Key Points:
- US Treasuries currently offer unprecedented yields compared to staking or supplying top lending protocols like Aave / Compound. The high US Treasury yields are due to the increase in interest rates, which are expected to stay high throughout 2023.
- US Treasury yields and USDC Supply Rates tend to be inversely correlated, and the inverse correlation strengthens in bear markets. As a result, cryptocurrency holders and protocols (such as MakerDAO) are investing in US Treasuries.
- Because of the high US Treasury yields, there has been an increase in platforms enabling users to purchase US Treasuries without off-ramping.
Executive Summary:
Over the past two years, supplying stablecoins such as US Dollar Coin (USDC) into lending pools has been perceived as a low-risk, high-return investment. On the other hand, while US Treasuries are often seen as safe assets, they tend to offer relatively lower returns. With the United States Federal Reserve rapidly hiking US interest rates for the first time in almost a decade to slow inflation, a crypto downturn, and general bearish sentiment among investors, the stablecoin lending interest rate (Supply Rate) and US Treasury yields have dovetailed for the first time. With the stablecoin Supply Rate of the largest lending protocol generating less yield than the “risk-free” US Treasury yield, supplying stablecoins to DeFi platforms has completely lost its appeal, as shown in Fig 1. The outstanding debt of stablecoin from Compound has fallen from $9.3B to $0.6B over the past year (The Block). In this article, we will explore selected on-chain metrics to understand why more Web3 natives and protocols are purchasing tokenized US Treasuries on-chain. With more platforms offering tokenized real-world assets (RWA), there is certainly an opportunity for Web3.0 natives and protocols to invest in RWA such as US Treasuries and security tokens without off-ramping.
Key Definitions:
| Term | Definition |
| Bull Period | 1 Sep 2020 – 30 Sep 2021 |
| Bear Period | 1 Oct 2021 – 28 Dec 2022 |
| Short-Term US Treasury | A Short-Term debt obligation backed by the US Treasury Department with a maturity of one year or less. |
| Supply Rate | The interest rate earned by supplying base assets (USDC) |
Table 1
Figure 1: Aave and Compound Supply Rates vs 3 Month US Treasury Yield
About Stablecoin USDC
USDC is a trusted, widely accepted, and highly liquid digital dollar pegged to the value of the US dollar. It is an ERC-20 token, running on the Ethereum blockchain. USDC was first issued by Circle, a regulated fintech firm that passed a rigorous auditing process in September 2018. Over the past two years, the circulation of USDC has grown by a staggering 10,000%, and as of March 30, 2023, it has reached $33 billion, representing a 25% market share.
Comparing Stablecoin Supply Rate with US Treasury Yield
Since stablecoins are a Web3 analogue to USD, we compared historical Supply Rates with Short-Term US Treasury yields to evaluate the attractiveness of (and potential returns from) stablecoins versus fiat currency. Supply Rates are the interest earned from DeFi lending protocols by supplying one or more base assets into lending pools. As of 30 March 2023, Aave and Compound are the 1st and 3rd largest DeFi lending protocols, with $5.47B and $2.01B total value locked (TVL) respectively (Defilama). Until May 2022, we consistently found that the historical Supply Rates of USDC and USDT on Aave and Compound were higher than the Short-Term US Treasury yields, as we compared these rates in the analysis below. However, this trend has reversed in recent times.
A Shift in Demand from Crypto to Financial Instruments
Another interesting trend is cryptocurrency industry players’ recent increase in demand for traditional financial instruments, to manage concentration risk. In October 2022, MakerDAO, a leading DeFi protocol with a TVL of $8.2B, disclosed a plan to invest $500 million in US Treasuries and corporate bonds. These funds will come from its over-collateralized DAI stablecoin, with 80% going toward Short-Term US Treasuries and 20% toward investment-grade corporate bonds. The decision was made after token holders in the MakerDAO (Decentralized Autonomous Organization) community voted in favor of the allocation proposal in June earlier that year. According to MakerDAO, the move is intended to diversify the balance sheet by investing in “scalable legacy finance investments,” thereby reducing risk by limiting exposure to any one asset and increasing revenue streams. As of January 2023, real-world assets accounted for 57% of MakerDAO’s total protocol revenue, up from less than 10% in July 2022 (Messari Research). Similar messaging from other lending institutions and stablecoin providers suggests that MakerDAO’s views are becoming mainstream across the industry.
