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USD vs USDT: Stablecoins in DeFi

Find out why the interest rate is so different for the fiat and stablecoin market.

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Crypto Earn platforms have stablecoin interest rates that seem too good to be true, especially when compared to the interest earned on U.S. dollar (USD) deposits and treasury rates. These can be as low as 0.06% with a high of 2.47%. Meanwhile, advertised USDT APY on Earn platforms can range from 3% to 6%. In March 2022, the USDT Lending Rate on Aave, a leading DeFi platform, was 14.06%, with a high of 17.36%.

Interest Rate Range on USD vs USDT

So why is the interest rate so different for the fiat market and the stablecoin market?

USD Interest Rates

According to a New York Times article, “real” interest rates (what you earn on your money after inflation) are potentially negative, where your purchasing power is lower than it was when you deposited your money.

Real Interest Rates Decreasing

This is exacerbated by the accumulation of extra savings during the pandemic, as seen in the spike in the amount of U.S. dollars from 2020. 

Increase in dollars in circulation
Board of Governors of the Federal Reserve System (US), M1 [M1SL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M1SL, May 12, 2022.

That said, there are expectations that the Federal Reserve will be raising its interest rate by a full percentage point this year, which should have a positive impact on interest earned from deposit accounts. 

Ultimately though, these interest rate changes for the USD is more oriented around the domestic market, while developments around USD-pegged stablecoins impact the cryptocurrency market as a whole. 

Centralised and Decentralised Stablecoins

Before we look at the demand for stablecoins like the USDT, let’s start with looking at how stablecoins work. 

Many of these stablecoins are pegged to the USD, where their value is constantly maintained at around US $1 (with some minor price fluctuations), minimising their holders’ exposure to the volatility of the crypto market. 

The dollar-peg can be maintained through asset-backing, usually in the form of fiat, as in the case of USDT and USDC, where all coins in circulation is backed by an equal amount of cash and cash equivalents held by the issuing organisation. 

It can also be done through crypto-backing and algorithms, where these stablecoins, such as DAI, are backed by other cryptocurrencies and smart contracts. These are usually decentralised, where anyone can mint new units of the currency as long as smart contract conditions are met (in DAI’s case, putting up collateral worth 150% of the generated DAI), unlike the centralised authority of fiat-backed stablecoins.

Why the Demand for Stablecoins in DeFi?

One of the reasons for the high interest rate offered on USDT and other stablecoins is that they offer additional use cases for the U.S. dollar beyond the domestic market. While the value is tied to a fiat currency, like the USD, anyone anywhere in the world is free to use USDT or USDC for investments, trading, or lending, with the reassurance that they will be able to redeem their stablecoins for the value of US $1. 

In an exchange, stablecoins provide investors with a haven when cryptocurency price volatility is surging: they can cash out of their volatile cryptocurrencies, and park their investment profits in these dollar-pegged cryptocurrencies while they wait for the next trading opportunity.

On the lending front in DeFi, there is demand for stablecoins as collateral. After all, when compared to traditional cryptocurrencies and their price swings, using a stablecoin ensures that the value of the underlying asset remains stable. 

In our conversation with Celia Zeng, our asset manager who covers the investments of Cabital, we discussed the interest rates on stablecoins and the opportunities for investors:

“Interest rates on stablecoins lets you invest in worldwide opportunities that are usually open to hedge funds. This finally gives the retail investor a chance of a lifetime - to invest in projects that were once only open for hedge funds and high net worth individuals.” 

Risks of Investing in Stablecoins

There are risks associated with stablecoins, where a stablecoin depegs from the pegged currency, which results in a “run”, where a large number of holders try to redeem their coins, leaving some users unable to redeem the value of their coin. 

This happened recently with TerraUSD (UST), which fell to a low of around US $0.178 in May 2022. UST’s price stabilising mechanism is at risk because it centres on enabling users to trade US $1 of UST for US $1 of LUNA, and at time of writing, LUNA is valued at US $0.00005557 to UST’s US $0.178

However, a “run” is unlikely in the case of asset-backed stablecoins like USDT and USDC, because they have audit records of their reserves that prove they have an equal amount of USD held in cash and cash equivalents to ensure that their users can redeem 1 USDT for US $1 irrespective of market conditions.

Invest in Stablecoins with Cabital

At Cabital, our savings plans are focused around established cryptocurrencies with high market capitalisation like BTC, ETH and USDT. You can buy these cryptocurrencies with GBP, CHF, and euros through bank transfer with Cabital, saving you from hefty credit card fees. 

This article has been prepared by Cabital Fintech (LT) UAB  (the “Company”) and is general background information about some of the Company’s activities at the date of this presentation.

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