Black Swans and Crypto Lending, Stablecoins and DeFi
Editor's Note: This article comes fromBlue Fox Notes (ID: lanhubiji), reprinted by Odaily with authorization.
Blue Fox Notes (ID: lanhubiji)
Blue Fox Notes (ID: lanhubiji)
, reprinted by Odaily with authorization.
Foreword: The encryption market is full of huge volatility, and at the same time, it breeds black swans that almost no one can expect. The huge volatility of the encryption market not only affects its spot transactions, but also has a profound impact on the development of the cryptocurrency lending market, stablecoins, and DeFi. As a player in the encryption market, you need to have an in-depth understanding of the development of the encryption market. The author of this article is Justin Mart from Coinbase, translated by "SIEN" from the "Blue Fox Notes" community.
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Lending market: Behind the interest rate drive
The crypto lending market has been strong, with roughly $13 billion in total lending from traditional institutions and crypto-native products over the past few years.
* Lend cryptocurrencies to others and collect interest
* Borrow cryptocurrencies with collateral, pay interest rate fees
These lending markets are provided either through centralized intermediaries or through smart contract platforms designed to ensure that funds are not lost. In this space, the basic revenue stream for companies is net interest margin, which captures the spread. The spread is the difference between the rate offered to the borrower and the interest paid to the lender.
But lending comes with risks. Borrowers may default, especially if the underlying collateral experiences significant volatility. In this article, we study the performance of the lending market in this 3.12 black swan. Before diving in, it is important to understand what exactly drives interest rate changes and how it relates to market conditions.
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Reasons People Need Borrowing
Borrowers pledge some form of collateral and borrow cryptocurrency or cash because:
1. Speculation
Speculation involves going long or short. Shorting is borrowing a crypto asset and selling it for cash. Going long is borrowing cash and buying crypto assets. Both shorting and longing are important mechanisms for investors to increase returns or hedge risk, especially during periods of high volatility.
2. Working capital
Liquid funds to support business development or personal affairs. Bitcoin is important working capital for several businesses, including miners, OTC counters, remittances, trading companies, etc., which require access to significant amounts of capital to fuel operations. Additionally, borrowing and lending are generally not taxed, allowing exposure to cryptocurrencies without incurring tax penalties.
3. Derivatives arbitrage
Derivatives arbitrage requires a deeper understanding. Take Bitcoin futures contracts as an example. These contracts are an agreement to buy or sell bitcoin at a certain price at some point in the future. The way these markets are priced reflects investor sentiment. Generally speaking, the BTC futures market is bullish, where the price to buy or sell Bitcoin in the next three months is higher than the spot price today.
Sentiment in the crypto market is generally bullish. 60% of Coinbase Consumer’s average volume is buy, borrowing demand from leveraged long traders is net long, and the futures curve is generally bullish. This sentiment drives cash lending demand, but what happens when the market turns bearish?
First, the cash arbitrage transaction becomes an encrypted arbitrage transaction. Users can borrow BTC instead of cash to realize futures arbitrage, and then immediately sell in the spot market and go long on the futures contract.
When the futures curve turns bearish and the lending market turns to crypto lending, demand for cash lending dries up.
Given the volume of transactions in the derivatives market (typically greater than $5 billion per day), there are sometimes huge differences between futures and spot prices. Derivatives arbitrage is often an important source of borrowing demand.
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What drives interest rates? Why are DeFi interest rates usually high?
Like any market, interest rates are ultimately determined by supply and demand. However, there are deeper mechanisms at play:
1. The crypto lending market accepts cryptocurrencies as collateral
For many cryptocurrency institutions and individuals, their deepest capital pool is in cryptocurrency, which is the only viable way to mortgage lending.
2. Using cryptocurrencies as collateral is usually high risk
Cryptocurrencies are more volatile, making it difficult to have a suitable risk model for lending. This on the one hand limits the number of companies that accept cryptocurrencies as collateral (reduced supply), on the other hand they also demand higher interest rates to take the risk.
3. Stablecoins are preferred over cash due to increased efficiency
Importing cash into cryptocurrencies takes time. Many lending use cases require immediate action and thus can only be chosen among crypto-native solutions that are ready to deploy stablecoins, increasing the demand for stablecoins.
4. DeFi lending is still a niche market and difficult to exploit
5. Has contract risk
DeFi platforms are collections of smart contracts and may be vulnerable. Greater risk calls for higher interest rates.
Combining the above reasons, in general, this leads to higher stablecoin and crypto borrow/lend rates, especially in DeFi.
These rates will eventually decrease over time as adoption to the crypto market grows. More and more lending desks will accept cryptocurrencies as collateral, the adoption of stablecoins will grow, the conversion of cryptocurrencies and fiat currencies will be more efficient, DeFi will go mainstream, and there will be better protection against smart contract risks. Prior to this, we can enjoy higher annualized returns on stablecoin lending on Compound, Dharma, and dYdX.
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What happens when markets crash, and what should we expect in the future?
