DeFi rates are falling closer to traditional finance, will users still come to “deposit” coins?

Perhaps DeFi is entering a new phase of real demand.

DeFi lending rates are showing a clear downward trend, which raises a new question: What happens if DeFi yields fall further and converge with traditional finance (TradFi)?

LoanScan data shows that USDC’s lending rates (borrowing rates) on Compound and Aave have dropped from around 15% three months ago to 2.5% and 3.1% respectively, with similar declines in lending rates. As the chart below shows, stablecoin (USDC) yields on Compound and Aave have fallen to 1.2% and 1.6%, respectively.

DeFi rates are falling closer to traditional finance, will users still come to "deposit" coins?

All rates of return in this article refer to the base rate of return based on interest rates and do not take into account the additional incentive generated by liquidity mining.

Before we get started, we need to explain what the borrowing rate and lending rate are.

Similar to the way traditional finance works, a user who lends money from a DeFi program pays a certain amount of interest, and the rate used to calculate this interest is the lending rate; conversely, a user who deposits money on a platform, which can be interpreted as lending assets to the platform, also receives a certain amount of interest, and the rate here is the borrowing rate. The lending rate and the borrowing rate tend to move in tandem, with the former usually being higher than the latter.

The interest rate can be understood as the cost of acquiring capital, and a lower rate means that it is cheaper to acquire crypto assets, which benefits the lending party but disadvantages the lending party. Earlier this year, users were also able to deposit crypto assets within the DeFi app at higher yields, which could sometimes exceed 10%, but now, those rates are dropping towards 1%.

MakerDAO, the head lending program, has launched a vote on a new proposal for governance a few days ago, aiming to further reduce the stabilization rate for protocol vaults (vaults) (by stabilization rate, I mean the interest rate that Maker users pay to deposit collateral to generate DAI). The details of the proposal show that each vault will face a different reduction in its stabilization rate.

DeFi rates are falling closer to traditional finance, will users still come to "deposit" coins?

Lower interest rates have begun to raise concerns among users, and on MakerDAO’s governance forum, a user called PaperImperium mentioned that declining interest rates would make the agreement unprofitable on an operational level.

Why is this happening?
State.eth, an anonymous interviewee who works on governance-related issues at Aave, said that a big reason for the drop in interest rates is that more stablecoins are flooding into the DeFi ecosystem, which in turn is depressing market rates. The logic is well understood: in economics, “price” always decreases as supply increases, and in lending agreements, the feedback of “price” is the interest rate.

State.eth further states that the underlying transactions on centralized exchanges (CEX) are now on the decline and people no longer need to trade on CEX, but can place their assets in DeFi to earn income, hence the large amount of money coming into DeFi. This is why the supply of stablecoins in DeFi is increasing.

In addition, another reason why lending rates are falling is that the additional incentive granted by liquidity mining is starting to fall. A protocol like Compound provides both borrowers and lenders with their own native tokens as a liquidity incentive, and once the incentive starts to shrink, the incentive for borrowers and lenders will start to fall as well, which will further drive rates down.

Following the current trend, DeFi’s borrowing and lending rates are gradually dropping to TradFi’s typical levels. The 10-year U.S. Treasury, the most popular government bond investment instrument in the TradFi market and representative of the current underlying interest rate profile of the TradFi market, closed at a 1.449% margin on July 2, which is quite close to the figure within DeFi.

What happens next?
As DeFi yields converge with TradFi, what will happen?

In the opinion of DeFi Pulse co-founder Scott Lewis, this situation is not entirely bad, but even a sign that DeFi is entering a stable phase of growth, a trend Lewis calls “the coupling,” stating that For the vast majority of DeFi’s short history, there has been a severe shortage of stablecoin supply that has pushed up immediate interest rates in the lending market, making it affordable only for leveraged traders, speculators and professional DeFi miner yield farmers, and crowding out normal loan demand.

DeFi rates are falling closer to traditional finance, will users still come to "deposit" coins?

But as DeFi’s interest rates become comparable to the traditional financial market, there will be more institutions or businesses looking to lend with this transparent, open and decentralized financing path, which will attract more liquidity to the entire DeFi ecosystem, a sign that DeFi is gradually encroaching on TradFi.

Of course, there are two sides to any story, and as interest rates fall, the yield on the borrowing side will undoubtedly fall.

As for the future direction of borrowing rates in the DeFi market, State.eth predicts that a return to higher rates will depend on the market being able to return to a full bull market. A bull market will increase demand for loans, as the rising price of the asset itself will cover the cost of interest rates, driving them higher again.

However, at the current rate of money pouring into DeFi, the supply of stablecoins will only continue to grow and the days of (stablecoin) yields staying above 10% for an extended period of time may never return, as one investor with long roots in the DeFi space put it, “The window of opportunity is closing.”

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/defi-rates-are-falling-closer-to-traditional-finance-will-users-still-come-to-deposit-coins/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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