Cryptocurrencies and decentralized finance, known as DeFi, are a new, intriguing investment option for p2p investors. Euro-based p2p lenders are used to lending in Euros and getting repaid in Euros from European borrowers. And it works. But there’s a bigger market out there than just European borrowers.
With cryptocurrencies, the unit of account is in crypto. This means that what we lend and how we are repaid is in crypto, and it does not matter if the borrower is in Argentina, Andorra, or Afghanistan. DeFi lending is past the experimental stage. Loan volumes dwarf all but the largest US-based p2p lenders. Compound, which is not even the largest DeFi platform, has done over $5 billion USD loan volume.
But not all cryptocurrencies are created equal.
The best cryptocurrencies for lending purposes, and the lowest risk, are stablecoins.
What Is a Stablecoin?
A stablecoin is a coin whose goal is price stability. If you have looked at the price of Bitcoin, Ethereum, Litecoin, or any other big cryptocurrency, then you know that they are volatile. That price volatility is good for investment purposes but bad for specific uses like payments.
When you are buying something that costs 50 Euros, you don’t want to be paying 56 Euros or 48 Euros because your method of payment does not have a stable price. Payments are one of the two best uses of stablecoins.
How do they maintain price stability?
Different stablecoins have different mechanisms to maintain price stability. The most common methods are:
- Fiat (tied to a currency like the USD, EUR, Yen, or CNY) like Tether or USD Coin (USDC)
- Commodity (tied to a commodity like gold) like PAXG, whose price tracks the price of gold
- Crypto (tied to a cryptocurrency like Bitcoin) like WBTC or Wrapped Bitcoin. WBTC allows for Bitcoin to be Ethereum compatible and traded on its blockchain despite Bitcoin being on its own separate, non-compatible chain.
- Non-Collateral backed Algorithmic coins (tied to supply and demand) are coins that are enforced by code. The program examines supply and demand for the coin and adjusts the price accordingly. It’s automatic and always attempting to find the market price for the coin.
By far, the largest and most popular are fiat-backed coins. Six of the top 7 stablecoins (All but Dai) on this list from crypto data provider Messari are fiat-backed coins. You see in column 3 that Tether is by far the largest stablecoin by market cap and the most used. It’s particularly popular in Asia as a bridge between Asian currencies and crypto exchanges.
Stablecoins tied to fiat, commodities, or crypto (#1-3 above) are actively managed to maintain their pegs to the USD or Gold or Bitcoin. That management can include buying or selling assets as well as issuing or burning (destroying) existing coins to keep supply levels where they need to be. It’s not that different from what a central bank has to do, except these coins answer to the market while the Federal Reserve in the US prints as much money as they want to. The algorithmic only stablecoins are managed passively by the code only. They manage their supply based only on the market for the coin.
What are Stablecoins Used For?
If a stablecoin’s purpose is to maintain price stability, then by definition, people are NOT holding it for investment. The idea is for USDC or the Gemini Dollar (GUSD) to stay at or close to $1. There’s not much money to be made between 98 cents and $1.02 on price appreciation for a stablecoin. So people hold stablecoins for two reasons:
- Common Unit of Account
With all the customers that businesses have living in different countries and buying online, one of stablecoins’ best uses is Payments. A German business can easily sell to a Kenyan buyer or a Singaporean buyer and pay electronically with a stablecoin. Your $50 purchase will still be $50 when you make your payment and will still be $50 when the seller receives it. Both sellers and buyers all around the world want a stable price for a good when they buy it.
Common Unit of Account
While this is related to payments, a common unit of account is its own worthwhile goal. A unit of account means what currency and denominations we will lend and the borrower will repay us. The unit of account is one of the three things, along with a medium of exchange and store of value that makes something money.
For us as p2p lenders, stablecoins are a great unit of account. The most common are denominated and backed by US Dollars, and it doesn’t matter where our borrower is. They repay us in dollars. While this is a big advantage for us in USD or Euro countries, you may think this hurts an Asian or African borrower. But it doesn’t. The access to capital in some of the emerging markets is much better in cryptocurrencies than it is in their home currency.
So we can lend to anyone, anywhere with the common unit of account we get from stablecoins.
Earning Interest in Stablecoins
As a p2p lender, we will take advantage of both use cases. We will be using the payment feature to lend and be repaid. We will be using the unit of account feature to ensure how we will be paid with as little friction and currency exchange risk as possible.
So how will we earn interest in stablecoins through p2p lending? Here’s how
Liquidity Pools = Automated Investing
Many p2p lenders love the automated investing features platforms offer, so your money does not sit around earning nothing. Whether it’s Compound on Ethereum or BlockFi on their platform, you can immediately start earning interest in stablecoins. You only need your account ready and your wallet linked to the platform.
On Compound, you can earn the following rates on the top 5 assets.
Of those rates, the stablecoins are 4 of the top 5 by supply. Only Ether is not a stablecoin. The 5.13% on USDC is an attractive rate to lend your coins, and all you have to do is link your crypto wallet to Compound, and you can start right away.
On BlockFi, you can earn the following rates with their BlockFi Interest Account.
Of these ten assets, the stablecoins are the last 6 in the list from USDC down to BUSD. Rates are attractive here, too, where you can earn 8.6% or even 9.3% if you decide to lend Tether USDT. PAXG is a gold-backed stablecoin, and all the others are USD-backed.
Another option is MyConstant, who offers a liquidity pool with instant withdrawal as well as crypto lending with flexible withdrawal schedules.
More Advanced Stablecoin Investments
The term yield farming is when an investor actively searches and changes where they invest on crypto platforms. The liquidity pools, unlike the pools we discussed above, consist of two assets. One asset of the liquidity pool will be a stablecoin or high-value cryptos like BTC or ETH. The other asset is always a smaller, lesser-used asset that needs the liquidity you are providing. You invest equal amounts in both coins. Your stablecoin portion will earn interest. Your 2nd asset interest can be converted to a stablecoin, but you have to take that step and do it yourself. We will have more on this topic as much of it is beyond the scope of this article. Newer investors in crypto p2p lending will want to stick with the automated investing-like stablecoin options. With stablecoins, you can earn interest on your coins from borrowers outside your home region and all around the world with low currency or exchange risk.