Stablecoin Watch: Yields Plunge as TradFi Rates Climb

Summary

• US 3M treasury yields remain higher than stablecoin yields.
• The utilisation rate (36%) on Compound is historically low for USDC.
• USDD (+10%) and Binance USD (BUSD, +5%) registered the largest gains in market cap over the past month.

Stablecoin Yields Fall

Yields on stablecoin borrowing and lending have fallen significantly this year. On prominent DeFi platforms like Compound, yields neared 4% in May for many stablecoins, and they (lending rates) are currently less than 1% in some cases. But why is that?

DEX Volumes Decline

Stablecoin yield comes from a combination of staking, lending, collecting exchange fees, and platform incentives. The decline is partly due to a broader reduction in DeFi activity this year as crypto entered a bear market. Per Dune Analytics data, the monthly Decentralised Exchange (DEX) volume decreased every month this year since June. Additionally, monthly DEX volumes have been lower than those of 2021 over the same period.

Demand for Stablecoin Yield Reducing

More significant than the broader decline in DEX volumes is the impact of rate hikes around the globe. To earn yield on DeFi platforms, users must stake their stablecoins. Borrowers then use these and pay interest. Staking funds in DeFi protocols carries risk, though. The recent crypto credit crunch sent many centralised services like Celsius into turmoil, and DeFi services are vulnerable to hacks and similar liquidation risks. With interest rates rising rapidly in response to high inflation, fiat-dollar interest accounts now provide more competitive yields, reducing the demand for stablecoin yield. US 3m T-bill yields (currently 3.56%) now eclipse USDC lending yields (0.75%) on Compound (Chart 1).

Stablecoin Utilisation Rate Is Low

We can quantify the reduced demand for stablecoin yield with the utilisation rate. It is the share of total reserves currently being borrowed for a stablecoin (the total amount borrowed divided by the total liquidity). DeFi platforms rely on the utilisation rate to determine interest rates. When utilisation is low (little borrowing), interest rates are low to encourage more borrowing. When it is high (lots of borrowing), interest rates are high to encourage loan repayment, thereby injecting more capital deposits. 

Each platform has an optimal utilisation rate for each stablecoin as it relates to liquidation risk. On Compound, the optimal utilisation rate is around 80% for USDC. And though utilisation has been increasing slightly, it is still historically low at around 36% (Chart 2). This means borrowing rates should start to increase, and they have been slowly. So not only are lending yields lower than fiat yields, but it is also becoming more costly to borrow. This dynamic reduces demand for (borrowing and lending) stablecoin yield.

Major players such as MakerDAO (the protocol behind the DAI stablecoin) have even voted to invest $500mn in US Treasuries amid plunging stablecoin lending rates to try and capitalise on the higher yields available on government bonds. A large majority of the DAI collateral comprises USDC, which is yielding (lending rate) just 0.75% on Compound and 0.64% on Aave.

Latest Developments

Market Cap and Peg Risk

The market caps of USDD (+10%) and Binance USD (BUSD, +5%) are up the most over the past 30 days (Chart 3). The increase in BUSD market cap comes after Binance automatically converted all USDC, USDP, and TUSD holdings on the platform into BUSD. Meanwhile, the market caps of TrueUSD (TUSD, -15%) and Neutrino USD (USDN, -81%) are down the most over the past 30 days.

Volatility

The one-month annualised volatility of USDN is the highest at 21% (Chart 4). It is still yet to fully reclaim its dollar peg.

Over the past three months, FRAX and MIM join USDN in the top three most volatile stablecoins. Extending to the past year, FRAX and USDD join USDN as the most volatile. Notably, FRAX is another algorithmic stablecoin. Fiat-collateralised stablecoins remain the least volatile.

Yields

Turning to yields, on Compound, average lending and borrowing rates are down for all five stablecoins we track (Charts 5 and 6). US 3M treasury yields remain higher than the yields on all five stablecoins we track on Compound.

Appendix

USDT: Tether is a fiat-collateralised stablecoin primarily issued on the ethereum and bitcoin blockchains. It aims to be pegged 1:1 against the US dollar. Tether’s reserves are not backed 100% by US dollar deposits. Instead, they are backed by reserves that include cash, cash equivalents, short-term deposits, commercial paper, corporate bonds, funds, precious metals, secured loans, and other investments including digital tokens.

USDC: USD Coin is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It is 100% backed by cash and short-dated US treasuries. USDC publishes a monthly public attestation of 100% reserves.

BUSD: Binance USD is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It is backed 100% by USD held in Paxos-owned US bank accounts and US treasury bills (including through repurchase agreements and/or money-market funds invested in US treasury bills). Paxos is a New-York-regulated financial institution and publishes a monthly public attestation of 100% reserves.

TUSD: TrueUSD is a fiat-collateralised stablecoin issued by the TrustToken platform that is issued as ERC-20 tokens on the ethereum blockchain. It aims to maintain its 1:1 peg against the US dollar by being fully collateralised by US dollars using multiple escrow accounts to reduce counterparty risk.

USDP: Pax Dollar is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It aims to be pegged 1:1 against the US dollar by holding USD reserves in Paxos owned US bank accounts.

DAI: Dai is a crypto-collateralised stablecoin that attempts to maintain a 1:1 peg against the US dollar by depositing other crypto assets into smart contracts on the ethereum blockchain every time a new DAI token is issued. DAI is maintained by a decentralised autonomous organisation (DAO) called MakerDAO. And since the mechanism is maintained by a system of smart contracts, it has higher decentralisation than the centralised entities controlling USDT, USDC, or BUSD.

MIM: Magic Internet Money is a crypto-collateralised stablecoin launched by the DeFi platform Abracadabra. MIM is backed by interest-bearing tokens (ibTKN).

UST: TerraUSD is a crypto-collateralised hybrid stablecoin native to the Terra blockchain. To mint 1 UST, $1 worth of UST’s reserve asset, LUNA, must be burned. The idea was to try and ensure LUNA’s long-term growth. More people buying into UST means more LUNA gets burned, which should make the remaining LUNA supply more valuable. However, the system collapsed recently when UST de-pegged from the US dollar.

FRAX: Frax Finance is a fractional-algorithmic stablecoin that uses both collateralisation and an algorithmic process to create its decentralised stablecoin that is pegged 1:1 to the US dollar. Only stablecoins (currently, USDC) are accepted as collateral by the protocol.

FEI: FEI is an algorithmic stablecoin that aims to be pegged 1:1 against the U.S dollar that is backed mostly by ETH.

Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.