[Strategy Paper] Assess the Risk of Stablecoin Investments
We have earlier published two articles on stablecoin investments: Overview of Asset-Backed Stablecoins and Overview of Stablecoin Investment. Every week, we publish the returns of the selected stablecoin investment products in our Medium and Twitter.
Returns can be potentially unlimited, e.g. if you find a high-yield product and gear it multiple times, or ape into exotic product at first instance. However, risk can also be unlimited. We generally believe the cryptocurrency market is sufficiently large, liquid and transparent; so it’s an efficient market — risk and return are pretty much highly positively correlated.
Nonetheless, the cryptocurrency market, especially the one-year old De-Fi market, lacks data to prove it. We all know the risks are there, but we are not good at quantifying them. For instance, what’s the risk premium of shifting your stablecoin from Ethereum to Polygon? One way is to look at the yield difference of depositing DAI in Aave on both Ethereum and Polygon. On average, the major stablecoins provide 2.1% higher return on Polygon, ceteris paribus. So, we can reference that the implied Polygon risk premium over Ethereum is 2.1%. There are just not many ways to make comparison like this.
A more general but not quantitative way is to provide a comprehensive scorecard for any stablecoin investments. Firstly, we categorise the risks of any stablecoin product into 4 groups:
- Blockchain risk
- Stablecoin risk
- Protocol risk
- Strategy risk
Blockchain risk is how safety level of the blockchain compared to Ethereum, e.g. Polygon is probably slightly more risky than Ethereum, but safer than other new chains.
Stablecoin risks refer to what kind of stablecoins are used for the investment purposes. Some protocols uses only USDC or DAI, e.g. KeeperDAO or Idle Finance; some mingles your deposits into a pool like Curve’s 3pool, so the exposures are USDC, DAI and USDT; some issues its own stablecoin, e.g. Alchemix’s alUSD. Each stablecoins have their own risk, so you can arbitrarily assign a risk score to it, base on your own understanding.
Protocol risks are easier to understand. They are about how safe the protocol is, i.e. If it will rug-pull. Factors include anonymity, audit, TVL scale, VC backing, etc.
Strategy risks are a bit more complex and need knowledge of the protocols to understand the risks involved. But put it simple, it’s about if the economic design of the protocol and how much you might have your principal and yields converted into some other tokens.
Let’s take Alchemix’s as an example:
The more “Yes” scored in the table and the larger the weights of the risks, the higher the risk score, meaning the higher the risk. All the risk weights are arbitrary, you can assign a weight to each risk yourself and/or amend the types of risks.
Hope this helps you in understanding the risk exposure of your stablecoin investments.
(Serenity Team, 4 June 2021, Twitter: https://twitter.com/SerenityFund)