The current status quo is that there is a lot of demand for stablecoin lending from speculation, working capital, and derivatives arbitrage. But when sentiment reversed:
1. Increased borrowing and lending of cryptocurrencies for hedging (shorting)
2. In the case of increased risk, borrow cash to do long
Even if you believe the market is going up in the long term, massive volatility can quickly wipe out your position
Stablecoin Demand Shifts to Cryptocurrency Demand
Compound’s lending rates show how much this switch is
As market sentiment turns bullish and volatility declines, we could see stablecoin borrowing demand start to pick up, possibly reaching previous levels. This will be an important development, with many crypto companies relying on high stablecoin annualized returns to subsidize growth. These are crypto neobanks like Dharma, Linen and Multis.
Overall, crypto lending is a big business today and will likely continue to grow in the future. Market sentiment points to a demand preference, although overall demand remains high in both bull and bear markets. Coinbase seeks to expand its lending/borrowing business and increase liquidity in the lending market to drive the maturation of the crypto market.
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Stablecoins: Turbulence brings opportunities for growth
Before diving in, a brief recap of how stablecoins are used in the crypto space today:
1. Synthetic dollars for trading and speculation
2. Settlement
Stablecoins have the advantages of cryptocurrencies (fast, global, cheap settlements) without the disadvantages of cryptocurrencies (price volatility), and are increasingly used as settlements for goods and services. Interestingly, Asia seems to be adopting stablecoins naturally in some crypto-adjacent areas, with Coinbase commerce seeing strong and nascent growth in stablecoin adoption.
3. Capital circulation
Stablecoins are an open ecosystem globally, making them an attractive option for capital circulation and USD exposure. Now in the face of COVID-19 uncertainty, the U.S. issues a $2 trillion stimulus package (16 times Bitcoin’s market cap), cuts bank reserves to zero, and cuts federal interest rates to a record low level. At the same time, financial markets are in a mood of worry, with investors selling assets in large numbers to manage their leveraged positions, hedge risks, and seek stability.
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What happened to the stablecoin market?
As the market crashes, we see some downstream effects:
1. Stablecoins trade at a premium due to surging demand for security.
2. As arbitrageurs dig out stablecoins and sell them at a premium to meet demand, the issuance of stablecoins increases.3. In order to manage positions or capture arbitrage opportunities, investors adjust their holdings between exchanges, and the activity on the chain surges.》）
The severity and duration of stablecoin price shocks are directly related to the efficiency of deposits and withdrawals. If anyone can simply generate a stablecoin or redeem USD, any shock will be short term as arbitrageurs will quickly step in and keep the price stable.
Let's see what happened to Tether. With demand high, USDT was trading at a $1.05 premium on March 12. However, arbitrage caused its price to revert to its historical average within a few days.
Meanwhile, Dai traded at a higher premium, which remained in place until April 6, 2020. This is a direct result of some of the deeper mechanics behind the Dai ecosystem, including a failure to keep its liquidation engine running smoothly, resulting in a $4 million capital loss for MKR tokens. (Blue Fox Notes: You can refer to the previous article published by Blue Fox Notes "
Maker "Black Thursday" review: Digging deep into the timeline to peel off every layer
For USDC, these are also opportunities to continue to drive its adoption. While challenging Tether’s liquidity may take longer, it has managed to gain traction in other areas. Especially with the help of USDC Bootstrap Fund, cooperate with DeFi, emerging banks, remittance applications, etc. USDC is a regulated, fully backed stablecoin with smooth deposit and withdrawal channels.
DeFi: MakerDAO Liquidation Engine Cracks Amid Market Crash
Stablecoins are here to stay and are being adopted every day. In addition, the turmoil in the market is an opportunity for the growth of stablecoins.
Please note: Stablecoin adoption does not mean capital is leaving crypto. Instead, it represents capital waiting to re-enter the larger crypto market, an optimistic sign for stablecoin adoption.
DeFi: MakerDAO Liquidation Engine Cracks Amid Market Crash
MakerDAO is the smart contract DeFi platform behind the synthetic stablecoin Dai.
Some background on how MakerDAO works
MakerDAO users deposit collateral (mainly ETH) into the smart contract "vault", and generate corresponding Dai according to the amount of their collateral. If the mortgage rate is lower than 150%, the "vault" will face the risk of default. At this time, anyone can initiate an on-chain transaction to close its vault and auction its collateral. This ensures that Dai is backed by sufficient capital, or in the worst case, it is always redeemable with $1 in cryptocurrency.
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What happened when the market crashed?
On March 12, the price of ETH plummeted by more than 50%, briefly falling below $100 for the first time since 2018. results in:
*Several MakerDAO vaults became undercollateralized
*Liquidators closed quite a few "vaults", many of which had run out of Dai and could not quickly replenish their balance sheets
Results and Recovery
*Many liquidators are not prepared to pay high transaction fees and cannot get their auction transactions mined quickly
As a result, only three bidders participated in the auction. The lone liquidator bid $1 and got almost free ETH.
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Results and Recovery
End result: A liquidator got $4 million in ETH for free at almost no cost, and the MakerDAO system was not capitalized enough to ensure Dai remained fully overcollateralized.
