Can Stablecoins Yield a New Hope?
A crypto Antihero to save your Tradfi portfolio; Also: How big is ConsenSys?
Hi! It’s George from Investorama.
Thank you for joining me in the exploration of the future of investing. In this newsletter, I’ll be looking at alternative assets, blockchain, investment technology and trends - without the hype.
This Star-War inspired post highlights another part of my conversation with Lex Sokolin from ConsenSys about yields and risk in crypto.
There are Heroes and Antiheroes. An Antihero is a protagonist who lacks conventional heroic attributes, such as idealism, courage, and morality. It’s a classic storytelling mechanism: The Hero still has to accomplish a quest, but now he’ll have to team up with someone whose presence makes him feel uncomfortable.
In Star Wars: A New Hope, the first episode of the saga historically, two desperate Jedi Knights have to team up with a selfish, cocky smuggler named Han Solo (Harrison Ford). If you don’t know what I’m talking about the link to the scene is at the bottom of this post.
Jump cut to financial markets. Imagine a script for a story where every asset goes down. A year ago, this would be outlandish fiction, but today is different.
The above tweet is from March 14. It was just one day. But it would not be crazy to see further drops in stocks and bonds as rates rise. Commodities have spiked but are now correcting. The dollar is mixed, but currencies alone can’t save a long-only portfolio. Gold, cryptocurrencies are not providing a safe haven.
But if it’s a script, and we’ve reached our darkest hour, who could save the day?
There’s an asset that could make a good candidate because it’s stable, liquid and potentially high yielding: Stablecoins. But like Han Solo they are a Antihero. Unconvential, with unusual attributes and a sketchy past that can make us feel uncomfortable.
But can they be a saviour for traditional portfolios? Below is an investigation into the risks and rewards of stablecoins based on my recent interview with Lex Sokolin from Consensys.
What are Stablecoins?
Stablecoins are designed to avoid the volatility associated with cryptocurrencies (we discussed crypto volatility and its impact in a previous post). They are typically pegged to a fiat currency, mainly the USD. The peg is maintained via collateral or having its supply regulated by an algorithm.
There are numerous stable coins, the largest by circulating supply are:
Tether (USDT): $80b
USD Coin (USDC): $52b
Binance USD (BUSD): $18b
Terra USD (UST): $15b
Lex Sokolin explains stablecoins as “cash & equivalents”.
Stable coins are like cash and equivalent, in traditional finance. That's where they'd be classified. You can think of a money market, you can think of a Eurodollar.
Stablecoin Risks
You can split the risks into three categories:
collateral (what is backing the stablecoin)
company risk (what if the company behind the coin goes bust)
cybersecurity
Collateral
Holding these coins pegged to the USD is not like holding USD.
What risks are you taking? It's possible that the stablecoin potentially dies off and defaults.
And there's lots to say there. But it's less likely that happens than a junk bond fails out. Because it's not about: will this project work? It's usually some collateralized thing, especially in the case of USDC.
The risk can vary greatly depending on the coin. USDC is considered the safest as it is 100% backed by cash and Short Duration US Treasuries.
USDT is also collateralized,, but in 2021, it was hit with a $41 million penalty from the Commodity Futures Trading Commission over a misleading claim that it was fully backed by US dollars.
UST is pegged algorithmically and therefore represents a different type of risk.
Company
And then what about this Defi contract? What happens if the company that writes these contracts, everyone goes to jail because they are unregistered securities.
It doesn't matter at all. Actually, you can remove all the people from a lot of these defy protocols and it doesn't. Because the smart contracts are written to a gigantic machine, which is a computational blockchain that performs forever and ever, and never fails in most circumstances.
So the company failing actually doesn't matter if the protocol is big enough.
If the protocol is very small and is still quite centralized, of course it does.
Cybersecurity
And then the third and new risk, which is really important is what if the code's bad What's the cybersecurity risk. What if my wallet gets hacked?
And so this is actually the category of risks that people need to understand that they're taking on. So the more packaging and tokenization securitization that you're doing, the more software cyber risk you're taking on because you're introducing vulnerabilities and vectors of attack at your money.
Now, that's what you get rewarded for. You get higher interest. Earlier protocols because you're walking on the Razor's edge often. But I would say that's the primary risk that you should think about that.
In terms of risks, it’s essential to separate Defi (decentralized finance) and Cefi (centralized finance).
Stablecoin yields - Defi
Defi yields are based on a supply and demand mechanism matched automatically. Here is how it looks on Compound, an algorithmic, autonomous interest rate protocol.
There is traditionally a high demand in the crypto markets resulting in higher yields than traditional finance.
As a referencMarch 16 16), the USD money market rate is 0.07%, the 30-day Treasury Bills is 0.37%. On Compound, you can earn 2.02% for USDC (2.89% for USDT).
