I've heard the term “synthetic dollar” a lot over the years that I recently decided to look it up in a bid to find projects that were building on whatever the idea behind it was, just so I can become informed on the concept and understand the general appeal.
Turns out, it's just a case of a “collateral-based” backing mechanism(as expected) for stablecoins, nothing too fancy — at least, generally.
But, the first project that I happened to come across had something rather intriguing. I'd like to point out that I've never had any exposure to so-called synthetic dollars(those explicitly termed that) and I have zero understanding of past strategies nor risks associated, so this is the first I'm reading about and it's likely that the strategy applied here is far different from past alternatives.
The merit and risk focus will be entirely on what is explored here.
What is a synthetic dollar?
A synthetic dollar is any token created on the blockchain to trail the value of the United States Dollar, thereby maintaining price parity with the USD and acting as a flexible and stable alternative to central bank issued Dollars.
They're called "synthetic dollars" because they mimic the value of a U.S. dollar without being an actual dollar issued by the U.S. government or held in a traditional bank. The term "synthetic" comes from traditional finance, where it refers to financial instruments that replicate the value or behavior of another asset using derivatives or collateralized mechanisms.
By this definition, technically most supposedly decentralized stablecoins that you know are synthetic because of the presence of collateralizations but not all identify as one.
I'd argue that only algorithmic stablecoins can pass as not being synthetic because that's purely based on native mint and burns but if there's an introduction of reserve assets as a hedging mechanism for potential peg failures, then it effectively becomes synthetic because it is partly collateralized to maintain stability.
An observation really.
Delta-hedging: does that actually work?
Before proceeding, I'll like to clarify that I have zero exposure to Ethena and I sincerely doubt I ever will, so this is not an attempt at promoting the project.
That said, this is purely about exploring the concept of delta-hedging to maintain a stablecoin’s peg and also introduce a yield source to make stablecoin savers income “revenue-based.”
Anyone who has read a couple of my articles overtime would have come across various instances I've talked about revenue as being vital and something crypto projects should turn their attention to. So far, most projects lack any meaningful revenue and effectively run on unsustainable models that's doomed to lead to catastrophic events that the only solution will be for the believers to absorb the losses.
Delta-hedging hedging is actually a concept I've talked about in the past, although at the time, I wasn't aware of these words as a pair representing the idea I was explaining.
This was on January 2, 2025, when I talked about earning yields on Bitcoin, in a nonconventional way.
The focus was yields, through funding rates(fees) which is a mechanism exchanges employ to ensure price parity between an asset’s perpetual futures contract and the spot market of the underlying asset.
Data shows that historically, funding rates trends positively, annually. Meaning that having an active short position would earn you some % yield yearly, as long as the funding rate is positive, otherwise, your position would pay the fees to active longs.
What Ethena does to maintain its synthetic dollar “eUSD” peg is that it holds short positions of the underlying asset collateralized to mint the stablecoin to offset potential price fluctuations in the collateralized assets.
The yield it earns from funding rates(fees) plus staking collateralized assets makes the stablecoin yields earned for locking it sustainable.
But first,
What really is Delta-hedging?
Delta-hedging is a risk management strategy used in options trading to reduce or eliminate the directional risk (price movements) of an underlying asset. It involves adjusting the position in the underlying asset to offset changes in the option’s delta.
Delta (Δ) measures how much the price of an option is expected to change for a $1 move in the underlying asset. It ranges from 0 to 1 for calls and -1 to 0 for puts.
A delta-neutral position means that the overall portfolio's value doesn't change due to small price movements in the underlying asset.
This is the traditional definition as provided by ChatGPT, so to apply this to perpetual futures contracts, which are native to crypto, a delta-hedging strategy, more specifically achieving “delta neutrality” involves maintaining short positions on an underlying spot asset to ensure that price movements in either direction does not change the value of the overall portfolio.
If the value of the collateralized assets doesn't really change because of delta-hedging, then the stablecoin’s peg is expected to be held firm as user deposits remain sufficient for the stablecoin supply circulating.
Of course, this is not without its flaws.
The first weakness is funding rates, which can be negative, temporarily and at extreme, over an extended period of time, but historically, this hasn't happened yet — but it's not totally out of the equation.
A negative funding rate would hurt the value of the synthetic dollar because its collateral would have suffered losses.
Additionally, we also have to consider that for Ethena to hold short positions, it has to be exposed to some “favors,” essentially loans and there seems to not be public details on that.
I am drawing this conclusion because the project doesn't sell the collateral to open a short position, it rather stakes the ETH to earn chain-level yields. Given this, we cannot fully factor the extensivity of the risk because it is using money it does not really have to hedge its collateralized assets.
That said, I've also found that Ethena’s synthetic dollar eUSD can only be minted by authorized persons or institutions that have been KYCd and boy do I find that stupid and against everything a supposed decentralized stablecoin should be.
But this article wasn't about shilling Ethena but exploring the concept.
I figure that unless we can figure out a way to 100% fund the hedging using user deposits, we are often going to be exposed to centralized flaws. Being that I've previously explored the concept of hedging Perps with Spots and vice versa, I'd say I 100% love the idea of exploring its application to maintaining a peg for a decentralized stablecoin.
In scenarios where a protocol has more revenue sources that outweigh the risk of prolonged negative funding rates, potential liquidation costs, etc, the strategy explored would truly be something.