BTC Accumulation Intact, ETH's Bid Spark, and Revolutionizing Stablecoins

• Bitcoin ETFs draw over $5B in net inflows since launch
• Ether options open interest on CME hit a fresh all-time high
• Stablecoin developer Ethena raised funds at $300M valuation

Bitcoin's pile expands, Ethereum's bid commands

Cryptocurrency markets continued their upward trend for the fourth consecutive week led by high-beta names. The total market capitalization of the crypto space flirted with the $2 trillion mark, while bitcoin dominance dipped below 52%. Among the major cryptocurrencies, bitcoin was unchanged compared to the previous week, while ether rallied 6.9%, briefly breaching the $3,000 mark on Tuesday. In the realm of US listed spot bitcoin ETFs, GBTC experienced a rise in outflows. However, the significant inflows into other ETFs overshadowed the GBTC outflows, resulting in another week of strong net inflows. As of the end of February 21, less than two months since their introduction, the cumulative net inflows into the spot bitcoin ETF universe have surpassed the $5 billion mark.

Concerns have arisen within the crypto community following the recent court approval for Genesis to sell off GBTC shares, potentially exerting additional downward pressure on bitcoin prices. According to Coinbase's weekly report, there is uncertainty about whether the extra GBTC outflows will move into other spot bitcoin ETFs or be used to repay creditors directly. The ruling grants Genesis the option to either convert shares into underlying assets like BTC, ETH or ETC, on behalf of creditors or to sell the shares and distribute the cash. The confirmation hearing for Genesis's Chapter 11 bankruptcy plan is set for February 26 (9:30 am ET) where the court will decide on the debt repayment plan. The extent to which additional GBTC outflows may enter other US spot bitcoin ETFs if not used for direct creditor repayment remains unclear. Nevertheless, the report suggests that a significant portion of these funds will likely remain within the crypto ecosystem, potentially resulting in a neutral overall market effect.

Notably, ETH finally played catchup versus BTC this week, breaking past $3,000 on Tuesday for the first time since April 2022. According to The Block's data, open interest in CME ETH Options has hit an all-time high this month. Separately, a recent research report from broker Bernstein suggests that ether could emerge as the "Institutional Darling". The report suggests a 50% chance of approval for a spot ether ETF by May, with a near-certain probability of approval within the next 12 months. It highlights that institutions are not merely interested in launching spot ether ETFs. Rather, they aim to "build more transparent and open tokenized financial markets on the Ethereum network", emphasizing a utility beyond asset gathering. Ethereum's forthcoming upgrade, Dencun, scheduled for March, promises a dedicated corridor and blockspace for rollups, potentially slashing transaction costs by an additional 50%-90% according to the report. Additionally, Ethereum continues to follow a deflationary trend post The Merge, with the ultra sound money dashboard indicating (at the time of writing) a net supply reduction of 364,109 ETH or 0.210% year on year, resulting from the burning of 1,418,394 ETH. Data from Dune shows that over 30 million ETH, equivalent to a quarter of all ETH in circulation, is currently being staked, leading to a limited supply of available ETH in the spot market. In the case of a deflationary currency like ether, a tightening supply combined with extensive network usage has the potential to positively impact the price.

Revolutionizing stablecoins, Ethena Labs's vision for a new landscape

Shifting focus from ETH price action to projects built upon it, Ethena Labs, the developer behind the Ethereum-based stablecoin USDe, announced last Thursday that it had successfully raised $14 million in a strategic funding round. The round was co-led by Dragonfly and Maelstrom, the family office of BitMEX founder Arthur Hayes, and brought Ethena's valuation to $300 million. Following a stealth launch in December, Ethena also publicly launched its USDe stablecoin. Ethena's creation was inspired by Arthur's blog post "Dust on Crust '' from last year in which he outlined his vision for a crypto-native, derivative-backed stablecoin operating independently of the traditional banking system.

