Saving with DeFI — May2022 update

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  1. Update on AAVE borrowing+lending strategy
  2. Saving with DeFI — Part 2: Blending In

This is the third update of my project looking for high-yielding cash alternatives using DeFI — for more information about it check out here

The crypto world has been in complete disarray for the past few months, with the collapse of the UST “stable” coin and of the LUNA ecosystem with it (check this out for more info). Moreover, with rates rising in traditional safe assets (the FED has lifted its interest rate to 0.75% and is expected to keep raising it), the yields you can get in the “safer” DeFI projects start looking less interesting.

For this update I want to check how have yields changed since my April update and if the BLending strategy I started last month survived last weeks’ carnage.

In periods of volatility, do DeFI lending yields rise as market wants more compensation to take crypto risk or do they fall as crypto investors run to safer alternatives?

Lets start by reviewing the current lending rates you can get on some DeFI projects:

APY -> lending yield on platform, APY+ -> yield including incentive token

Compared to the previous update, rates are significantly lower, with the only exception of DAI at the Venus platform, which is probably a side-effect as that platform had to temporarily shut-down:

  • The table above includes the incentive token you get by participating in the protocols, and those tokens have collapsed in the past month. XVS went from $12.6 to $4.6, COMP from $158 to $67 and AAVE from $231 to $86. Usually those platforms issue a fixed amount of tokens every day, and as the value of those collapsed, the actual APY you receive is significantly less
  • Overall yields are much lower, which is somewhat counterintuitive — if traditional bond rates are higher, shouldn’t crypto ‘safe’ yields also increase? Why are we seeing the opposite?

The chart below shows the yield on 90d AA commercial paper — the yield you get on a short-term high quality corporate bond in traditional finance — compares it to the yield you get by lending USDC in the Compound platform. There isn’t any noticeable correlation between the two lines.

Crypto safe yields actually went down as traditional bond yields rose

In the short-run, “safe” crypto yields are mostly a function of supply and demand for leverage and thus move higher as the market gets bullish and move lower as the market gets bearish. They do not depend on traditional bond yields

As I explained here, the yield you get on those lending platforms depends on the “utilization rate”, which is the percentage of the assets supplied to the platform that is being borrowed. If investors are borrowing more assets, the utilization rate goes up and so does the APY. As investors reduce their borrowing, both the utilization rate and the APY also drop.

Investors who are borrowing stablecoins such as USDC/USDT want to lever up their crypto holdings (ie, use those stablecoins to buy more crypto), and thus the demand for borrowing increases when the market is strong and drops when the market is weak.

We should expect that, over time, those lower yields reduce the supply of USDC in the protocols as investors look for higher-yielding alternatives elsewhere, but this process could take some time. In the short-run, what only matters is whether there is demand to borrow stablecoins.

Update on AAVE borrowing+lending strategy

Last month I tried a simple strategy where I borrowed 25.0 AAVE at the Venus platform and then deposited those same 25.0 tokens back to earn the incentive token XVS. Over time, my balance of borrowed AAVE would grow at the same time that I would also earn additional XVS. So as long as the ratio of AAVE/XVS price stayed constant I was not taking any large market risk and, in thesis, would earn a small positive rate. This was an example of the BLending strategy I discussed in details in the link below:

Since then, AAVE went from $231 to $86 and XVS from $12.6 to $4.6 — a very large drop (-63%) but pretty much the same on both tokens! So let’s see if the strategy worked as expected:

Quite disappointing results! Including the gas fees of around $1.70, the end result was a tiny loss. The net rate on this position is currently around +0.5% (at current XVS prices), so I will keep it for another month and see how things play out.

As yields on traditional investments rise, lending stablecoins becomes a lackluster (and boring!) alternative. We need to look at additional strategies besides just depositing tokens on those lending platforms. Please stay tuned for the next article in this series as I will cover liquidity provision (LP) which is a very interesting strategy that can offer better returns (but also more risk!)