The tether equation for investors: risk vs. return

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There’s a very simple reason for Tether’s dramatic growth as a cryptocurrency, despite questioning how it works: its returns.

The world’s largest so-called stablecoin has grown by more than 300 percent in the past 12 months, with almost $ 71 billion in funds currently parked in the digital coin. In the past 30 days alone, it has drawn around $ 1.5 billion in funds.

Stablecoins are tied to other assets, such as mainstream currencies, so they can act as a bridge between the crypto and traditional finance worlds. Traders use traditional currencies to purchase stablecoins and then use them to purchase other crypto assets or borrow their holdings for a fee.

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

This month, the company agreed to pay a $ 41 million fine to clear up allegations by a U.S. regulator that it falsely presented that its digital tokens were fully backed by dollars. Claims also surfaced that month that the company was even issuing new stablecoins in exchange for cryptocurrency-backed loans.

But Tether continues to grow, in part because it’s a major lubricant for the fast-growing digital asset lending and borrowing industry. It is also used as collateral for transactions and for loans denominated in other cryptocurrencies.

The demand is so great that Tether pays the holders a nice return when they loan their tokens.

“Stablecoin returns on established platforms are typically around 5 percent – about ten times the returns available for insured bank deposits,” Goldman Sachs analysts wrote in a report earlier this month. “And these returns can be increased in various ways (including leverage).”

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

Max Boonen, the CEO of one of the largest cryptocurrency trading companies B2C2, says there is also a rapidly growing cryptocurrency derivatives market, fueled by the total of $ 100 billion worth of assets parked in stablecoins.

“We are on the verge of having an institutional market for income products. This is a market that is relatively large now, ”adds Boonen.

Investors are willing to pay a premium to borrow stablecoins for a number of reasons. One of them is to place bets and take advantage of the difference between futures and cash prices. Brokers like Robinhood and eToro also use stablecoins to hedge against price volatility during trade execution.

This fledgling digital money market is still relatively small when compared to the trillions of dollars worth of activity taking place in traditional assets like stocks and bonds. But a year ago this market hardly existed. Now companies are writing certificates of deposit, arranging short-term loans and issuing commercial papers.

“The next step will be asset management and stablecoins themselves could be converted into a fund. Crypto bonds that are paid out in stablecoins are also in sight, ”says Boonen.

However, this market is still fraught with risk. Now the regulatory authorities are circling.

On Thursday, a global standards body set standards for decentralized financial markets, where a large part of lending and borrowing takes place. According to industry sources, further regulations are also to follow that specifically target stablecoins. The rating agency Fitch has already warned that stablecoins could lead to contagion in the credit markets.

In general, crypto trading itself is not yet regulated and it lacks the level of investor protection that comes with traditional asset classes. And the debate about what the inherent value of crypto assets actually is is still raging.

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

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

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