Decentralized and Synthetic Stablecoins (DAI, USDS, USDe)
DAI, USDS, USDe, UST: overcollateralization, delta-neutral strategy or algorithm. Understand how each stablecoin holds its price and can lose it.
The essentials
Three main families of stablecoins
A stablecoin is a token designed to hold a stable value, most often $1. For stablecoins backed by conventional money, like USDC or USDT, an issuer holds reserves (cash, government securities) and promises redemption. We cover them in a dedicated guide.
This guide covers the other models:
| Model | What supports the price | Example |
|---|---|---|
| Overcollateralized CDP | Crypto locked as collateral, for more than the value issued | DAI, USDS |
| Delta-neutral synthetic | Crypto hedged by short positions on derivatives | USDe |
| Algorithmic | A mechanism for exchanging it against another token of the same project | UST (collapsed in 2022) |
None of these models is "risk-free." Each swaps the risk of a banking issuer for another type of risk: market, contract, counterparty or design risk.
The CDP model: DAI and USDS
The principle of overcollateralization
CDP stands for collateralized debt position. The principle is close to a pawn loan:
- You deposit a crypto (for example ETH) in one of the protocol's vaults.
- You borrow stablecoins against that deposit, for an amount below the value of your collateral.
- To get your collateral back, you repay the borrowed stablecoins, plus stability fees.
Stablecoins in circulation are therefore debts, each backed by more than its value in crypto. This is overcollateralization: it creates a cushion that absorbs price drops in the collateral.
What happens if the collateral falls?
Each type of collateral has a minimum collateralization ratio set by governance. If your collateral's value falls below that threshold, your vault is liquidated: the protocol seizes the collateral and auctions it off to repay the debt.
Sky's documentation (formerly Maker) describes the current mechanism known as "Liquidation 2.0":
- Auctions are Dutch auctions: the starting price is calculated from the oracle price, then it falls over time until a buyer steps in. Settlement is immediate.
- A liquidation penalty applies. The documentation's example: with a debt of 1,000 DAI and a 13% penalty, the auction aims to raise up to 1,130 DAI.
For the borrower, liquidation means losing part of their collateral. For the holder of DAI or USDS, the risk lies elsewhere: that very sudden drops prevent liquidating in time and leave uncovered debts.
From DAI to USDS
MakerDAO, DAI's historic protocol, rebranded as Sky and launched a new stablecoin, USDS. DAI hasn't disappeared: according to Sky's documentation, an official converter lets you swap DAI for USDS at a fixed 1-to-1 ratio, in both directions, with no fees.
A few technical differences to know:
- The USDS contract is upgradeable (following the UUPS proxy standard, per the documentation). This allows for changes, but also means governance can alter the token's behavior.
- There is a savings version, sUSDS, meant to pay a return on USDS deposits (the rate and its conditions are published by the protocol and may change).
Limits of the CDP model
- Dependence on oracles: liquidations rely on a price supplied by an oracle. A wrong or lagging price can cause unfair or missed liquidations.
- Collateral composition: if accepted collateral includes other stablecoins or real-world assets, the stablecoin inherits some of those assets' risks. Check the composition published by the protocol.
- Governance: parameters (ratios, penalties, accepted collateral) are voted on by governance token holders.
The synthetic model: Ethena's USDe
A delta-neutral position
According to its documentation, USDe is a "synthetic dollar," backed by crypto-assets and matching short positions on futures contracts.
The idea: if the protocol holds 1 ETH and at the same time shorts 1 ETH through a perpetual contract, the total value of the combination no longer depends on ETH's price. If ETH falls, the short position gains what the long position loses, and vice versa. This is called a delta-neutral position (delta measures price sensitivity). Our guide on the delta-neutral strategy explains the mechanics in detail.
The documentation says the reserve portfolio now combines several sources: basis trades on crypto derivatives, loans, stablecoins, tokenized real-world assets, with exposure limits set by a risk committee.
Where the yield comes from
The holder of a short position on a perpetual contract receives the funding rate when it is positive, meaning when leveraged buyers pay sellers. This funding, added to the reserve's other income, feeds the yield of sUSDe, the savings version of USDe.
Funding risk
The flip side is simple: when funding turns negative, the short position pays. Ethena's documentation devotes a page to this "funding risk" and provides a reserve fund intended to cover periods when combined income is negative. It also states that, in such periods, the reserve can be shifted into yield-bearing stablecoins.