It is not a risk-free rate, but you may consider that six times the Treasury Bills is a good payoff.
You may also consider that 2.02% is not very exciting. You can get a more exciting number through Centralized lending platforms (Cefi).
NB: there’s also another type of Defi yield with stablecoins - liquidity pools - but that’s for another episode.
Stablecoin yields - Cefi
The counterparty risk when you use Defi is lower than the counterparty risk when you use a centralized exchange.
The exchange or platform will be lending your assets to third parties, which implies they are managing credit risk and liquidity risks.
The risks stack up:
Stablecoin risk
Platform risk
Counterparty risk: liquidity and credit
And the rates can vary accordingly, here’s Google results answer to ‘highest USDC lending rates'.
The platforms themselves are unregulated and are often based in emerging markets (Midas investments is based in Russia).
There are however a few better-known names, such as:
Crypto.com: famous for renaming the Los Angeles Staples stadium and an ad with Matt Damon
Blockfi: famous for having been fined $100m by the SEC
These claims to fame may not feel reassuring, yet these are well capitalized businesses having raised hundreds of millions of dollars of venture capital and holding billions of dollars of assets.
With a centralized counterparty, more consumer-centred, you're introducing the idea that maybe you will be bailed out. That may be because the platform has lots of customers, they will care to make you whole. If, for example, all their staking funds are lost and the reason why they make you whole. Not because they love you, but because that's the regulatory environment for them. That's the trade-off you would be making.
Crypto.com pays an eye-watering 14% on USDC.
Where do the yields come from?
It's just margin. It's demand by institutional investors to take a position. And if I'm an institutional investor and I want to go along and I have really big portfolios, then I I need another capital base to do it against,.
We discussed Blockfi specifically and the announcement in February 2022 that it has agreed to pay $100 million in fines to the Securities and Exchange Commission and 32 states over charges it violated securities laws and made false statements about the riskiness of its activity.
I'm a fan of consumer protection and I think unregulated markets can swing into really funky places. Personally, and this is a personal view, I find it really befuddling when you've got something like Blockfi fined a hundred million dollars for generating really amazing financial outcomes for people like it's those aren't damages. There’s no lawsuit from investors that lost money and this investment firm defrauded them by misrepresenting something. I think there's probably some negligence in disclosure, which is damaging and a bad practice, but there are no investor damages where people were hurt.
In fact, they outperformed the traditional financial system probably by an order of 52. Relative to interest rates in an account. And there's a lot to say about the traditional financial system kind of failing savers and the inflation, all that stuff, which I think is probably outside of our scope at this stage of the conversation.
Do you need Stablecoins?
Maybe I’m over dramatizing.
First, portfolios may not need to be saved, we could see a rebound (as I write this on March 16 - everything is up).
Second, even if a downturn occurs, there are other tools you can use (buy puts?). If you have a long term horizon you can wait, or keep buying. That’s what dollar cost averaging is for.
The question is deeply personal. Do I need stablecoins?
I’ve been converting part of my GBP into dollar-pegged stablecoins and placing them on Defi but mainly Cefi platforms.
One of my largest position is USDT on Blockfi, earning 8% APR. Having done so, I often remind myself that USDT (Tether) and Blockfi have been fined a combined $141m USD in the last 7 months.
My rationale is simple (NOT INVESTMENT ADVICE):
I prefer USD when there’s heighten geopolitical risk in Europe and it looks like the Fed will be raising rates
It’s risky but I estimate it’s a good risk/reward and it’s replacing equity exposure
I’m positioned for a downturn, as I tend to agree with Sergei although I don’t have a macro view and I’m ready yo change my mind
This is not the Hero part of my portfolio. It’s not something that I intend to hold forever. Aside from the yield, I am interested in the liquidity and low cost of trading compared to bonds. Before allocating meaningful sums, I’ve tested how fast I could unwind (assuming the centralized exchanges are not down).
Stablecoins on Cefi are the Antiheroes of my portfolio, but you don’t always choose who you team up with.
Here’s a clip with Han Solo’s first appearance (Star Wars: A New Hope -1977):
How big is Consensys?🐋
After I interviewed Lex Sokolin, his employer ConsenSys announced a $450m funding round, valuing the company at $7bn.
Their most famous product is the consumer-facing Metamask, the dominant ETH wallet browser extension.
But their B2B operations are equally huge (Coindesk): “most of the Uniswap ecosystem relies on ConsenSys infrastructure services, like Infura. This has also proven to be the common pattern for copycat DeFi projects like SushiSwap. ConsenSys spokesperson James Beck said the Ethereum conglomerate restructured to make infrastructure and wallet services, like Infura and the DeFi-friendly wallet MetaMask, pillars of the company’s “core software business.”