Will Rising Interest Rates Damage Stablecoins?

By and large, stablecoins get used the most for crypto trading — and at least until recently, they’ve also been seen as a good way to park your funds in between trades if you don’t want too much risk exposure.

See also: How Do Stablecoin Issuers Make Money?

That wasn’t much of a problem for investors when a typical savings account at a bank was paying out interest in tiny fractions of a percent and three-month treasuries were at .06%. But now, the No. 2 stablecoin issuer, Circle, is pulling in about 2.4% on the $42 billion of its $55 billion it has parked in three-month treasuries to back its USD Coin (USDC).

If you want to park your USDC with Circle Yield, a crypto lending program, rather than leaving it in a wallet, you can earn … half a percent.

Read more: Circle Expands Access to Crypto Yield Service

And if you want to leave in in a cold wallet or on an exchange, you can get nothing.

While there are signs that the use of USDC and other stablecoins as a payments currency is growing, users certainly aren’t spending them on a daily basis. On July 25, the 24-hour trading volume of USDC was about $5.9 billion — somewhat more than 10% of the total. The same can’t be said of the No. 1 stablecoin, Tether’s USDT, which saw $45.7 billion of its $68.2 billion traded in the past 24 hours.

So where is it all going?

DeFi Isn’t Enough

You’re certainly not getting a cut of that T-bill interest.

Some of those stablecoins are being used in staking — putting up crypto to earn a share of newly-minted cryptocurrencies generated when new blocks are added to a blockchain. And much of the rest are locked in decentralized finance (DeFi) in crypto lending programs — the same business model that has driven lenders like Voyager Digital and Celsius into bankruptcy over than past few weeks.

Circle clearly did a better job. For one thing, it claims that all of its loans are overcollateralized, backed by bitcoin at 125% of the amount borrowed and subject to margin calls, something that Voyager and a number of other lenders didn’t do — hence why a hedge fund’s collapse sent ripples of insolvencies across the industry.

That half-percent yield, Circle Chief Financial Officer Jeremy Fox-Geen told Decrypt last week, “is not very attractive,” particularly compared to the 10.75% it was offering in November 2020 when the company launched Circle Yield, which loans it out to borrowers.

Related: How a Stablecoin’s $48B Collapse Rippled Across Crypto

Nor does it compare favorably to the 6% to 8% it was offering for terms of one, three, six or 12 months this past December, when Circle expanded access to the program — although not to the general public, as there is a $100,000 minimum for accredited investors.

While some DeFi lenders are still offering 7% to 10%, many others are offering rates closer to what Circle Yield is. Coinbase is offering 0.15%

And here’s the thing: Even with the higher rate of return, many excess stablecoins are never invested in DeFi projects. From a high of more than $100 billion at the peak of the crypto boom in December, just $42.5 billion is now locked in DeFi — and not a lot of that comes from stablecoins. USTD and USDC between them have a $123 billion market cap.

Why Park in Crypto?

That leaves a serious unanswered question for stablecoin issuers.

With DeFi in poor repute since an unbacked “algorithmic” stablecoin collapsed in May, billions are still locked in bankruptcy cases. That total now stands at $39.5 billion, according to DeFi Pulse — down about 45% since the Terra/LUNA stablecoin crashed to zero in a week.

That isn’t likely to happen to USDC and USDT, although concerns about the latter’s reserve led it to briefly losing its dollar peg. However, Tether was able to redeem $16 billion in a few days, suggesting that its backing reserve is more or less solid.

But there’s still that question: Why park funds in stablecoins for a half-percentage point yield when you can get nearly five times that from the Federal Reserve?

Especially since that’s what both Circle and Tether are doing with their own funds.

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