According to the historical data Ethena presents over three years, about 8.84% of days showed negative combined income for ETH. These are past figures, published by the protocol itself: they guarantee nothing for the future, particularly in the event of a long and deep negative period.
Other risks listed by Ethena
The documentation lists, among others: liquidation risk, custody risk, exchange failure risk, reserve asset risk, risk related to held stablecoins and margin collateral risk. Since the short positions are opened on centralized platforms, the failure of one of them is a scenario to take seriously.
Who can mint and redeem
According to the documentation, direct minting and redemption of USDe are reserved for approved counterparties that have passed KYC/KYB. Individuals obtain USDe on the secondary market, for example via DEX pools. Practical consequence: under stress, your exit goes through market liquidity, not a direct redemption.
The situation in Europe
Ethena's documentation states that acquiring sUSDe is not offered to persons whose habitual residence or registered office is in the European Union or the European Economic Area. More broadly, the European MiCA regulation governs stablecoins issued by identified entities; before using a decentralized or synthetic stablecoin from France, check the access conditions published by the protocol and by the platform you use. Our guide on MiCA covers the framework in detail.
The algorithmic failure: Terra UST in 2022
UST, the stablecoin of the Terra ecosystem, relied on a different mechanism. According to the SEC, UST was presented as an "algorithmic stablecoin" meant to maintain its dollar peg by being exchangeable for another token of the same project, LUNA.
The idea: if UST is worth less than $1, you can swap it for $1 worth of newly created LUNA, which reduces the supply of UST and pushes its price back up. The problem: the backing is a token whose value depends on confidence in the system itself. In the event of a massive exodus, creating LUNA in large quantities makes its price fall, which further weakens confidence in UST. This is known as a death spiral.
The SEC also states that UST was promoted as a "yield-bearing" stablecoin, with up to 20% interest via Anchor Protocol, and that in May 2022 UST lost its peg before its price and that of the associated tokens collapsed to nearly zero. In 2023, the SEC sued Terraform Labs and its CEO for fraud.
General lesson: a high, "stable" yield on a stablecoin should always prompt the question "who pays this yield, and what happens if it stops?"
A concrete example: comparing two on-chain dollars
Imagine you hold 1,000 USDS and 1,000 USDe in your wallet.
- Your 1,000 USDS are backed by overcollateralized vaults and other assets managed by Sky's governance. The main risk: a sharp fall in collateral, an oracle problem, a contract flaw or a governance decision. You can convert them to DAI at 1 to 1 via the official converter.
- Your 1,000 USDe are backed by a reserve hedged on derivatives markets. The main risk: a long period of negative funding, the failure of an exchange or a custodian, or a lack of liquidity on DEXs if many holders sell at once. As an individual, you can't redeem them directly.
In both cases, if you deposit these stablecoins in a lending protocol or a pool, you add that protocol's risk.
Checklist before using a decentralized or synthetic stablecoin
- I know what supports the price: crypto collateral, derivatives positions, real assets, or another token of the same project.
- I know how I can exit: direct redemption, official converter or only the secondary market.
- I know the source of the advertised yield and what happens if it drops to zero or turns negative.
- I know whether the contract is upgradeable and who controls the upgrades.
- I have checked the official contract address in the protocol's documentation, so as not to buy a copy.
- I have checked the access restrictions for EU residents.
- I haven't concentrated all my cash holdings in a single stablecoin.
Mistakes to avoid
- Believing a stablecoin is necessarily worth $1. Any of them can depeg, temporarily or permanently.
- Confusing stability with absence of risk. A stable day-to-day price says nothing about resilience in the extreme scenario.
- Chasing the highest yield. A "stable" 20% yield was precisely UST's pitch.
- Stacking layers: a synthetic stablecoin deposited in a lending protocol, then borrowed against with leverage. Each layer adds a breaking point.
- Ignoring exit liquidity. Without direct redemption, you depend on pool depth at the moment you want to sell.
This guide is general information and does not constitute investment, legal or tax advice.
Key takeaways
- DAI and USDS are stablecoins issued against crypto collateral worth more than their value, with liquidations through Dutch auctions.
- DAI and USDS convert 1 to 1 via Sky's official converter; the USDS contract can be upgraded by governance.
- USDe is a synthetic dollar hedged by short derivatives positions; its yield depends in part on funding, which can turn negative.
- Individuals have no access to direct USDe redemption, and sUSDe isn't offered to EU residents according to Ethena.
- UST's collapse in May 2022 shows the limits of a stablecoin backed by a token from the same project.
- Before using a stablecoin, identify what supports it, how to exit it and who pays its yield.