"Collateral Custody" refers to where protocol backing assets are held.
To access centralized exchange liquidity, Ethena must provide collateral to support the delta hedging derivative positions that act as the peg stability mechanism.
Ethena deposits all collateral with "Off-Exchange Settlement" providers. These providers both custody deposited assets as well as enable Ethena to delegate/undelegate assets to/from centralized exchanges without ever transferring the assets to the exchanges.
"Off-Exchange Settlement" providers enable Ethena to settle the outstanding PnL of our derivatives positions frequently. This enables Ethena to mitigate any potential owed liability in the event of an exchange failure between settlement cycles.
Most importantly, Ethena depositing collateral assets with an "Off-Exchange Settlement" provider does not transfer beneficial title over the assets to the provider or our exchange partners. In the event of an agreed exchange failure, Ethena will be able to delegate funds to another exchange to support our hedging requirements.
"Off-Exchange Settlement" providers such as Copper, Ceffu, and Fireblocks have long been used by institutional participants in the space to ameliorate this exact risk.
Ethena strongly believes in users' ability to independently verify the existence and control of the protocol collateral as well as the hedging derivatives positions.
All of our "Off-Exchange Settlement" providers enable us to provide onchain wallet addresses as so users can validate the existence of the protocol collateral.
One user, Mantle, has requested part of the collateral from their mint of USDe be custodied on exchange.
We are actively exploring tools to help publicly prove & enable users to independently verify the existence of our hedging derivatives positions. We plan to use Proven Tools' ZeKnown Solve when it is launched. We are always searching for alternate solutions.
Approach to Decentralization
There are a variety of trade-offs to consider when evaluating the degree to which the protocol relies on maximally decentralized solutions.
The core mission of creating a stablecoin equivalent that is not reliant on banking infrastructure has to date required either:
Capital inefficient overcollateralized "loans" onchain.
Unstable algorithmic designs.
Unscalable delta-neutral designs that are fully reliant on decentralized exchanges.
In order to address the shortcomings of prior delta-neutral peg mechanism designs it is necessary to interact with centralized liquidity venues where open interest and trading volume on derivatives are >25x larger than onchain liquidity venues.
However, doing so introduces new custodial risks with exchanges. How do we address this?
In our view, the focus has to be on leveraging solutions for the most important qualities of decentralized exchanges, namely:
Custody of assets outside opaque centralized servers.
Fully auditable and transparent.
Permissionless and programmatic withdrawal.
The use of "Off-Exchange Settlement" providers largely addresses these qualities & enables us to create a synthetic dollar that can meaningfully scale without being overly reliant upon a single source of liquidity, a single custodian of funds, etc.