The market cap of Ethena’s USDe token fell below $2.7 billion from $3.6 billion as demand faltered.

The protocol generates yield for investors by shorting bitcoin and ether derivatives in a “carry trade,” but funding rates have turned negative over the past weeks.

Even so, the token’s price held stable around $1 during the unwinding, defying early concerns of a downard spiral.

Crypto yield protocol Ethena, which skyrocketed earlier this year to over $3.6 billion in deposits, faced its biggest test as crypto markets cooled off and investors pulled the funds that backed its USDe synthetic dollar token. Even so, USDe held steady to its $1 peg.

The protocol has endured nearly $1 billion in outflows since July, DefiLlama data shows. That’s a 27% decrease in the token’s supply. The protocol’s governance token, ethena (ENA), has tumbled 85% from its April high.

The decline coincided with funding rates for crypto perpetual futures, a key source of yield for USDe, falling to near-zero in the past few weeks. They hit an annual 40%-70% in March.

“Lower funding rates makes it less attractive to hold and stake USDe,” Julio Moreno, an analyst at CryptoQuant, said in an interview with CoinDesk.

USDe uses bitcoin (BTC) and ether (ETH) as backing assets, pairing them with an equal-value short perpetual futures position on exchanges. Perpetual funding rates are usually positive, which means Ethena’s USDe generates revenue on its backing derivative assets.

“One of the most important risks USDe faces is an environment of sustained negative funding rates in the perpetual futures market,” Moreno said. “In this scenario, Ethena would need to pay funding in order to keep its short positions open.”

The yield offered to USDe tumbled to 4.4% from its March peak of over 50%, according to DefiLlama. That’s lower than less risky investments such as a vanilla money-market fund or other Treasury-backed digital token offerings.

Price stability

Skeptics raised concerns about Ethena’s model, likening it to the imploded stablecoin project Terra-Luna. Terra’s algorithmic stablecoin fell into a spiral in May 2022 after its subsidized growth ran out of fuel, kickstarting a brutal crypto winter.

Read more: Ethena Labs Divides Opinion as High Yield Stirs Memories of Terra

The current, unfavorable market environment and flurry of withdrawals offered a chance to prove the protocol’s stability.

“We are pleased with how Ethena has responded to multiple deep market corrections in the last few months,” said Guy Young, co-founder and CEO of the protocol’s development firm, Ethena Labs. “Stress tests were always going to surface, and growing at the pace we were indefinitely is clearly not possible.”

The price of USDe remained stable at its $1 peg during the outflows, and the subsequent unwinding of trading positions to meet demand for withdrawals happened “all orderly with zero issues experienced on the US dollar peg,” Young added.

Ethena keeps a “rainy day” fund, known as the reserve fund, to pay for funding rates if needed.

To minimize protocol risks, the reserve should stand at least at 1% of USDe supply, CryptoQuant’s Moreno said.

“This is the case at the moment, as the reserve fund stands at $45 million, which is around 1.6% of the current USDe market capitalization,” Moreno said. “Investors need to watch this key metric to assess Ethena’s risk.”