Crypto is facing a winter unlike any other, confronted with monetary tightening and a historically strong dollar. Analysts speculate that higher interest rates will diminish investors’ appetite for high yield, high risk assets. Stablecoins, they argue, linked to the newly powerful dollar, like tether and USDC, are likely to be the winners of this new environment. Banks providing services to crypto firms will also profit from the interest earned on those firms’ deposits.
Alex Fowler is CEO at Transparent Systems. Patrick Murck is president and chief legal officer at Transparent and an affiliate at Harvard's Berkman Klein Center.
However, analysts have stopped short of investigating the implications of newly empowered stablecoin providers and banks for the rest of the crypto community. In doing so, they’ve ignored the emergence of a new rentier economy in crypto. Or, to put it in crypto-native language, a silent vampire attack.
The original vampire attack was about siphoning off liquidity from one automated market maker (AMM) platform to another. Though the perpetrators of this attack are different, the consequences are much the same: Crypto firms are bleeding capital and liquidity.
How has this phenomenon emerged? It’s well known that crypto has become increasingly reliant on centrally operated, asset-backed stablecoins such as tether and USDC – they are integral to the operations of crypto firms, traders and the DeFi (decentralized finance) sector. As stablecoin operators hold assets in reserve to back their coins, they receive interest on those reserves. Higher interest rates mean their profits are set to climb.
Circle estimated in its latest SEC filing that a 100 basis-point increase in interest rates in the first quarter of the year would have increased its annual interest income by more than $150 million. These stablecoin operators, however, do not share their interest income with their users. Nor do they share the income generated from users’ economic activity, though those users pay fees to utlize these private forms of payment.
To be sure, these firms have positively contributed to the crypto ecosystem. Nonetheless, this arrangement means that crypto firms are missing out on interest income that could be a meaningful addition to their balance sheet – particularly in a bear market.
Likewise, crypto firms are not the only affected parties – DeFi is also entangled in this extractive relationship. Consider, for example, MakerDAO’s Dai, which is often touted as crypto’s largest decentralized stablecoin. MakerDAO relies heavily on USDC to collateralize Dai. This creates several issues.
On the one hand, MakerDAO is silently paying a large fee to USDC’s operators in float interest. On the other, by relying so significantly on USDC, Dai becomes entangled in its accompanying risks and relationships. This makes Dai both vulnerable to any issues with USDC’s reserves and an unwitting party to USDC’s business relationships.
For example, Circle and Coinbase – which jointly founded Centre, USDC’s operator – share the revenue generated from USDC reserves. In this way, CeFi (centralized finance) and DeFi have come to be in a parasitic relationship, with CeFi leeching value from DeFi.
But stablecoin issuers aren’t the only entities behind this silent vampire attack. Just as crypto has come to rely on a few centralized stablecoins, crypto firms have increasingly relied on a small number of banks for fiat services. Silvergate Bank and Signature Bank, which provide the lion’s share of banking services to major industry firms, also stand to profit from higher interest rates – and to keep those profits to themselves. For example, Silvergate Bank projects in a 2022 SEC filing that for every +25bps increase in interest rates, its net interest income would increase by around $23 million.
Why do banks stand to make these gains? Crypto firms rely on these banks’ proprietary payment rails to facilitate their businesses. They must deposit funds with these institutions to conduct their transactions, but the deposits are not interest-bearing so crypto firms are unable to maximize returns on these funds.
In a bull market, it was perhaps easy for crypto firms to overlook this silent vampire attack or to simply write it off as the cost of doing business. But in a bear market – and in the face of a potential recession – this is unlikely to remain tenable. Crypto firms can no longer afford to cede interest income to banks and stablecoin providers, nor should they when innovative alternatives are available to defend against this attack.
Applying the principles honed in the last bull market – collective ownership, decentralization, and shared financial benefits – to the fiat side of crypto businesses is one potential antidote. This isn’t simply wishful thinking – Xand, a software protocol and governance platform developed by our company, Transparent, enables businesses to deploy these ideas today. Other proposals are emerging for tokenizing deposits that may also provide more equitable arrangements in the future.