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Portfolio Scenario Analysis

Understanding how price movements in ETH impact USDe
Given USDe's underlying peg stability mechanism is for the protocol to be long staked Ethereum assets & short a derivatives position, a common question has been:
"How does a change in the price of ETH affect the underlying backing composition?"
This is a great question in that it allows us to discuss in more detail the composition of assets in our portfolio in different ETH price scenarios.

Overview

Given the protocol utilizes both inverse coin-margined and linear usd-margined contracts as well as trades across multiple exchanges, there are differences in how we settle outstanding PnL. These differences stem from:
  • Each exchange's contract specifications, margining, and risk systems being subtly different.
  • Inverse coin-margined contracts typically recording & settling PnL in ETH terms while linear contracts typically recording & settling in USDT (eg for ETHUSDT Perpetual contracts).
This brings us to an important subject of "unrealized" and "realized" PnL.
  • "Unrealized PnL" refers to when an existing position has incurred a profit or loss (difference between the average position price & the mark price of the contract), but the position has not yet been fully or partially closed. In essence, for example, the position has an outstanding profit/loss denominated in ETH or USDT, but this has not been received or paid from or to the portfolio's collateral balance.
  • "Realized PnL" refers to when a part or all of a position has been closed and has received or paid the PNL to/from the collateral balance.
What this means is that we typically receive/pay profit/loss in ETH or USDT depending upon the exchange and margin type of the positions we are trading. A change in the price of ETH does NOT mean the portfolio is immediately buying/selling collateral to meet unrealized PnL moment by moment. As a result, this means that the portfolio at times has balances owed to it or owes in ETH or USDT terms. The ~USD value of the collateral underpinning the synthetic dollar remains constant.
The protocol expects to be able to naturally "realize" "unrealized PnL" by:
  • Closing existing positions when redeem USDe requests are received.
  • Periodically settling PnL to reset back to a 100% long staked ETH position on the spot leg.

Scenarios

ETH Price Decreases

In this scenario, the price of ETH decreases from when the positions were opened upon minting USDe. This means the portfolio's derivatives positions have unrealized profits across both inverse coin-margined & linear margined positions. These unrealized profits are denominated in ETH & USDT. Ethena has not sold or reduced the amount of staked Ethereum asset collateral we are holding.
Given the protocol would like to maximize our yield, by holding as much staked Ethereum assets as a proportion of our collateral's ~USD value in total, the protocol will naturally "realize" these profits by closing existing positions. There is no significant drag to the portfolio's yield or risk by holding a small proportion of the portfolio in unrealized ETH or USDT terms.
Below are two examples demonstrating the impact of differing price scenarios upon inverse & linear contract margined positions. You'll notice the portfolio is able to either purely hold staked Ethereum assets to margin positions or is able to hold a proportion in the "Settlement Currency" (the motivations will be discussed further down).
Linear Margined Positions
Inverse Margined Positions
You'll notice as the price of ETH continues to fall, a greater proportion of the protocol's collateral value resides in the unrealized profit of the hedging position.
It's important to keep in mind the portfolio is automatically rebalanced by Ethena and the extreme price scenarios are designed to demonstrate if rapid movements were to occur and the Ethena system were not to intervene. This is not a realistic assumption in reality.

ETH Price Increases

In this scenario, the price of ETH increases from when the positions were opened upon minting USDe. This means the portfolio's derivatives positions have unrealized losses across both inverse/coin-m & linear margined positions. These unrealized losses are denominated in ETH & USDT. Ethena has not sold or reduced the amount of staked Ethereum asset collateral we are holding.
Given the protocol would like to maximize our yield, by holding as much staked Ethereum assets as a proportion of our collateral's ~USD value in total, the protocol will naturally "realize" these losses by closing existing positions. There is no significant drag to the portfolio's yield or risk by holding a small proportion of the portfolio in unrealized ETH or USDT terms.
It is important to note that the loss on the derivatives positions is perfectly offset by the gain in the value of the spot assets. The ~USD collateral underpinning USDe remains constant.
One difference between the price of ETH increasing vs decreasing is that Ethena across many exchanges needs to be able to meet the unrealized loss with the "Settlement Currency" asset of the contract. The "Settlement Currency" asset of the contract is the asset in which PnL is settled. For example, for ETHUSDT Perpetual positions, PnL is settled in USDT. As such Ethena is able to:
  • Maintain a balance of the "Settlement Currency" in the portfolio to meet this requirement.
  • "Borrow" the balance from the exchange, at a reasonable variable interest rate, until the debt is extinguished (by acquiring the "Settlement Currency").
Below are two examples demonstrating the impact of differing price scenarios upon inverse & linear contract margined positions.
Linear Margined Positions
Inverse Margined Positions
You'll notice as the price of ETH increases, a greater proportion of the protocol collateral value resides in the spot Staked Ethereum asset with the unrealized loss in ETH or USDT terms growing.
It's important to keep in mind the portfolio is actively managed by Ethena & the extreme price scenarios are designed to demonstrate if rapid movements were to occur & Ethena were not to intervene. This is not a realistic assumption in reality.

Scenario Consequences to the Portfolio

As you'll notice from the scenarios the examples above, there is benefit for the Ethena system to manage the composition of the portfolio as the ETH price changes. This management does not need to occur every 5/10/20% difference in price as the implications are related to economic efficiency rather than stability. We're able to ensure the proportion of the portfolio's ~USD value remains in the staked Ethereum assets, used to margin the derivatives positions & generate yield, by naturally minting & redeeming USDe.
The natural mint & redeem USDe flow in combination with automated rebalancing ensure even in the most volatile markets for the cost to the portfolio the yield to be minimal.

Further Notes

Given Ethena utilizes both inverse/coin & linear margined contracts, a question we've received a couple of times has been: "What proportion of your portfolio is in USDT under different rapid ETH price movements?"
Keeping this brief:
  • You'll notice when the ETH price increases, the portfolio holds 0% USDT (or ETH). This is because we assume the protocol will constantly be swapping into staked Ethereum assets to both margin positions and maximize yield.
  • When the ETH price decreases, depending upon the proportion of hedging being done by the inverse/linear contracts, the composition of our portfolio skews heavily towards USDT.
    • It's important to keep in mind Ethena actively manages the portfolio and despite changes in the price of ETH, as discussed before, Ethena expects to naturally & proactively roll positions before the extremes are realized.
    • To clarify, holding a greater proportion of USDT isn't necessarily a problem; but rather it's a judgment around risk, with respect to the quality of asset (stETH/ETH vs USDT), as well as potential "borrowing" costs.
    • Ethena has a strong preference to hedge as much as possible using inverse contracts both due to the "Settlement Currency" being ETH, a high-quality collateral asset, but also because of substantially lower "borrowing" costs.
Last modified 1mo ago