With a portfolio of equally-weighted stablecoins generating yields of above 10%, investors will find it tempting to put all of their funds into stablecoins and achieve financial independence immediately. Imagine having just $100,000 invested in UST on Anchor Protocol yielding $19,400 a year. This can be financial independence for some people.
This article highlights 4 reasons why this is a bad idea.
1) Forex risks when you covert USD to SGD
The first reason is that because your stablecoin is pegged to the US dollar, you can experience losses if the Singapore dollar were to strengthen against the USD. The risk is rather small compared to investing in equities but expect the volatility to be about a quarter of what stock investors are normally used to.
Interesting enough SGD has been weakening slightly against the USD over the past 10 years, which is actually reinforces the case for stablecoins pegged to the USD.
2) Market risks of stablecoins are exchanged for new forms of risks which are hard to model using mathematics
The second reason is that while market risks like those fluctuations in the equity markets disappear, there are new forms of risk that take their place. Flaws in smart contracts can cause tokens to disappear. Hackers can confuse oracle or data sources so as to perform profitable trades. There may also be a flaw in tokenomics design that can cause stablecoins to lose their peg against the USD dollar.
Just because we can’t put a standard deviation on these risks does not mean that they don’t exist and there is always a chance that investors will be taken by surprise.
3) Governments may regulate stablecoins
Stablecoins can threaten financial institutions so they will attract a lot of scrutiny over the next few years.
Suppose a generation of investors were to park their funds in stablecoin yield farms instead of bank deposits, it would become much harder for lending to take place. Such concerns will guarantee that studies will be launched over the next few years which can result in yields disappearing or, in a drastic case, lead to coins taken out of circulation.
4) Different stablecoins present unique idiosyncratic risks
The nature of each stablecoin matters to the investor as well.
Terra USD or UST is unlikely to sustain yields of 19.4% on Anchor protocol and much hinges on whether Terraform Labs will continue to top up yield reserves to support their ecosystem. USD Tether or USDT is actually not fully backed by cash and is not even contractually obligated to exchange one unit of coin for fiat currency.
Diversification is key
To manage these risks, the investor should ask themselves what kind of loss is acceptable if a stablecoin fails and limit their portfolio allocation to just this amount. Suppose you can tolerate a 5% loss and invest in a stablecoin portfolio of USDT, USDC and UST. Then you should not allow your stablecoins to exceed 15% of your portfolio. In fact, to play it safe, I will not allocate more than 10% of my portfolio to three stablecoins.
The second precaution is that even if it means earning lower yields on average, it is always better to distribute the money over your stablecoins in equal weights. If you have $30,000 over USDT, USDC and UST, allocate $10,000 to each and ensure that the monies reside on different yielding platforms.
The good news is that as more projects are launched in the future, having a diverse universe of stablecoins can lead to larger allocation.
But as it stands, there are only about 3-4 different stablecoins that are investable at the moment.
But, there are rewards for taking on these stablecoin risks
The bottomline when investing in stablecoins is that for taking on these risks, the investor can get yields of above 13% coming out from their stablecoin portfolios. An investment of $200,000 can produce $26,000 a year that can provide to single person a fairly modest level of existence.
These yields can be used to complement dividends that are derived from an equity or REIT focused portfolio.
