Fidelity: Fed Rate Cuts Could Drive Institutions into DeFi

A recent report from Fidelity suggests that institutions may finally jump into DeFi in 2024 as interest rates begin to rise.

Saturday, 17 February 2024 10:50

The report addresses Fidelity's outlook for the cryptocurrency industry in 2024, focusing on several key development areas, including Bitcoin mining, stablecoins, and DeFi.

The report states:

"There may be renewed interest in 2024 if DeFi yields once again become more attractive than TradFi yields and infrastructure development advances."

TradFi (Traditional Finance) refers to non-crypto financials – large banks, asset managers, hedge funds, etc.

This prediction comes as the yields that DeFi investors can earn by lending stablecoins surpass those of the US Treasury Bonds.

Fidelity acknowledges its company's 2023 prediction that institutional investors would begin meaningfully interacting with DeFi did not materialize.

During last year's "widespread risk-off environment," institutions found the average single-digit DeFi returns too low compared to the associated risks.

The report further states that the Federal Reserve's decision to raise interest rates in 2023 provided institutions with better or at least perceived safer options.

Throughout 2023, dollar-pegged stablecoins were affected as DeFi investors shifted to US Treasury Bonds to earn higher yields.

However, if the Fed cuts rates by 0.75% by the end of 2024 as forecasted, institutions may begin looking for higher – albeit riskier – ways to earn more money, such as investing in DeFi.

The Boston-based financial conglomerate, which manages $4.5 trillion in assets, controls $4.25 billion worth of Bitcoin through its spot ETF.

DeFi Yields Increase

In DeFi, returns that investors can earn often increase as risk appetite rises.

DeFi lending protocols like Aave, the largest in this category with over $8.3 billion in deposits, provide an easy way for investors to leverage their cryptocurrency holdings. However, to do so, other investors must deposit assets – specifically stablecoins – for them to borrow.

In recent months, the returns that Aave users can earn by lending stablecoins have surpassed the yield on the 10-year US Treasury Bond.

The US 10-year yield is often considered a risk-free rate for dollar-denominated investments, currently around 4.3%. In DeFi, investors can earn up to 14% from USDT, the largest-dollar-pegged stablecoin in DeFi with over $97 billion in circulation.

According to Dune, this figure has increased from around 5% in August.

Other stablecoins also offer higher yields. Dai, the third-largest stablecoin with about $4.8 billion in circulation, yields around 8.5% for depositors on Aave, while the second-largest stablecoin, Circle's USDC, earns just under 5%.

Investors typically view the interest rates offered by DeFi stablecoins lending protocols like Aave as the industry's risk-free rates. That's because it represents the fundamental profit from all other evaluated DeFi positions.

The interest rate offered to lenders on Aave is determined by the protocol's algorithm. Yields increase depending on the popularity of that asset for borrowers.

High yields could attract institutions to DeFi if and when the yields on US Treasury Bonds decrease.

And as long as the risk appetite continues, the attractive returns that DeFi investors can achieve through lending stablecoins are unlikely to diminish in the near future.