DeFi Debacle - Overcoming Low Interest Rates

DeFi Debacle - Overcoming Low Interest Rates

Wow! What a month it has been. We have a worldwide pandemic, falling oil prices, and near zero percent interest rates on DeFi. On Fulcrum, the interest rate for USDC is barely half a percent, and Tether is less than point 06%. Compound isn't much better, as the interest rate for USDC is hovering at less than .5%. What in the world is going on? Why are interest rates so low, and is DeFi still a viable investment strategy. 




A Little Background

Before we start, I think its important to ask why the interest rates on DeFi are so low. I can remember about a year ago when I started lending on DeFi and the interest rates were between 7-11% depending on the specific crypto that I wanted to lend, so what happened? Well, there are a variety of reasons that the interest rate on stable coins could have fallen, but I believe that the biggest reason was that the majority of the world's central banks have instituted zero or no-interest rate policies. 


I don't want to turn this post into an Economics lesson, but it is important to understand how central banks work and how they influence crypto. In the US, the Federal Reserve has what is known as a "Dual Mandate" of promoting both price stability and full employment. It tries to accomplish both objectives by raising or lowering the interest rate. Now, when we say raising or lowering the interest rate, we have to keep in mind that there is no singular interest rate. The Federal Reserve does not mandate an interest rate for credit cards, home loans, car loans, or DeFi lending. Rather, the Federal Reserve tries to manipulate the Federal Funds Rate. Manipulating this rate is supposed to cause other interest rates in the economy to follow suit. I do believe that the Fed's decision to lower interest rates was a key contributing factor in the lower DeFi rates, but let's not spend too much time on the past. 

FDIC High Yield Savings Account

Sometimes we have to play with the hand that we are dealt. Whatever the cause, the simple fact of the matter is that DeFi rates are considerably lower than they were several months ago. We can't change that fact, but we can change what we do with that information. I'm certainly not telling anyone what to do, but I would like to present three possible options for your consideration. The first option would be to redeem stablecoins for the underlying USD and put that USD into a high yield savings account. Currently, Ally offers a 1.5% interest rate, which is more than 3X the interest that Compound is offering on USDC. DeFi can and has been hacked before, and placing money in a traditionally insured FDIC bank gives extra security. 


However, placing money into a traditional bank may not be the best option, especially for us crypto fanatics who support decentralization and independence. We are in uncertain times, and governments have a bad habit of locking down banks and limiting withdraws to prevent bank runs. With crypto and DeFi, we might get a slightly lower interest rate, but we always have access to our funds without the permission of some centralized authority. Do you really want to put your money into a bank during these uncertain times? What if you can't get it out? These are questions that each of us must ask ourselves. 

Convert to Non-Stablecoins "Real Crypto"

The greatest benefit of stablecoins is that they are tied to the value of the US Dollar. This makes them ideally suited to day to day transactions, but it is also their greatest weakness. Because stablecoins are tied to the value of the USD, they will lose value as the government inflates the USD to pay for the stimulus packages and bailouts needed to fight the economic impacts of the virus. According to its own admission, the Federal Reserve aims for 2% inflation per year. This means that under ideal circumstances, your USD (or USD backed stablecoins) would lose about 2% of their purchasing power per year. When DeFi interest rates were between 7-11% this wasn't much of a big deal. Given an interest rate of 7% and an inflation rate of 2% you would still have 5% more purchasing power after one year of lending stablecoins.  Now that the interest rate is lower than the inflation rate, you are virtually guaranteed to lose money by lending stable coins.

In contrast to stablecoins, traditional cryptos such as Bitcoin, BAT, and ETH are not pegged to the value of the USD. Rather, their value is determined by supply and demand. For example, BTC has a fixed cap of 21 million. Regardless of what the Federal Reserve does or how bad the economy gets, there will only be 21 million BTC; this creates scarcity and could help BTC (and other cryptos) rise in value. 

One way that I like to describe the differences between traditional cryptocurrencies and stablecoins is to use the example of bonds vs stocks. Stablecoins are kind of like bonds. They traditionally have a higher interest rate, but the price of the actual stablecoin will remain more or less at $1. When I lend stablecoins, I'm not hoping that the value of my USDC or DAI goes from $1 to $5 so that I can sell the stablecoin and make a profit. Rather, I am content to hold a stable asset that delivers a consistent stream of interest from lending. By contrast, I like to think of traditional cryptocurrencies such as Bitcoin and BAT as stocks. Because traditional cryptos are not pegged to the value of the dollar, they have the possibility of appreciating in price. The interest rate on BTC isn't that high, but when I buy BTC at $6,000 I am hoping that I can sell it for $7,000 or more at some point. I believe that the real purchasing power value of stablecoins will fall as a result of the Fed's money printing and that the DeFi interest rate won't be able to outpace the inflation of the USD. If this proves to be the case, it might make more sense to swap stablecoins for other cryptos such as BTC that could resist the devaluation of the USD. 

Stay the Course

I will admit it. I am a huge fan of stablecoins. I think that their ease of use and simple concept makes them ideal candidates for helping the masses adopt crypto as a day to day means of payment. I like the fact that stablecoins combine the privacy and permissionless aspects of cryptos with the relatively stable purchasing power of fiat. Given all of these advantages, its hard for me to sell my stable coins and put that money into an FDIC bank. Its also hard for me to swap my USDC for an asset like BTC that has such extreme volatility. The point that I'm trying to make is that even though stablecoin lending rates are pretty low right now, there are still advantages to holding stable coins.



So, what should you do? Should you swap all your USDC for Bitcoin and ride the BTC wave to the moon? Or, should you keep holding your stable coins for a few more months and then purchase BTC when the price is even lower than it is today? Should you just give up on this whole crypto business and throw your money into an FDIC High Yield Savings account where you can get higher interest rates and security for your deposits? The simple fact of the matter is that I can't tell you what's best. I have no idea if BTC is going up or down over the next week, month, or year. I have no idea whether the government will shut down banks or limit deposits. For all I know, this virus could be the plague that ends humanity or a miracle cure could be developed tomorrow. 

My goal isn't to tell anybody what to do. Rather, I wanted to point out a few possible options and the strengths and weaknesses of each choice. Everyone has their own risk tolerance and their own theories about what will happen with the economy. These theories and risk tolerances will mean that each of us invests in a slightly different way. At the end of the day, the right choice is the choice that YOU make for yourself based on YOUR own situation. Good luck!


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The Part Time Economist
The Part Time Economist

Hi everyone. I'm just a simple man trying to make my way in the universe. I am passionate about cryptocurrency and hope that I can make at least some small contribution towards promoting wider crypto adoption and understanding.

The Part Time Economist
The Part Time Economist

Hi everyone. This is just a place for me to post some of my thoughts and analysis. I hope that someone finds them useful.

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