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DeFi and Credit Risk
Due to monetary tightening and a historically high dollar, the cryptocurrency market is experiencing a winter unlike any other. Analysts predict that investors' enthusiasm for high return, high risk assets will decline as interest rates rise. They contend that the victors in this new climate will likely be stablecoins like tether and USDC that are linked to the newly dominant dollar. The interest earned on the deposits held by crypto companies would benefit the banks that provide those companies with their services.
The CEO of Transparent Systems is Alex Fowler. Patrick Murck is the president and general counsel of Transparent as well as a member of the Berkman Klein Center at Harvard.
Analysts, however, have not yet looked into how the newly empowered stablecoin suppliers and banks will affect the rest of the crypto ecosystem. They have neglected the rise of a new rentier economy in crypto by doing this. Or a stealth vampire attack, to use the parlance of crypto-natives.
Transferring liquidity from one automated market maker (AMM) platform to another was the initial vampire attack's goal. Despite the fact that this attack's perpetrators were different, its effects were mostly the same: Crypto companies are losing money and liquidity.
How did this phenomenon begin to exist? It is commonly known that the operations of cryptocurrency companies, traders, and the DeFi (decentralized finance) industry depend heavily on centrally managed, asset-backed stablecoins like tether and USDC. Operators of stablecoins gain interest on the assets they have in reserve to support their coins. Their earnings will increase as interest rates rise.
A 100 basis-point increase in interest rates during the first quarter of the year, according to Circle's most recent SEC filing, would have improved its yearly interest income by more than $150 million. However, these stablecoin providers do not distribute their interest earnings to their customers. Additionally, despite the fact that consumers pay fees to use these private forms of payment, they do not share the profits made from their economic activities.
CeFi and DeFi have come to be in a parasitic relationship, with CeFi leeching value from DeFi
These companies have undoubtedly improved the crypto ecosystem. However, because of this arrangement, crypto enterprises are losing out on interest income that might significantly boost their balance sheet, especially during a bear market.
Likewise, DeFi is also involved in this exploitative arrangement, making crypto businesses not the only ones who are impacted. Take Dai from MakerDAO, which is frequently referred to as the most decentralized stablecoin in crypto. Dai is heavily collateralized by MakerDAO using USDC. This causes a number of problems.
One the one hand, MakerDAO secretly pays USDC's operators a sizable sum in float interest. On the other hand, because Dai depends so heavily on USDC, he is drawn into the associated relationships and risks. Due to this, Dai is exposed to any problems with USDC's reserves and unwittingly participates in USDC's business dealings.
For instance, the income from USDC reserves is split between Circle and Coinbase, who founded Centre, the company that runs the cryptocurrency. This has led to a parasitic connection between CeFi (centralized finance) and DeFi, with CeFi draining value from DeFi.
However, there are other organizations driving this covert vampire attack besides stablecoin issuers. The same way that cryptocurrency has come to rely on a few few centralized stablecoins, crypto companies have come to depend more and more on a select few banks for fiat services. Higher interest rates will also benefit Silvergate Bank and Signature Bank, who supply the majority of banking services to significant industry enterprises, and they will retain those gains to themselves. For instance, Silvergate Bank estimates in a 2022 SEC filing that its net interest income would rise by about $23 million for every +25bps increase in interest rates.
Why are banks in a position to profit from this? In order to run their businesses, cryptocurrency companies rely on these banks' exclusive payment rails. To complete their transactions, they must deposit money with these institutions, but because these deposits do not pay interest, cryptocurrency companies are unable to get the most out of their money.
It may have been simple for crypto companies to ignore this stealthy vampire attack during a bull market or to simply write it off as a normal business expense. This is unlikely to hold true during a down market and in the event of a probable recession. Since there are creative solutions to thwart this attack, crypto companies can no longer afford to cede interest income to banks and stablecoin suppliers. Nor should they.
One potential remedy is to apply the ideas developed during the previous bull market—collective ownership, decentralization, and shared financial benefits—to the fiat portion of crypto firms. This isn't just wishful thinking; firms can already implement these concepts thanks to Xand, a software protocol and governance platform created by our company, Transparent. There are further ideas for tokenizing deposits that could eventually result in more equal arrangements.
Interest rates are currently between 2.25 percent and 2.5 percent, therefore crypto enterprises must evaluate their payment providers more carefully and use cutting-edge systems, like Xand, that enable users to directly participate in the interest advantage.
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