The Tether equation for investors: risk vs yield

There is a very simple reason for Tether’s dramatic growth as a cryptocurrency despite questioning of the way it operates: yield.

The world’s largest so-called stablecoin has grown more than 300 per cent in size in the past 12 months, with nearly $71bn of funds currently parked in the digital coin. In the last 30 days alone, it has drawn some $1.5bn of funds.

Stablecoins are pegged to other assets such as mainstream currencies, enabling them to act as a bridge between the crypto and traditional finance worlds. Traders use traditional currency to acquire stablecoins and then buy other crypto assets with them or lend out their holdings for a fee.

Tether dominates this market after rapidly expanding despite intense regulatory and media scrutiny over the asset backing for the cryptocurrency.

This month the company agreed to pay a $41m penalty to resolve a US regulator’s claims that it had falsely represented that its digital tokens were fully backed by dollars. Claims also emerged this month that the company even issued new stablecoins in exchange for cryptocurrency-backed loans.

But Tether continues to grow partly because it is a key lubricant of the rapidly growing industry for lending and borrowing digital assets. It is also used as collateral for transactions and for loans denominated in other cryptocurrencies.

Such is the demand for this that Tether pays handsome returns to holders when they lend out their tokens.

“Stablecoin yields on established platforms are typically around 5 per cent — about 10 times the yields available on insured bank deposits,” wrote Goldman Sachs analysts in a report earlier this month. “And these yields can be enhanced in a variety of ways (including with leverage).”

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In a world of low interest rates, returns like these are fuelling the growth of wholesale crypto “money markets” where large investors borrow and lend these assets for a profit. Some crypto companies that tout juicy returns to retail clients from cryptocurrencies are simply lending out stablecoins in wholesale markets.

Max Boonen, the chief executive of one of the largest cryptocurrency trading firms, B2C2, says there is also a rapidly growing derivatives market for cryptocurrencies powered by the $100bn of assets parked in stablecoins overall.

“We are close to having an institutional market for yield products. This is a market that’s reasonably large now,” Boonen adds.

Investors are willing to pay a premium to borrow stablecoins for several reasons, one of which is to place bets and profit from the difference between futures and cash prices. Brokers such as Robinhood and eToro also use stablecoins to hedge against price volatility while trades settles.

This fledgling digital money market is still relatively small compared with the trillions of dollars worth of activity that takes place in traditional assets such as equities and bonds. But a year ago, this market hardly existed. Now companies are writing certificates of deposit, agreeing short-term loans and issuing commercial paper.

“The next step will be asset management and stablecoins themselves could convert into a fund. Crypto bonds that pay out in stablecoins are also on the horizon,” Boonen says.

However, this market is still rife with risk. Regulators are now circling.

On Thursday a global standard-setting body laid out standards for decentralised finance markets, where a lot of the lending and borrowing activity takes place. More regulation specifically targeting stablecoins is also set to follow, according to industry sources. Rating agency Fitch has already warned that stablecoins could lead to contagion in credit markets.

More broadly, crypto trading itself is still unregulated and lacks the scope of investor-protection measures that come with traditional asset classes. And the debate over what the inherent value of crypto assets actually is still rages.

Despite their rapid growth in the past year, cryptocurrencies have many critics who think the inherent value of digital coins is zero. Jan Kregel, an economist and director of research at the Levy Economics Institute of Bard College in New York, says cryptocurrencies are nothing but a video game, warning that as the sector grows, so do risks to the financial system.

“There is potential for the crypto world to blow up and cause a bigger crisis than subprime. It’s not so big now, but in the future it could absolutely happen,” he says.

eva.szalay@ft.com

This news is republished from another source. You can check the original article here

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