Figure 2: Compound Supply Rate of Stablecoins vs Short-Term Treasury Yields
We think the increased attractiveness of traditional fixed-income assets due to higher rates has become so obvious that everyone – crypto or not – can’t help but allocate to this asset class. Sidney Powell, CEO of Maple Finance, the biggest crypto lending platform mentioned, “Higher appetite for Treasuries has sucked out liquidity from crypto.” As mentioned above, a comparison of Supply Rates to Treasury yield shows a clear picture as below in Fig 3 (Aavewatch Data):
Figure 3: Aave Supply Rate of USDC vs 3 Month Treasury Yield
Analysis of Stablecoin Yields vs TreasuryKey Findings:
The average yield for USDC during the bull market was 3.90%, higher than the average yield during the bear market of 1.98%, a significant drop of 49.0% (Table 1). One potential reason for this drop could be that during the bear market, prices of cryptocurrencies face a sharp decline. The crypto lending industry has been facing one of its largest crises with cryptocurrency prices dropping to 2020 levels, and the total market capitalization shrinking by more than $1 trillion. For example, Celsius and Babel Finance – both major lending platforms – suspended withdrawals on their platforms citing extreme market conditions in June 2021 (Cointelegraph). In a bear market, the crypto industry may suffer due to the sharp decline in the prices of their native token and the loss of liquidity in other cryptocurrency projects and investments. Moreover, the demand for borrowing tends to decrease during this period as investors become more risk-averse and less willing to take on debt (Blockworks). As evidenced by data from Dune Analytics, the total amount of borrows on Aave and Compound decreased from $6.6 billion and $7.2 billion to $4.8 billion and $5.7 billion, respectively, between December 2 to December 21. Aave deposits demonstrated a consistent outpacing of borrows as well, indicating a reduced appetite for leverage (Blockworks). A reduced demand for borrowing and an increase of stablecoin deposits during a bear market naturally leads to a lower Supply Rate of USDC.
Figure 4: Compound Supply Rate of USDC vs 3 Month Treasury Yield
On the contrary, the average yield for Short-Term US Treasuries increased from 0.07% to 2.04% (from bull to bear market). This is mainly caused by rising inflation as seen by the CPI graph (Fig 5 and 6). The rate hikes in 2022 to curb inflation affected the disposable income of US residents, which in turn dampens their appetite for high-risk assets such as cryptocurrencies.
Figure 5: CPI Data for U.S. and Euro Area
Figure 6: U.S. Interest Rates
The trend of falling USDC Supply Rate and an increasing US Treasury yield rate hike has led to the convergence of both yields on May 2022, falling from a peak differential of 10.9% in June 2021 (Fig 4).
Correlation Trend
Looking at the period from 2020-2022, the correlation between the Short-Term US Treasury yield and USDC Supply Rate was negative at approximately -0.50 (Table 2). This negative correlation persisted through both bull (-0.66) and bear (-0.77) market periods (Tables 3 and 4). The strengthened negative correlation during the bear market could have been due to the lower volatility of USDC and a rise in the Short-Term US Treasury yield. The standard deviation for USDC Supply Rate dropped by 45.9% during the bear market, in contrast to the high fluctuations of the USDC Supply Rate before Oct 2021.
Future Outlook for US Treasury and Crypto.
