by Adil Abdulali, Chief Investment Officer at Securitize Capital
Feb 24, 2022
Like a wanderer in the desert who would pay anything for a cold glass of water, digital asset markets are starved for U.S. dollars and will pay to use them. The strong demand for full-reserve digital dollars like USD Coin (USDC) is putting a premium on supply. This supply-demand imbalance creates opportunities for borrowing and lending, which can generate significant yield for accredited and institutional investors. While alternative investments have long been a hedge for institutions, one alternative might not yet be in view – stablecoin yield.1
Stablecoins are a relatively new form of cryptocurrency that directly correspond to fiat currencies like the U.S. Dollar. You can think of stablecoins as distinct units of digital money that are purpose-built for the internet. This new, internet-native currency came into existence as a way to lower the costs and friction of processing payments online, and maintain a stable asset price for trading digital assets against. Today, stablecoins provide an efficient medium of exchange that can move the industry forward.
Unlike cryptocurrencies like bitcoin which generate value by consensus, stablecoins use existing financial instruments like cash and treasuries as collateral to give each unit a stable value. For everyday users, this translates into faster, cheaper transactions. For investors, stablecoins mean new opportunities to invest. Understanding how these new financial instruments work can help all parties keep sight of their goals.
What’s in a Stablecoin?
Stablecoins vary in currency and composition. Some early stablecoins like Tether (USDT) and Dai (DAI) are denominated in dollars and composed in different ways. As a result, there can be slippage in how these stablecoins trade and what they trade against. It is important that investors take note of the difference between stablecoins with provable reserves and those with approximated or algorithmic reserves.
Full-reserve stablecoins like USDC carry all the benefits of these earlier stablecoins like settling faster and costing less to transact in than using traditional payment services, and the certainty of knowing that each USDC token is backed one-to-one with assets in reserve. This digital currency composition brings new opportunities to save, invest, lend, and borrow.
USDC also brings with it institutional trust. The fully collateralized stablecoin is highly liquid and used daily by trusted institutions around the world. In fact, Circle, which is behind USDC, announced that it is going public specifically to increase trust and transparency across its user base. When this was announced, Circle’s CEO, Jeremy Allaire, took the opportunity to bring USDC’s transparency to the fore. In a statement, Allaire vowed Circle to be "the most public and transparent operator of full-reserve stablecoins in the market."
When you add lending operations to the mix, new cryptocurrency yield funds like the Securitize USDC Yield Fund can offer investors access to potential returns that outperform average U.S. savings accounts by more than two orders of magnitude. This is accomplished by arbitraging the difference in demand for digital dollars like USDC and the supply currently available. So far, these lending operations have generated some pretty impressive returns. Let’s explore what they are and how yield funds may help increase portfolio performance.
USDC processed more than $2.5 trillion in on-blockchain transactions in 2021 alone. Compared to Visa’s payments volume for 2021, which clocked in at $10.4 trillion dollars, USDC’s adoption rate is staggering. In fact, USDC’s market cap recently reached a $50 billion market cap and continues to surge in size. With nearly a quarter of Visa’s payments volume transacted in 2021, USDC’s growing pace of adoption signals a strong demand for full-reserve digital dollars.
This increased demand also signifies trust, which is needed to build new financial products and services. As inflationary pressures make public asset valuations extremely volatile in the short term, investors tend to flock to cash and other safe haven assets to weather the storm. New lending operations enable funds denominated in USDC to generate annual percentage yields that can potentially exceed traditional high-yield savings accounts. When you marry this fixed income stream with USDC’s downside protection as a full-reserve stablecoin, you get a new financial instrument with institutional appeal.
As the larger macroeconomic environment trends towards inflation, USDC yield funds can potentially provide steady returns on stable assets. With domestic inflation reaching 7.5% in early 2022 and the industry benchmark only averaging 7%, investors need more options. The USDC Yield Fund provides optionality, and has the potential to put purchasing power back in the hands of USDC holders with a refreshed ability to invest.
In order to grow, institutions have an obligation to deliver targeted rates of return. Adding USDC yield to institutional portfolios can provide a new fixed income stream denominated in an asset that is accelerating in both volume and velocity, which has already grown by more than 20% in total market capitalization since 2021. This is what I call a “cash hedge,” or the ability to hedge depreciation risk with stable assets that have the potential to yield significant interest over time.
Using USDC yield as a cash hedge has the potential to provide a rate of return that exceeds current inflationary pressures and enables institutions to deliver on their obligations with compounding interest. In other words, yield funds provide investors optionality in an environment that can otherwise feel like a desert.
Institutions seeking long-term appreciation in other cryptocurrencies also have options. Securitize offers investors BTC and ETH Yield Funds that generate potential returns using similar lending operations. These funds take custody of the underlying assets and reinvest yield produced from lending to compound interest over time, giving investors exposure to beta plus interest.
For accredited and institutional investors seeking optionality, setting up a cash hedge can help bridge trading between other investment opportunities. Investors can take yield generated from one fund and invest it into another, creating new alternative investment buckets for different time horizons.2 In volatile markets, having this optionality combined with the ability to outpace inflation may be worth more than a cold glass of water in the hot desert sun.3, 4
Private market investments are speculative and considered risky, including potential loss of your investment, and may not be appropriate for every investor. Private investments are generally an illiquid asset class; investors cannot sell their funds when they want to without potentially facing high losses. Any discussion of liquidity is purely speculative.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.
Investors should consider the risks relating to digital assets and conflicts of interest, including that Securitize Capital is an affiliated entity and may be under common ownership. Securitize Capital Markets and Securitize Markets are under common ownership. Please refer to the Conflicts of Interest of the offering documents prior to investing. Any questions should be addressed to the funds.
Securitize Markets is an affiliate of Securitize Capital, LLC, (Securitize Capital) both of which are wholly owned by Securitize, Inc., their parent company. James Finn and Carlos Domingo are general partners of Securitize Capital. James and Carlos are general partners in certain yield fund offerings that we are retained to provide services and receive payments for, thus, creating a conflict of interest.