USDe distinguishes itself as an Ethereum-based stablecoin backed by derivatives. It is backed by both a long staked ether position and a short ether position, structured to function as an ETH staking and basis trade. In simpler terms, if USDe were offered as a structured note, the purchaser would provide stablecoin/dollar to the dealer. Subsequently, the dealer would sell the stablecoins/dollar to acquire ETH, then stake the ETH in the Liquid Staking Derivatives protocol, resulting in the locking of ETH but the acquisition of stETH by the dealer. The dealer would then utilize stETH as margin to open a short ETH perps/futures position to achieve delta neutrality. In scenarios where the funding/basis is positive, the dealer would collect funding and staking rewards. Conversely, if the funding/basis falls below, the dealer would collect/pay the net of staking and funding/basis rewards. Now, suppose the dealer reveals the rules governing the delta-hedging mechanism, risk limits, and execution, with the entire process automated on-chain—that encapsulates USDe. The key risks associated with USDe are primarily on funding, liquidation, custodial, exchange failure, and collateral risk.

In the event of prolonged periods of heavily negative funding rates, where the perps funding rate surpasses the staking rate, it could lead to a negative yield on the stablecoin. To mitigate this risk, Ethena has established an insurance fund, which intervenes when the combined yield from the Liquid Staking Token (LST) asset (such as stETH) and the funding rate for a short perpetual position turns negative. This safeguard ensures that the collateral backing USDe remains unaffected. Notably, Ethena does not pass on any "negative yield" to users who stake their USDe for sUSDe. While historical funding data tends to exhibit a positive bias, it's crucial to consider the broader crypto market dynamics over longer timeframes, which have generally shown a bullish trend. However, if the market experiences prolonged periods of negative yield on USDe, it's reasonable to anticipate that individuals would redeem their holdings. This could trigger unwinding on short ETH futures positions, thereby alleviating the funding pressure, especially if the redemptions are significant relative to the ETH futures open interest. However, the greater risk lies in individuals continuing to hold the stablecoin during these extended periods of negative yield.

At a high level, exchanges' risk engines ensure each user has sufficient collateral, or "Maintenance Margin”, to margin existing positions. Many exchanges now offer incremental liquidation to reduce costs for users and the exchange, where a position is closed slowly instead of immediately in full. Ethena uses staked Ethereum assets, such as Lido's stETH, to collateralize short ETH-USD and ETH-USDT Perpetual positions across CeFi Exchanges. Ethena, therefore, is using a different asset, stETH, than the underlying asset of the derivatives positions, ETH. The risk engines of the exchanges calculate the collateral value to margin derivatives positions, typically based on the price and liquidity across two separate independent markets on the exchange. This is where the liquidation risk and collateral risk exist. Ethena has outlined a list of measures they are taking to mitigate this risk.

Ethena Labs uses Off-Exchange Settlement (OES) providers to custody protocol backing assets, introducing custodial risk linked to their operational capability. This encompasses factors like asset accessibility, availability, and custodian reliability. To mitigate these risks, Ethena avoids overexposure to a single OES provider, manages concentration risk, and utilizes multiple providers across exchanges. Ethena Labs offsets staked ETH delta with derivatives on CeFi exchanges, posing exchange failure risk. However, assets are controlled via Off-Exchange Settlement providers, minimizing exposure. In case of exchange failure, collateral is delegated elsewhere and outstanding deltas hedged, closing derivative positions without further obligation to the failed exchange. While Ethena has outlined a robust risk management framework and experienced significant inflows, it is still in its early stages and requires further testing with larger scale and across various market conditions to fully validate its potential.

Macro pulse 

Among the TradFi assets, Oil futures rallied 1.9% contrasting with a 0.4% decline in US equities compared to the previous week, driven by weakness in the tech sector. Additionally, market attention was drawn to the release of the FOMC minutes. The minutes indicated that most policymakers acknowledged the risks associated with easing monetary policy too swiftly and underscored the significance of incoming data in assessing whether inflation is steadily moving towards the 2% target. Furthermore, officials assessed that the policy rate is likely at its peak for this cycle. Elsewhere, the US Dollar index slipped 0.7% lower and the 10 year US treasury rose by 6 bps while the Gold & Silver rose 2.3% week on week.

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*Note: Weekly (7 calendar day) performance figures are as of 8am SGT on February 22, 2024 

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