Rates in DeFi money market: Connection between on-chain lending yields and the basis trade

TL;DR

What a surprise — rates in crypto are connected! In this article we explore correlation between yields on stablecoin lending and ETH delta-neutral basis trade. Based on that, we suggest indicative money market yield ranges applicable to different parts of market cycle.

Yields from basis trade have to be distilled from counterparty risk to be comparable to on-chain lending yields, and this is what Resolv USR has under the hood. Good news is that USR yield natively outperforms on-chain money market benchmarks!

INTRODUCTION

As the market experiences a bullish trend, opportunities to earn substantial returns in crypto money market have also increased. Right now those yields hover around 10–15% across prime Ethereum Mainnet protocols such as Aave, Compound and Spark. On L2 networks, those yields are even higher, hitting 30% at some points.

In this deep dive we have looked at correlation between different sources of money market yield in DeFi. One insight is that, knowing trends, we can move on from gazing at fleeting 30%+ 1-day APY figures and start predicting longer term average rate environment.

RETROSPECTIVE: HOW HAVE DEFI MONEY MARKET YIELDS BEEN EVOLVING

What is DeFi money market? Looking at Defillama, we have defined benchmark consisting of yields at Aave, Compound and Spark as top protocols based on their contribution to TVL.

The chart below captures a period starting from November 2022 to March 2024, presenting 30-day moving average APYs of three main stablecoin yields (USDT, USDC, DAI) collected across Aave, Compound and Spark. For benchmarks, 3 month T-bill rates are also shown on the chart.

DeFi lending vs 3m US Treasury rates

T-bill yields have shown consistent yield at 4–5% APY, while stablecoin yields initially reported lower figures, hovering at or below 2% APY. However, there was a gradual increase in the market average. Recently, starting from December 2023, the yields caught up with T-bills and then surpassed them.

The risk-averse sentiment that preceded 2024, lower interest in leverage and general uncertainty were one of the reasons for low stablecoin yields.

Nevertheless, as the crypto space is getting hotter, especially with the rise of first Bitcoin ETFs, and a use case for massive leverage in the bull run, there is a higher demand for money. Hence we are experiencing much higher interest rates across DeFi.

MARKET DRIVERS OF STABLECOIN YIELDS

Picking up on the leverage topic, let us dive deeper here! Higher demand in taking long positions in BTC and ETH has multiple effects on the rate environment. First, on-chain lending pools are utilized more, as market participants want to gain more leveraged positions across the space. Secondly, building more leveraged long token positions on perpetual exchanges results in higher funding rates. This hints at an idea of looking at two different sources of delta-neutral money market yields — on-chain lending and synthetic USD basis.

Let us look at yields of ETH basis trade strategy against composite money market yield (USDC, USDT, DAI across Aave, Compound, Spark).

ETH basis trade vs money market yield benchmarks

In recent months, starting from November 11, higher money market yield became more correlated with basis trade yields as the latter also was getting higher. Scatter plot below can provide a bit more insights into the correlation between the two yields.

Scatterplot: correlation between basis trade and DeFi money market benchmark

While the exact nature of what drives the yields is much more complex, definitely there is correlation. In particular, the last chart clearly indicates that APY of the strategy in the upper range is more linearly correlated with higher money market yields. In general, such structural correlation between the variable rates in DeFi and basis trade was already discussed in a great research article by Galaxy.

This correlation, on a practical level, gives us a reason to identify benchmark yields for different parts of market cycle and forecast accordingly.

DeFi and ETH basis rate through different phases of market cycle

During bearish 4Q 2022 and 1Q 2023 phase of market cycle, yields on stablecoins were bound within 1.5–2% range. In relatively neutral segment of 2–3Q 2023, yields started to catch up with US Treasuries with average moving from 2 to 4%. A few competition-driven reasons for that is the emergence of yield-bearing RWA stablecoins and Dai Savings Rate hikes in the summer.

By the end of 2023, with the rise of the bullish cycle, the yields soared and increased their rate of change, so starting from November 2023 we see a structural increase from around 5–7.5% to 12–15%.

SOURCING SUSTAINABLE MONEY MARKET YIELD FROM BASIS TRADE

It is a great idea to understand which instruments are more competitive among the sources of money market yield. But how do we compare benchmark DeFi yields (or US Treasury rates, or any other benchmark, really) and the basis trade, which contains a few types of exposure, most notably counterparty risk?

For Resolv, the idea is to split general delta-neutral yield into (1) money market yield; and (2) risk premium. We have approached this by segmenting the delta-neutral trade into two pools: USR and RLP. USR allows to achieve a money market-like yield which is protected by a higher yielding RLP pool where counterparty exposure is isolated.

Yield profile of these instruments is different. For example, if a basis trade strategy is earning 15% APY, staked USR holder would achieve 9% while RLP holders will get 40%. We have earlier covered details of the double tranche model which distributes the strategy return.

Modeled USR staking yield vs DeFi money market benchmark

This way, Resolv utilizes the fundamental relationship between market yields and basis trade yields, allowing to construct a money market-like instrument with higher yield. The chart below demonstrates raw staked USR performance against the market yield. Note positive spread between USR yield and market average benchmark!

CONCLUSION

Yield of the basis trade is fundamental to crypto money markets. Data indicates there is the relationship between it and overall market rate. So, can we use such relationships to extract a money market yield benchmark from the basis trade? Yes — however despite the basis trade is delta-neutral, it is not risk-free, and we have structured Resolv specifically to isolate exposure into a separate instrument.

What should we expect in future? While bullish sentiment prevails, the buying pressure on main digital assets will continue, so the yields under the basis trade will be high even though we expect sustainable average rate to go back to a 15–20% range from current 3-year highs.

For Resolv USR and RLP yields, it means likely outperformance of the other yield sources in the market within comparable risk profile. If interested, ping us for early investment into those instruments!