The Risk and Return of USDS
※Added on 04/12/2021
This is an overview of v0 of Soteria. Once derivatives dex starts accepting BTC or SOL as collateral, we will not custody funds and users will be able to issue/redeem USDS trustlessly.
How do users of USDS receive interest? Does Soteria lend out the bitcoin it receives? In this post we explain how Soteria is able to generate interest for USDS users. We also explain why it’s less risky and more efficient than lending out your stablecoins like USDT, USDC to lending platforms (BlockFi,Celsius etc).
To understand how users receive interest, it is useful to understand how Soteria operates in the backend. When Soteria receives BTC from our users, Soteria issues USDS in return. We then send the BTC to FTX and short an equivalent amount of futures. Since our position is delta-neutral, our position is unaffected from BTC price fluctuations. As a result, we are able to issue/redeem USDS at par value.
Now since the BTC futures curve is most of the time in a contango structure, we are able to pay that futures basis directly to our users in the form of interest. USDS is an ERC-20 token which grows by the amount of interest and is paid directly to your wallet.
The BTC futures curve is important because it determines how much interest users receive. You can check the BTC futures curve of various cryptocurrency exchanges here and can verify that the interest that you receive is very close to the BTC futures annualized rolling basis of FTX.
How much interest will you receive?
Many of our users might wonder how much interest they can receive over the long run. Is the futures curve sustainable? To answer this question, we will look at the OKEx 1 month futures rolling basis(We use the FTX 1 month futures for hedging but since OKEx has a longer history we will use the OKEx data).
The OKEx 1 month futures rolling basis is the interest you receive when you roll the 1 month futures constantly. You can see that it averages to 8% APY. We expect to pay out an equivalent amount of interest to our users over the long run. Our current interest rate is 10% APY because the BTC futures curve is steeper than average. In BTC bull markets, the futures curve will be steeper than average, which enables us to pay a higher interest rate.
What is the risk?
Being able to earn 8% interest per year just by holding on to USDS seems to be too good to be true. 10y US treasury bonds yield less than 1% per year. If markets are efficient there must be some kind of risk involved in owning USDS.
The risk of owning USDS compared to US treasury bonds is counterparty risk. US treasury bonds are basically risk-free. The Federal Reserve can always issue more currency to buy US Treasury bonds, so the US government is protected from default(The USD may inflate and lose its value but that is another question). On the other hand, if Soteria or FTX loses access to its BTC, the USDS will not be backed 100% by bitcoin and may result in USDS losing its peg. Soteria may not be able to redeem users if that happens.
Why it’s better than keeping your coins on lending platforms
You can currently earn interest with other stablecoins by saving them on lending platforms.
The lending platforms then lend them out to market makers and cryptocurrency hedge funds, which then tries to capture the basis on futures. There are several problems with this structure.
1. Too many intermediaries
Since both the lending platform and market makers, hedge funds have to make a profit, the users who have their stablecoins on these platforms receive interest after their profit. The lending platforms have to do due diligence on their counterparties and also have to do KYC/AML whenever they onboard users. All of these add up and ultimately results in less interest for users.
Soteria’s simple structure minimizes cost and is able to pass on most of its interest to their users.
2. Inconvenient
To earn interest on their stablecoin, users have to put them on a lending platform for some period of time. During that period, users cannot exchange their stablecoin for other cryptocurrencies or transfer the stablecoin to other platforms. They have to wait for a set period of time to expire until they can exchange or transfer their stablecoin. Interest is also paid out in intervals, ranging from 1 week to several months.
Users also have to go through KYC/AML of lending platforms, which is inconvenient and may reject some users from onboarding.
On the other hand, users of USDS will earn interest everyday whether the USDS is stored on Soteria’s wallet or in the users own wallet. Users can exchange or transfer USDS at any time. This makes USDS much more convenient than savings accounts at lending platforms.
3.Not transparent
Lending platform’s source of interest is not transparent. They lend stablecoins to various market makers, hedge funds, and institutions but their balance sheets are not disclosed to the public. Furthermore, they do not disclose how they generate returns which sometimes result in the counterparty engaging in fraudulent activities.
Soteria’s source of interest is transparent. It is the BTC futures basis on FTX. You can go to this website and verify for yourself that the interest rate that we pay does not deviate from the BTC futures basis of FTX.
In the future, USDS will be listed on CEX(Centralized Exchanges) and DEX( Decentralized Exchanges), which will allow users to trade between USDS and cryptocurrencies. This will increase the liquidity and utility of USDS, which will directly benefit users.
Since USDS is an ERC-20 token, users can withdraw USDS to their own wallet and receive interest. USDS is like a digital swiss bank account, which users control at their complete discretion and enables them to store value in a stable currency anonymously.
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