay interest to attract deposits, but depositors face risks.

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

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 mechanism 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 the 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 goal 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, resulting in 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 remained 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 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 willing to lend reserves to paying customers rather than leaving 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 demand interest from the Federal Reserve for 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 the reserve balance )IORB(. IORB must fluctuate between the lower and upper bounds of the Federal Reserve's funds rate. Please read my article "Kite or Board" to understand the reasons behind this.

Loans carry risks. Borrowers may default. Banks prefer to earn risk-free interest income from the Federal Reserve rather than lending to the private sector and facing potential losses. Therefore, as quantitative easing progresses, the growth rate of unpaid loans in the banking system does not align with the growth rate of the Federal Reserve's balance sheet. However, success does not come cheap. When the Federal Reserve funds rate is between 0% and 0.25%, the cost of bribery is not high. But now, with the Federal Reserve funds rate at 5.25% to 5.50%, the bribery for IORB costs the Federal Reserve billions of dollars each year.

The Federal Reserve maintains a "high" policy interest rate to curb inflation; however, due to the rising costs of IORB, the Federal Reserve has become unprofitable. The U.S. Treasury and the American public directly fund the Federal Reserve through the IORB program.