DeFi to TradFi interest rate differences: sustainable, for how long?

I’m a former economist working on a crypto interest rate POV.

Can anyone help me explain what sustains the large interest rate gap between DeFi and TradFi (e.g., crypto stablecoin deposits are paying 10%+ and deposits at US banks are paying <1%)?

In particular, if you think about this like international economics (suppose TradFi and DeFi are countries), capital should flow to the country (or in this case ‘type of finance’) with the highest interest rates. Overtime, as capital flows to DeFi, rates should fall, while in TradFi, rates should rise.

In addition to what is sustaining the gap, I’m wondering, how long before the gap closes / collapses? In particular, will a US Fed CBDC cause this to happen (e.g., banks can now start to borrow a crypto currency from the Fed at 0.25% and start to offer cheap capital in DeFi)?

All ideas would be helpful. TIA!

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10 thoughts on “DeFi to TradFi interest rate differences: sustainable, for how long?”

  1. I think the gap will close somewhat, but once protocols are safe enough that they aren’t getting hacked all the time a major expense will be taken away and it will still have one of its major advantages which is the lack of need for overpaid bankers, rent, and so on, or at least these expenses will never be in the same ballpark as TradFi. These savings can be used to maintain higher APY.

  2. As for most protocols you’ll notice the apy rapidly decreases to 0 the more TVL is accrued. An example being the DeFi blue chips like aave or compound, offering pretty “low” rates (for DeFi standards).
    Apart from that, many protocols are literally printing money out of thin air with their governance tokens and use it to give incentives, creating a vicious circle of farming and dumping, collapsing the token price altogether.

  3. I could see an argument that interest rates for DeFi stay elevated forever because there are more lucrative investment opportunities in DeFi compared to traditional banking.

  4. They won’t be able to pay 10%+ forever but they can totally crush a bank forever.

    Banks are making record profit and doing record stock buybacks and record overdraft fees while giving record low deposit apy. That’s a massive reason why defi rates are so much better: banks are happy to give you the middle finger. There’s so much more to do with the yield made from deposits than giving it back to depositors.

  5. The gap will close when crypto becomes mainstream. Right now, the average person thinks all of crypto is a scam. They are not paying attention. They don’t even know what a stablecoin is. But they are comfortable with banks, they know banks. It’s still early in crypto, and I think we still have lots of time, but eventually rates will equalize between crypto and TradFi.

  6. Defi may have higher rates for its inherent smart contract risk.

    But only to a small extent.

    Most of its competitive rates are driven directly by supply & demand (eg: compound, aave).

    And also by other things like
    -staking revenue from borrowers collateral, like Anchor (though they should consider lowering the rates)
    -liquidity pools. Stablecoin LPs have no IL yet pay 10-20% APY.
    -protocol rewards

    Banks have simply been ripping people off. As they see more people flowing to defi, they will need to adapt. They need to cut costs and profits so they can offer higher rates to close the gap.

  7. You are comparing apples with oranges, or apples with rotten apples.

    DeFi would pay lower rates if it could, why pay high rates if you don’t have to? They need to pay higher rates to attract money. Nobody would put money into DeFi for a few percent.

    Why not? Because these projects are risky and dodgy as hell, hacks, scams, bugs, massive price volatility, risk around stable coin pegs, regulatory and tax uncertainty.

    So you get what you pay for aka there is no free lunch. But as an economist you must know that already.


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