Why Do Stablecoins Offer Such High Rates of Interest?

If you’re a finance nerd, the Coinbase-SEC kerfuffle this week about regulations and what constitutes a security is an interesting story.

I myself am a finance nerd so I read Matt Levine and the Brian Armstrong tweet thread but I know most people don’t really care about the intricacies of financial regulation.

Most people care about how Coinbase can possibly pay 4% on crypto deposits in a world where the average bank savings account pays 0.1%.

Britney Spears has been under conservatorship (#FreeBritney) for longer than crypto has existed. It makes sense if you remain confused or ill-informed about the workings of crypto because it’s so new.

I wrote a primer about stablecoins this past June:

A stablecoin is simply a cryptocurrency that is backed by reserves. So you get all of the benefits of the blockchain without the volatility of bitcoin and other cryptos. You can loosely think of stabelcoins as the money market fund of crypto.

I have some money in stablecoins at BlockFi. There are other places you can earn interest on your crypto or stablecoins.

If you check BlockFi’s current rates, they are paying 8% on your first $40k in stablecoins and 5% over that amount. This is just a tad more than the 0.5% I’m earning on my online savings account at Marcus.

How is this possible?

My first introduction into the world of crypto rates came from an Animal Spirits interview we had with BlockFi CEO Zac Prince around Thanksgiving time last year (listen here).

He explained to Michael and me why rates are so much higher in the crypto space than the traditional finance system:

Obviously, these rates are determined by market forces. They can and will change over time. The rates Zac quoted us back in November 2020 no longer apply (nor does the $20k bitcoin price).

But his explanation makes sense.

This is still a nascent industry. There is no FDIC insurance. There aren’t nearly as many regulations as a traditional bank account. There are other risks involved to earn these higher rates.

I would expect as more money pours into these products and they become more institutionalized that rates can and will decline in the crypto space. You’re already seeing some of that in certain products.

However, crypto is always going to be riskier than a savings account at the bank so I would imagine the rates will remain much higher than traditional yields for the foreseeable future.

You just have to understand that 8% doesn’t come without risk.

We’ve had Zac back on our show a number of times since his first appearance last November. Every time we chat with Zac our inbox1 fills up with questions about how to think about stablecoins in terms of your emergency savings.

Should you use stablecoins for your emergency fund?

Well, a lot of that comes down to how you actually define “emergencies” but we posed this question to Zac when we had him back on the show again last month (listen here).

His response may surprise some people:

I appreciate this response because there are so many people in crypto who are all-or-nothing. Either your all-in or you’re all-out.

Financial decisions are rarely all-or-nothing. These things require some thought and nuance.

Personally, I still have my online savings account with Marcus in addition to some money being held in stablecoins at BlockFi. I understand there are risks involved in stablecoins so I’m not going to keep all of my liquid reserves there.

I look at this as another form of diversification. The whole point of diversification is we don’t know what’s going to happen in the future so it makes sense to spread your bets.

I do think stablecoins can be a gateway for those who are interested in dipping their toe in the crypto space but don’t want to go all-in on the more volatile coins in the space.

And just as crypto is far more volatile than the stock market, stablecoins have more risk than a savings account. That’s one of the reasons you’re being compensated with much higher rates of interest.

Further Reading:
A Short History of Money Market Funds
Some Thoughts on Coinbase

And here’s another good episode we did with Zac where he explains in more depth what stablecoins are and why they exist:
Talk Your Book: Crypto as an Emerging Store of Value

1Send us an email: animalspiritspod@gmail.com