Exchange Failure Risk

Context

Ethena utilizes derivatives positions to offset the delta of the protocol backing assets. These derivatives positions are traded upon CeFi exchanges such as Binance, Bybit, Bitget, Deribit, and Okx. As such, in the event an exchange were to suddenly become unavailable such as FTX, Ethena would need to manage the consequences. This is the "Exchange Failure Risk" we are referring to.

Protocol backing is NEVER deposited to exchanges and always resides with "Off Exchange Settlement" providers. Ethena has made significant efforts to minimize exposure to exchange failures.

What happens in the event of a failure of an exchange?

Ethena retains complete control and ownership of the assets via Off-Exchange Settlement providers with no collateral ever being deposited with any exchange. This limits Ethena's exposure to idiosyncratic events on any one exchange to the outstanding PnL between Off-Exchange Settlement providers' settlement cycles.

Copper's Clearloop runs a settlement cycle daily.

As such, in the event of an exchange failure, Ethena would delegate the collateral to another exchange and hedge the outstanding delta that was previously covered by the failed exchange. In the event of an exchange failure, the derivatives positions are considered closed with Ethena holding/owing no further obligation to the exchange estate.

Capital preservation is front of mind for Ethena. In the event of extreme circumstances, Ethena will always work to protect the value of the collateral & USDe stable peg.

How is the exchange failure risk managed?

As with all parts of Ethena' workflows, Ethena is agnostic to each provider at each step of the workflow.

• Ethena diversifies the risk and mitigates the potential impact of exchange failure by utilizing multiple exchanges.

• Ethena is continually integrating with new sources of liquidity in an effort to limit the protocol's exposure to each source.

• Ethena actively monitors the ecosystem with investors, advisors, and friends across the industry, taking a proactive approach to de-risking exchange exposure if associated risks are perceived to have changed.

Worked Example: Exchange Failure

Below we have laid out a scenario when spot prices fall 20% in the event of an exchange failure, and for different levels of USDe supply, how much profit from our short position would be left on that exchange that fails. This profit would hypothetically be tied up in an exchange failure on that day and owed to Ethena, while the spot value of our collateral falls in value.

Ethena's risk controls will aim to ensure our concentration per exchange is close to the distribution of open interest across the market.

Using open interest figures as of October 2023, each exchange's market share is listed below for a total of $5.15bn of ETH open interest:

With the above market share in mind, below are the profits that would hypothetically be owed to Ethena on the day of an exchange failure, using a 20% fall in spot ETH price as our base case.

In these calculations, daily funding payment that would be due were accounted for using a -0.03% daily rate that was hit during the FTX collapse as an assumption.

The table below demonstrates the total circulating supply of USDe as well as the size of corresponding positions across exchanges.

If Ethena settles the funding rate every 8 hours with the exchanges, as is the standard funding rate settlement period, the unsettled losses owed to each exchange in that period are listed below. The final row details the % of USDe collateral that would potentially be lost in that instance.

It is worth noting that the Ethena reserve fund would be available to cover the above scenarios, growing in size as the amount of USDe in circulation grows to ensure the protocol is able to absorb an exchange failure without issue.

Exchange failures have been an all too common occurrence in crypto and Ethena takes this risk very seriously, by not only using Off-Exchange settlement to hold collateral but managing position concentration risk exposure & settling with exchanges as often as reasonable.

Funding Impact during Exchange Failure

With regards to the impact on funding rates during an exchange failure, we have a perfect case study in the collapse of FTX in November 2022, charted below. Funding rates dipped to ~30% annualized on the day of the collapse, before bouncing back to positive a few days later.

The average funding from November 1st 2022 - December 31st 2022 was still yielding 6.9% on an annualized basis despite the collapse of FTX.