Tuesday, November 16, 2021

The dangers of stablecoin lending


These days I see many do-it-yourself investors comparing the huge yields they can earn on stablecoin lending to the tiny yields on bank accounts. Cryptocurrency influencers like to draw attention to this big gap, portraying crypto as the heroic replacement to stodgy regular finance, or "TradFi". The Celsius Network, one of the leading providers of high-yield stablecoin products, uses the slogan "Unbank yourself." The implication is that anyone who holds their money in a bank account is a chump.

Beware, DIY investors. These marketing pitches are wrong, indeed dangerous. 

In finance, a juicy yield is almost always associated with big risk. Shifting finance to blockchains doesn't change this truth. High-yielding stablecoin strategies are not a better sort of bank account. Rather, they're a potentially hazardous investment more akin with penny stocks and CCC-rated junk bonds.

Let me explain with a recent example:

The premise of this tweet and the attached chart is that you can make far more on your stable crypto dollars than on old fashioned dollars stuck in a bank account.

The problem with this comparison is that it's not contrasting equal things. It's comparing apples to oranges.

The true counterpart to a 0.06% yield on a bank account isn't the interest rate one can earn by on-lending stablecoins via protocols like Celsius or Compound. No, the proper analog is the interest rate one earns by simply holding a stablecoin such as Tether or USDC. And because stablecoin issuers don't pay interest to people who own stablecons, this rate is effectively 0%. Which is *ahem* below the 0.06% rate on a U.S. savings account.

Hardly a selling point. Unfortunately, the above chart forgets to mention the 0% rate on stablecoins.

Let me flesh this out further. When you own a stablecoin or keep money in a saving account, you are basically lending to the issuer of those dollars. If you hold 1,000 USDt (Tether stablecoins), for instance, you're a creditor to Tether Inc. That is, Tether Inc owes you $1,000. Likewise, if you keep $1,000 in a Bank of America savings account, you're lending $1,000 to Bank of America.

Think about this or a moment.

Lending involves risk. The borrowing party may not be able to keep its promise to you. Bank of America is a pretty safe entity to lend to. It'll probably keep its promise to you. But the firms that issue Tether and USDC are not safe borrowers. They are small. Not much is known about them. In Tether's case, it is entirely unregulated. And Circle, the issuer of USDC, is only lightly regulated. If you are acting as a lender to Tether or Circle, you should be getting *much* more than the 0% rate that they're offering you.

On top of that, your loan to Bank of America is protected by government insurance. Nothing protects your loan to Tether or Circle. Even worse, as a creditor to Tether and Circle, it's not apparent where you rank in terms of seniority. This ranking is important because in the case of a failure, senior creditors get paid first, junior creditors last. At least with a Bank of America account you're at the front of the line.

Far more prudent to lend to a government-insured bank and collect 0.06% than lend to a black box stablecoin and get 0%.

Of course, stablecoins aren't just held. It's what you can do with stablecoins that excites people. Which gets us to the massive crypto lending rates that are illustrated in the chart. Aave and Compound are decentralized lending protocols. If you on-lend your stablecoins via these two protocols, you can earn 2.69% to 3.14%.

Celsius, Nexo, and Blockfi are centralized marketplaces where rates for onlending stablecoins reach as high as 8.88%.

The thing is, you *should* be getting a high rate for onlending your stablecoins on these venues. You're taking a big risk by using them. These platforms could go broke, get hacked, or break. In the case of centralized platforms, there is very little information about how they are using your funds. Furthermore, you don't know where you stand in seniority among other Celsius, Nexo, or BlockFi creditors. These are black boxes, folks.

And remember, even though you've lent away your Tether or USDC on Celsius or Aave, you're still fully exposed to all the original credit risk of Tether or Circle. 

For instance, say you lend 1,000 USDt on Celsius's platform and Tether, the issuer of USDt, collapses. The price of USDt stablecoins falls from its $1 peg to $0.10. Celsius comes through, though. It keeps its promise to you and repays the 1000 USDt it owe you. Alas, now that amount is only worth $100.

So for DIY investors considering stablecoin lending strategies, any loan to Celsius or Aave involves a combination of two risks: the possibility that Tether or Circle (the issuer of USDC) go under and the chance that Celsius or Aave break. Add the two together and you're getting involved in a pretty dangerous strategy, one for which you should be well-compensated.

Rather than clapping your self on the back for getting 8% from stablecoins instead of 0.06% in a savings account, you should be asking yourself whether 8% is enough.


  1. Interesting article, thank you for the counter points to stablecoin lending, I've been trying to find some and with all the excitement, it's been difficult. However, I don't think all angles have been fleshed out here. Stablecoin lending is not as safe as holding money in a savings account, yes, but I think there is a good argument for it being safer than your typical 10% yielding investments and will still outperform most common "safer" investments (Ie. the common 60/40 split mutual fund presented by most banks). If you do your homework, and continue tracking the credibility of the stablecoin in use as well as the lending platform, it seems very worthwhile despite your counterpoints.

    1. That's fine. The main point of my article is to disabuse anyone of the idea that these are bank account-equivalents.

  2. The author of this article totally overestimates the risks. First, there are regulated and fully backed stable coins such as Pax. Having that said, the author totally ignores that banks are not backed like e.g. Paxos is. Banks, just like Tether or other companies usually backed the $ value in different ways, some of which are much riskier than others. Pax is fully $ backed, thus in that regard safer than your bank. In that sense some stable coins are safer than bank. Please have a look at the Ukraine right now. People cannot access their money from the author's beloved banks. This happened many times in history in many countries. In conclusion, if you pick the right stable coin, the risk is equivalent to putting your money on a bank, especially if you live in a country where there is less security than e.g. if you can have money in the bank of America.

    Next, Celsius is MUCH more transparent to the average customer on how they generate money with your money compared to any bank. And if you dive a bit deeper here, your will realize that banks are allowed to things that Celsius is not allowed to do such as high leverage trading. And yes, banks do all kinds of risky stuff with your money. Again, having your money on Celsius does not seem less safe but more safe to me living in a country where my bank might shutdown any day...But not surprised to see the American only see what is going on in America because hey there is nothing beyond the US, right?

  3. Not to mention that holding stable coins would have saved any russian or turkish person from their respective local currency issues. To me, holding an $ equivalent that I can buy quick, with basically 0 fees is a fucking blessing that is so much lower in risk than holding my local currency, especially compared to only holding my local currency. I have basically all my cash in stable coins and I will never go back...