Tempus Takes #8

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There has been a lot of discussion around stablecoins ever since the $18bn algorithmic stablecoin terraUSD (UST) crashed last month. This has continued to ripple across the crypto market, with lending and borrowing firms such as Celsius and BlockFi freezing withdrawals for their clients.

Background

Stablecoins are cryptocurrencies with a price that is designed to be pegged to crypto, fiat money, or to exchange-traded commodities such as industrial metals or precious metals. They were created during the initial days of the crypto industry when liquidity was low in the market due to low adoption, resulting in high volatility in the price of digital assets.

Some of the most popular stablecoins are USDT (launched in 2015) and USDC (launched in 2018). Both are pegged 1:1 to the USD.

USDT Market Cap (Source: CoinMarketCap)

The total market capitalisation of USDT has fallen by approximately $17 billion to $66 billion since 10 June 2022, while the total market capitalisation of USDC has risen by roughly $6 billion to $56 billion, around the same time indicating a transfer of funds from USDT to USDC. This could be due to speculation that Tether, the issuer of USDT, holds Evergrande’s commercial paper as part of the reserve for its stablecoin, along with the general opaqueness around where the reserves are actually held.

USDC Market Cap (Source: CoinMarketCap)

What’s new?

USDC creator, Circle, is planning to launch a Euro pegged stablecoin Euro Coin (EUROC) on 30 June 2022 on the Ethereum network.

More information:

Tether, the issuer of USDT will also launch a GBP-pegged stablecoin named GBPT in July this year.

Takes

With the Euro Coin launching on the Ethereum network, there are different expectations on the supply/borrow rate. There are multiple approaches to estimating a reasonable rate. We will try to imagine how a USD vs EUR carry trade strategy could unfold either on-chain, based on the Euro Coin rate on DeFi money markets such as Aave, or off-chain using a traditional bank.

To begin with, let’s denote the currency with the lowest interest rate with L and the currency with the highest interest rate with H. The carry trade strategy is:

1. Borrow L

2. Convert L into H

3. Invest in a riskless financial instrument denominated in H

4. Convert a portion of the principal and interests from the financial instrument from H to L and repay the debt denominated in L

The profit of this strategy is made up of the rate differential between H and L. In our case, H is the US dollar and L is the Euro (at least in the TradFi environment).

Now, let’s check whether executing a carry trade strategy on-chain or off-chain is more profitable.

Assumptions

• Fiat yields:

– USD 1Y rate on T-bills: 2.85%

– EUR 1Y rate (Euribor 12 months): 1%

– Both US and Eurozone issuers won’t default over the 12-month period

• Fiat-backed stablecoin yields:

– USDC 1Y supply rate on Aave: 0.59%

– Euro Coin 1Y supply rate on Aave: ???

We assume these rates to be constant over a year and we don’t consider gas fees and trading fees for converting EUR into USD and vice versa

On-chain strategy

1. Deposit 10,000 USDC on Aave

2. Borrow $8,550 worth of EUROC (using the maximum LTV of 85.5%)

3. Convert the EUROC into USDC (it remains $8,550) and withdraw it off-chain into USD

4. Buy a newly-issued 1-year T-bill with USD and hold it until maturity

5. Use the 1-year T-bill proceeds to repay the EUROC debt

6. Withdraw the 10,000 USDC on Aave collecting the 0.59% rate

The P&L (in USD) of this strategy is the following:

• Yield earned on the T-bill: $8,550 * 2.85% = $244

• Cost of borrowing Euro Coin: $8,550 * x%

• Yield earned on the USDC deposit on Aave: $10,000 * 0.59% = $59

The total P&L is then:

Off-chain strategy

1. Borrow 9,523 EUR (at a 1.05 EUR/USD exchange rate it’s equivalent to 10,000 USD)

2. Convert 9,523 EUR into 10,000 USD

3. Buy a newly-issued 1-year T-bill with USD and hold it until maturity

4. Use the 1-year T-bill proceeds to repay the EUR debt

The P&L (in USD) of this strategy is the following:

• Yield earned on the T-bill: $10, 000 * 2.85% = $285

• Cost of borrowing EUR: $10, 000 *1% = $100

The total P&L is then:

To see at what Euro Coin rate x the on-chain strategy outcompetes the off-chain one, we need to solve the following expression:

This gives x < 1.38%. Hence, if the cost of borrowing Euro Coin is less than 1.38%, it’s actually more profitable to execute the carry trading strategy on-chain using DeFi money market protocols.

It would be interesting to see how the market for stablecoins and their rates change as new stablecoins get launched over time.

Market Move

The yields available for most cryptocurrencies on both Ethereum and Fantom blockchains have fallen over the past two weeks. Additionally, more people are fixing their yields on the USDT pool on Tempus on the Fantom blockchain. This has resulted in a fall in fixed interest rates from 21.78% to 14.43%.

Interest rates on the ETH and Lido pools have no significant changes with Tempus offering a higher fixed APR on ETH.

If you would like to fix your yields in this market of uncertainty then do check out our rates and deposit your tokens now!

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Disclaimer

The information provided in this article is provided for informational purposes only and does not constitute, and should not be construed as, investment advice, or a recommendation to buy, sell, or otherwise transact in any investment, including any products or services, or an invitation, offer, or solicitation to engage in any investment activity. You alone are responsible for determining whether any investment, investment strategy, or related transaction is appropriate for you based on your personal investment objectives, financial circumstances, and risk tolerance. In addition, nothing in this article shall, or is intended to, constitute financial, legal, accounting, or tax advice. We recommend that you seek independent advice if you are in any doubt.