Who Would Invest in DeFi When T-Bill Yields Are Higher?

It’s hard to come up with an investment riskier than crypto lending, which offered ridiculous returns of up to and even over 20% APY to anyone who’d put up the crypto collateral that funded various decentralized finance (DeFi) schemes.

It’s even harder to come up with a safer investment than three-month treasury bills, which are highly liquid and backed by the full faith and credit of the United States.

But at least those high risks came with potentially high rewards at a time when traditional investments ranging from T-bills to savings accounts were offering tiny fractions of 1%. However, three-month U.S. Treasury bills now offer substantially better rates than crypto lending, with CNBC and MarketWatch quoting a bit over 3.2% on Sept. 13.

And crypto lending? Well, BlockFi, a centralized lender saved from bankruptcy by a timely loan from FTX CEO Sam Bankman-Fried, is now offering 0.1% to 3% APY on many tokens (although some dollar-backed stablecoins still fetch 6% to 7% APY).

See also: Crypto Basics Series: How Does Centralized Crypto Lending Work?

Top DeFi lending platform Aave is offering under 2% on dozens of tokens. Another top DeFi lender, Compound, is only offering more than 1% APY on a single token — Tether’s USDT stablecoin — which is 1.44% APY, according to DeFi Rate.

Read more: Crypto Basics Series: How Does Decentralized Crypto Lending Work?

That raises a fairly simple question: Why on earth would you invest in extremely risky lending programs when the safest of investments is paying more? The answer, particularly from the hedge funds and institutional investors who have been playing footsie with DeFi for a while, is that you wouldn’t.

“Two years ago, interest rates in crypto were at least 10% and in the real world rates were either negative or near-zero,” said Jaime Baeza, CEO of digital asset-focused hedge fund ANB Investments. “Now it’s almost the reverse, because yields in crypto have collapsed and central banks are raising rates.”

That has, according to crypto lender Maple Finance CEO Sidney Powell, led to a “higher appetite for Treasuries that has sucked out liquidity from crypto.”

Risky Business

Briefly, crypto lending/borrowing schemes work like this: At the core, a crypto owner deposits, or locks, stablecoins and other cryptocurrencies into lending DApps in exchange for interest, generally termed yield. Borrowers put up crypto collateral worth 125% to 150% of the amount they wish to borrow.

If the volatility of crypto prices knocks that down close to the value of the loan, a margin call is made, and if missed — and it can happen very fast, while borrowers are sleeping — the collateral is liquidated to cover the loan and interest owed.

That latter part can be staggering. One of the outliers offering far more than T-bills at the moment on Aave is wrapped ether, bringing in 15% APY. However, it is being loaned out for 45% APY.

That’s the way it works on DeFi lending/borrowing platforms, and the way it was thought to work on centralized versions like Celsius and Voyager Digital — now both in bankruptcy.

After the $48 billion collapse of the Terra/LUNA algorithmic stablecoin ecosystem brought down a high-profile crypto hedge fund called Three Arrows Capital, it turned out many crypto lenders had given it hundreds of millions of dollars’ worth of loans without collateral — driving more than a half dozen big firms into bankruptcy.

Learn more: Reckless Crypto Lending, Opaque Operations Paved Voyager Digital’s Path to Bankruptcy

That has left hundreds of thousands of punters who came in search of rates ranging from 2% to 20% or more in limbo, looking at big losses as the firms they invested in go through Chapter 11.

Unstable

There are a few cryptocurrencies — most notably stablecoins — that are still drawing high rates of return in the 6% range from some centralized lenders (although DeFi platforms based on algorithms, rather than optimism, are offering well under 2.5% in many cases).

A reason is that stablecoins are “the lifeblood of the DeFi” ecosystem, in the words of Sen. Elizabeth Warren — who is decidedly not a fan — as they are the currency of crypto lending and borrowing transactions, and of many DeFi investments.

See also: Sen. Warren Calls DeFi the ‘Most Dangerous’ Part of Crypto at Senate Hearing

That’s the other part of crypto lending and borrowing’s high-risk profile. The vast majority of those loans are cycled right back into other, even riskier DeFi projects like yield farming and liquidity mining. It is in many ways a closed ecosystem, although the stablecoins borrowers receive can in theory be used for anything.

Related: DeFi Series: What is Yield Farming and Liquidity Mining?

It’s probably worth pointing out the irony of this situation: Stablecoins have two major purposes at this point — lubricating the trading of crypto and DeFi investments — although they are growing more popular as a payments currency.

However, they are increasingly backed by short-term treasuries as the “highly liquid investments” of choice that the top stablecoins embraced after it was discovered that their “one-to-one dollar reserves” actually had a lot of corporate paper of questionable liquidity.

Additionally, much of the stablecoin legislation written in the European Union and proposed in the U.S. has mandated that backing reserves be either currency or treasuries.

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