Just a few months ago, it was possible to earn over 10% interest rate by lending cryptocurrencies such as Dai and USDC on Decentralized Finance. However, this is no longer the case, and DeFi interest rates are barely above what you could earn on an FDIC insured high yield savings account. Changing circumstances demand a different strategy, and in this article, I want to highlight some of the reasons why I have decided to switch a portion of my funds from DeFi to the centralized lending platform Nexo.
Revisiting Risk and Reward
As any investor will tell you, the two most important considerations are risk and reward. My journey into DeFi began a few months ago when I received some Dai stablecoin for writing a few articles on Publish0x and deposited these coins into the Compound protocol. At the time that I first started lending the Dai stablecoin, interest rates were just above 10%. To put this in perspective, the US stock market averages about 10% returns per year. This high rate of return made lending the Dai stablecoin a no-brainer. I could easily earn greater returns than the stock market with considerably less risk.
However, I slowly noticed that the interest rate on Dai, and other stablecoins, was decreasing. Every week or so, I would log back into Compound and see that the interest rate on my stablecoins had slipped by another half percent or so. I tried to earn a slightly higher interest rate by moving funds between the leading DeFi platforms to get an extra percentage point of interest. This was a short term fix, and each time I logged in, I kept seeing that I was earning a lower interest rate every day. As of 03 December 2019, the interest rate for Dai is barely above 2.5%.
Keep in mind that the risk for lending the stable coins was the same whether the interest rate was 10%, 5%, or 2.5%, but the reward for lending has decreased significantly. A constant risk with a decreasing reward means that DeFi lending in December is a comparatively worse investment than it was in October. In and of itself, a 2.5% interest rate isn't bad, but we have to remember that if I invest $100 on Compound, this is $100 that I can't invest in stocks, bonds, or any other investment - economists call this "opportunity cost."
Opportunity cost is the thing that we give up to pursue a given option. That can be a bit confusing, so let's use a simple example. If an investor has $100 to invest, they could buy some stocks or some crypto. If an investor buys crypto instead of the stocks, then we call the stocks the “opportunity cost.” Because the investor decided to purchase the cryptocurrency, they lost the opportunity to purchase the stocks.
I want to put this risk/reward balance in perspective. I can open a fiat savings account at a variety of different banks in the US that earn around 2% per year. The reward for opening these accounts is about the same as what I would earn by lending on Compound, but the risk is considerably lower. In the United States, savings are covered by the Federal Deposit Insurance Corporation (FDIC) which means that even if the bank goes bankrupt, the government is obligated to pay back the money that I had in the bank. I do believe that DeFi lending is secure, but saving money in an FDIC protected bank is widely considered to be the most secure way of earning interest, so DeFi should have somewhat higher interest rates to compensate investors for this risk. When Dai could earn 10% on DeFi, I was more than willing to accept this slightly higher risk, but if the interest rate is about the same, it only makes sense to choose the less risky investment.
However, simply investing money into a savings account presents its own problems. The average inflation rate in the US is between 2-3% per year which means that the same $100 will only buy $97-$98 worth of products at the end of the year. If the inflation rate is 3%, and I earn 2% in a savings account, I am still loosing 1% of my purchasing power every year. The bare minimum acceptable rate of return on any investment should allow an investor to stay ahead of inflation. Because the interest rates on DeFi have fallen so close to the inflation rate, I simply had to find another investment option.
At this point, I faced a dilemma. I believe in crypto and wanted to earn by lending crypto, but I also could not watch as my savings received a substandard rate of return that would be eaten away by inflation. I did not want to take my funds out of crypto, but I also was not satisfied with such a low interest rate. Thankfully, centralized lending platforms, such as Nexo have provided a solution. By offering an 8% interest rate on stablecoins, platforms like Nexo allow crypto investors to earn a reasonable rate of return without having to abandon crypto and invest in the stock market or traditional financial investments. In addition, Nexo mitigates risk by offering $100 Million worth of insurance for investors. They are also audited by Deloitte, one of the most prestigious accounting firms in the world, and investor's funds are held offline in multi signature, cold storage wallets.
As I stated in a previous article, I still feel that DeFi is more in line with the true spirit of cryptos than CeFi. At the same time, I realize that sometimes we can't have everything that we want and sometimes have to make compromises. As an investor, I value high returns and low risk, and I simply can't afford to place funds in an investment that barely outpaces inflation. CeFi platforms, like Nexo, certainly aren't perfect, but they offer a good compromise. Lending on Nexo has given me the ability to continue holding and lending crypto while also giving me the ability to earn a decent rate of return. Although they differ in their exact implementation, CeFi and DeFi both allow people to borrow, lend, and earn from crypto. DeFi and CeFi each have their own set of advantages, but at the end of the day, they are two players on the same team that are helping drive crypto adoption in their own ways.
I want to be clear that this article is written strictly from my personal view as an investor who is focused on maximizing returns while minimizing risk. Every individual must make their own investment decisions, and the intent of this article is to simply give you some points to consider.
FDIC Insurance: https://www.thebalance.com/what-is-the-fdic-315786
Nexo Insurance: https://nexo.io/why-nexo
Nexo Multisig Wallets: https://support.nexo.io/hc/en-us/articles/360008115334-What-is-Nexo-
Image Credit: https://unsplash.com/@johngibbons