[Market Info] De-Fi Risk Free Rate

Published in

Coinmonks

4 min readJun 28, 2021

We have been working on the stablecoin business for a while and from time to time, we are asked: what’s the risk free rate for De-Fi?

It’s an interesting question, as De-Fi is inherently high risk. The entire industry has barely started last summer, no regulations, full of hacks and reg-pulls, and quite a lot of projects are anonymous. Nothing here is free from risk.

However, we believe in the principle of pareto improvement, i.e. given the risk set, what’s best yield one can achieve. It’s a reasonable choice not to invest in De-Fi or cryptocurrency at all. But if you do, what’s the minimum yield you should get?

Therefore, there are two issues here:

1) What’s the minimum risk exposure you have to take in order to earn some return in De-Fi?

2) What’s yield and how do you measure?

For the first question, we propose that you have to at least be exposed to one blockchain, one stablecoin, and one protocol. For now, we think Ethereum should be the safest chain, USDC and DAI are equally the safest stablecoin (USDT is out for alleged reasons it’s not fully backed). There might be a few safest protocols, we take Aave, Compound and Curve for now.

For the second question, it’s a bit tricky. Yield has to be USD-donominated. There’s a thin line between inflation and risk free rate, which we will discuss on another article on De-Fi inflation. For instance, you can hold eth2.0 and have 7% yield on ETH. Is this 7% risk free — it’s not risky but it’s not an income to the ETH system. Eth 2.0 staking yield basically redistributed ETH amongst validators and other holders; the value of ETH system does not change due to act of staking ETH. This is, in the economic sense, inflation. Risk free return has to be an income incremental to the system.

Therefore, now we take three yield readings, and take the arithmatic average of them to be the risk free rate:

$usdc saving rate + rewards on Aave
$usdc saving rate + rewards on Compound
Yields (base + rewards) of Curve 3pool (without boost)

As of today, the rate is 2.73%, being the average of 2.81%, 3.09% and 2.28%

A few things we have considered as well:

The yields include reward tokens, as we believe when investors compute return when making decisions on where to allocate capital, they generally consider all the streams of income. The reward token prices do fluactuate (quite a lot), but if we are taking a snapshot and treating the prices as-is, it’s less of calculation issue (but yes, a timing issue).
Uniswap V2 and V3 stablecoin pairs. They are also safe enough. But the design of V3 is not risk free. It’s effectively liquidity providing plus selling options. As such, the yields are firstly not reflective of the actual yield if you stretch a very long range for stablecoins; second, the returns comprised of option values. As V3 is not purely passive return on liquidity providing and has a risk component, V2 is affected indirectly as the liquidity providers move capital between V2 and V3. The rates might change due to market sentiments of price direction, rather than risks.
Choice of USDT, DAI and USDC. For this, we largely rely on Aave analysis. So USDC is chosen.
Curve’s Compound pool. This is actually Curve and Compound, two protocols and with Compound yield embedded.
Other centralised operations — we can reference Blockfi yield, but it’s not transparent on how it’s determined and plus, the yield is usually after deducting a component of the company cost (we believe De-Fi risk free rate should be higher, due to less cost of management).

We also seek your opinion in this and look forward to improve the De-Fi risk free rate in the future. Please contact us at Twitter SerenityFund.

(Serenity Team, 28 June 2021, Twitter: https://twitter.com/SerenityFund)

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[Market Info] De-Fi Risk Free Rate

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Written by The Serenity Research