TL;DR: BA Labs supports the proposal to onboard SOL as a USDe backing asset. We favor a conservative approach to SOL backing given past history of volatility in SOL derivatives and liquid staking markets.
We’d like to echo Gauntlet and Blockworks above that it will be appropriate to undertake additional research on optimal positioning and strategy for taking on SOL collateral, including further review of available derivatives contract venues and liquid staking products. We also note that Ethena Labs has significant experience with delta neutral positions which will help inform the overall SOL strategy.
Market Dislocation Risk
Our principal concern for onboarding SOL as a backing asset is potentially greater susceptibility to severe dislocations during market crashes. Based on historical data, we have seen SOL has faced much larger spot vs perp price divergence and funding rate volatility versus BTC and ETH. SOL liquid staking products have also faced significant discounts during market crashes.
The chart above shows SOLUSDT perp market dynamics for the period leading up to and immediately following the collapse of FTX. We see that there was a severe price crash of as much as ~75% over a few days, and this corresponded with extreme and protracted periods of negative funding and perp vs spot price discounts. If a delta neutral SOL perp position was held open through this period, it could have lost well over 25% of position value due to the accumulated impact of negative funding rates, which peaked at nearly -5% per 8 hour funding period. In comparison, aggregated funding rates on ETH perps fell only as low as -0.23% per 8 hours at the trough of the FTX collapse (20x lower magnitude).
This also corresponded with a significant perp vs spot price discount of as much as ~15%, and ideally traders would have been able to close out their delta neutral position and capture this spread as a profit. But, use of SOL liquid staking products as collateral may interfere with this opportunity as they were generally trading at significant discounts while this event was ongoing. Taking the example of Marinade’s mSOL, the primary LST at the time, we see that it has experienced several depegs of up to ~20% in the 2022-2024 period.
The SOL crash corresponding with the FTX collapse is arguably a worst case scenario that is unlikely to reoccur with similar severity. We have also seen that Solana has achieved increased market maturation across both cefi and defi venues over the past two years, with a greater diversity of liquidity sources and less reliance on single exchanges or sponsors. But based on the available evidence, we conclude that SOL still presents an elevated risk of severe dislocations during a market crash, which could potentially result in impairment to the Ethena reserves depending on specific positioning and responses.
SOL Liquid Staking
We have seen that SOL LSTs have experienced significant depegs and have generally shown lower liquidity and stability versus ETH counterparts. However, we also note that the Solana staking mechanism has several features that make it potentially more attractive and suitable for including LSTs as part of a delta neutral strategy.
Ethereum staking requires waiting through a variable length unstaking queue to receive liquid ETH back, and while this unstaking period is typically short increases in queue length are highly correlated with periods of market stress where Ethena may want to exit liquid staking. In contrast to this, Solana staking operates based on short, fixed length epochs of roughly 3 days, meaning that it should never take more than roughly 3 days for LST holders to fully exit their position regardless of market conditions. This means SOL LSTs have substantially less duration risk, and should have a lower propensity to trade at a discount per any given level of secondary market liquidity. Over time, we believe that SOL LSTs will achieve a lower level of duration and liquidity risk versus ETH LSTs such as stETH.
Solana also has a substantially higher base staking yield versus Ethereum. While ETH LSTs are currently delivering slightly more than 3% yield, SOL LSTs can consistently provide roughly twice as high of a yield. This implies that the opportunity cost of holding unstaked SOL for delta neutral positions is much higher than for ETH.
On balance, we find that it is appropriate to accept up to ~⅓ of Ethena’s SOL backing in the form of LSTs. While the level of duration and liquidity risk is currently higher with SOL than ETH, we believe that fundamental factors will push this risk down over time, while the benefits in terms of LST yield enhancement are significantly greater for SOL.
Market Sizing
Per data from Velo, we observe that there is a relatively higher ratio of SOL open interest to market cap (roughly 3%) vs ETH”s OI to mcap (roughly 2%). This increased leverage does not seem to correspond with relatively higher trading volume, implying that SOL derivatives have a higher global leverage level and more “days to cover” (ratio of short interest vs average daily trading volume). Given this, we believe it may be appropriate to benchmark Ethena’s exposure to SOL based on the lower of share of open interest or share of market cap, so that greater global leverage on SOL vs BTC or ETH doesn’t result in excessive exposure to SOL derivatives. We also suggest a measured ramp up period when onboarding SOL as a backing asset to minimize impact on derivatives markets.
Conclusion
As the 4th largest crypto asset, and host to arguably the second most important onchain ecosystem after Ethereum, SOL presents a clear opportunity for growing the Ethena protocol.
We support onboarding SOL as a backing asset for USDe, and proposed inclusion of SOL liquid staking tokens as a minority share of the spot assets for SOL delta neutral positions.