Over the past years, there has been a strong correlation between cryptocurrencies and stocks. This is especially so amid heightened concerns about the economy, inflation, an uncertain geopolitical climate and monetary policies. For example, during a mid-June sell-off in 2022, the 90-day correlation between Bitcoin and the S&P 500 hit 0.9. This is because investors consider cryptocurrencies to be risky assets subjected to some of the same influences as the stock market and technology company shares (CoinDesk). With a potential recession, many believe the crypto bear market will stay for at least one or two years (Forbes). On the flip side, the US Treasury yields will likely continue growing this year. The Federal Reserve (Fed) has projected that interest rates will continue to rise steadily through 2023 (World Economic Forum). Since 2022, they have been continuously increasing interest rates, with the economic outlook appearing stronger than initially projected. The unexpected collapse of Silvergate Bank, Silicon Valley Bank and Signature Bank, along with liquidity issues at Credit Suisse and First Republic, have compelled the Fed to limit the latest rate hike to 25 basis points, resulting in interest rates of between 4.75% to 5%. While markets are speculating about a potential recession and rate cuts (Bloomberg), it is likely that the positive divergence between the US Treasury yields and USDC Supply Rate will continue in the near future.
Opportunity for Crypto Asset Owners:
Despite a lowered risk-return ratio relative to Short-Term US Treasuries, there is still a $0.6B outstanding debt of stablecoins on Compound alone. The existing and continuing divergence between the US Treasury yields and USDC Supply Rate presents a considerable and stable investment opportunity for crypto asset owners. Crypto natives can diversify their portfolio with short-term US Treasuries that offer lower counterparty risk and volatility. Regulatory compliant platforms and exchanges such as DigiFT offers an avenue for investors to access and trade US Treasuries and other real-world assets without off-ramping.
Appendix:
Data:
This study uses a time series data set comprising of a 158 weekly 7-day moving average of USDC and USDT stablecoin Supply Rate observations from Compound Finance and USDC Supply Rate on Aave.
Short-Term Treasury will include 3 Month, 6 Month, and 1 Year US Treasury yields. The daily Short-Term US Treasury data is obtained from Federal Reserve Economic Data (FRED). This will be converted into weekly data for analysis purposes, where the average interest rate for the week will be taken. Missing data will be replaced with the value of the previous day’s observation.
Average and Standard Deviation of Yield:
Average of Stablecoin Supply Rate and Short-Term US Treasury Yield (Aug 2020- Dec 2022)
Table 2
Standard Deviation of Stablecoin Supply Rate and Short-Term US Treasury Yield (Aug 2020- Dec 2022)
Table 3
Correlation Matrix:
Correlation Matrix of Stablecoin Supply Rate and Short-Term US Treasury Yield (Aug 2020- Dec 2022)
Table 4
Correlation Matrix of Stablecoin Supply Rate and Short-Term US Treasury Yield During Bull Market (Aug 2020- Oct 2021)
Table 5
Correlation Matrix of Stablecoin Supply Rate and Short-Term US Treasury Yield During Bear Market (Oct 2021-Dec 2022)
Table 6
Bull Market
The bull market is defined from 1 September 2020 to 30 September 2021. In this period, Bitcoin prices started to rally and break the support at USD 18,152, which can be attributed to several factors, namely increased institutional adoption, more acceptance from many in the traditional finance space, as well as the Fed printing money leading to investors flocking to cryptocurrencies as a hedge.
Bear Market
The bear market is defined from 1 October 2021 to 28 December 2022 (Bitcoin Price History: 2009 to 2022). There are a few key events to take note of that caused the markets to go into decline, mainly due to the Fed rate hikes (in attempts to reduce the rate of inflation). Another key event was China regulators banning crypto mining and trading, leading to the crypto fear and greed index falling below 30, signifying fear in the markets. Additionally, the Terra-LUNA crash followed by the collapse of FTX, brought about significant liquidations due to the use of high leverage, fuelling uncertainty in the markets and lower investor confidence.
關於 DigiFT
DigiFT aims to provide regulated decentralized finance solutions on the Ethereum public blockchain. We are operating the first regulation-abiding decentralized digital asset exchange where asset owners can issue blockchain-based security tokens efficiently and cost-effectively. Investors can trade with continuous liquidity via an AMM mechanism and retain control over digital asset tokens in their own wallets. We are a global outfit backed by well-established venture partners. The founding team originates from international financial institutions and has deep blockchain technology knowledge.
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