With Interest Rates Near Zero, Why Aren’t Savers Flocking to DeFi?
With the Federal Reserve printing funds and slashing interest rates, the effects are everywhere. High-yield savings accounts, known for their 1-2% APYs, are seeing drastic reductions. So why aren’t savers turning to DeFi, where APYs of over 20% are common?
A Tale of Two Curves
High-yield savings accounts have always been a lucrative instrument when it comes to idle funds. Part of the appeal is in keeping an accessible nest egg immune from the impact of inflation. Many consumers prefer these accounts because they get significantly higher returns than the national average savings rate of 0.05%.
They’re almost like investing in a poorly performing asset, which still provides returns. Except there’s one major difference when compared to investments: high-yield savings accounts are insured.
Of late, the high-yield savings accounts have seen significant drops in their APYs than what they could offer even a year ago. From an annual yield of 2%, these rates have now come down to as low as 0.4%. The Federal Reserve cutting down its benchmark interest rate to almost zero has been the primary driver causing this drop.
While this is a story of a decline, the players in the world of decentralized finance have managed to amaze investors worldwide with their sky-high interest rates. The DeFi lending platform ‘dy/dx’ offers lending interest rates as high as 17.43% and 24.88% on specific crypto assets such as USDC and DAI. The platform Aave and Fulcrum give more than 10% return on popular crypto-assets such as the USDT, USDC, and DAI.
Platforms BlockFi and Nexo offer returns at the rate of 6-12% on the crypto world’s most popular asset—Bitcoin. With a market capitalization of nearly 1 trillion US dollars, Bitcoin occupies a little more than 60% of the total crypto market and equals almost US$50,000 in its per-unit price.
But, what’s the outcome of offering such a high rate of interest on such a popular asset? Has it boosted DeFi adoption rates? W1ell, the numbers indicate otherwise.
DeFi’s TVL is Under 2% of the Crypto Market
While the total market capitalization of nearly 8,500 cryptocurrencies traded in almost 34,000 markets has crossed the mark of 1.5 trillion dollars, the total value locked (TVL) in the DeFi space stands at US$19 billion. It does not occupy even 2% of the entire crypto market.
But why is it that despite offering such amazingly high rates of returns, DeFi has failed to capture the attention of more investors? We have seen, for example, the common trend of young Americans becoming increasingly active during the pandemic with stock and options trading. The markets were volatile, and millennials jumped in on the action.
So given the Fed’s drastic cut in interest rates, doesn’t the current situation create the precise situation that would foster DeFi adoption?
Surely, there’s more than a single answer to such complex questions. But, the one that seems to be of utmost importance is related to fund-protection practices.
Investors who keep a large chunk of their funds in the high-yield savings accounts are, at least, assured about the protection of their funds. According to the standard deposit insurance guidelines, the FDIC requires an insurance amount of $250,000 per depositor, per insured bank, for each account ownership category. DeFi fails to offer such protection.
So, exactly how much protection do stake funds receive via DeFi platforms?
How Protected are Assets Staked via DeFi?
BlockFi, a DeFi platform that offers returns at the rate of 5.25% and 6% on two of the most popular crypto assets of Ethereum and Bitcoin clearly states in the risk disclosure documents that its Crypto Interest Accounts do not get the protection of insurance against losses.
“Digital currency is not legal tender, is not backed by any government, and the BlockFi Interest Account is not a bank account nor a brokerage account, and is not subject to FDIC, SIPC, or other similar protections. Interest rates, withdrawal limits, and fees are subject to change and are largely dictated by market conditions. This is not a risk-free product and loss of principal is possible.”
Even if some of the platforms qualify for insurance benefits, the coverage is not often adequate. Bitfinex, a platform that offers crypto lending interest rates as high as 34.13% and 17.59% on assets like YFI and UNI, had fallen prey to severe cyberattacks where it lost $70 million worth of Bitcoin—at one go.
While its collaboration with BitGo made it eligible for FDIC-like coverage of $250,000 per account, it was not enough at all to cover the losses of the large-sized customers with funds over 1 million US dollars. According to BitFinex’s estimates, a minimum of $20 million of its hacked funds was ineligible for coverage.
Will DeFi Eventually Include Insurance?
The trend is on a shift. Nexo, one of such DeFi lending platforms, has built an insurance portfolio amounting to $375 million. Fulcrum, another similar platform, allots 10% of the interest paid by its borrowers to an insurance fund aimed at mitigating potential losses suffered by lenders when undercollateralized loans are not properly liquidated.
But, are these efforts enough? How feasible is it for the up-and-coming platforms working in such a nascent domain to ensure large-volume insurance funds? Until the industry comes under FDIC-like mandatory guidelines, will investors have to see the protection of their funds as a trade-off for the astoundingly high returns they are getting?
Of course, the future is unknown. And if the Fed continues to maintain near-zero interest rates, it’s more than likely DeFi will only continue to gain traffic in terms of staking and yield farming. But insurance will also likely remain an issue.
Staking ETH, for example, is done to earn interest, like a savings account—it’s not an investment. Yet with no insurance or protection, it basically is.
Do you think that FDIC-like mandatory guidelines will help to increase the adoption rate in DeFi? Are there any other changes that you would like to see in the DeFi space? Let us know in the comments below.