In finance we sometimes talk about a “risk free rate”. It’s a mythical investment with no risk, paying with 100% certainty according to some defined schedule. As any real investment with actual risks should compensate for those, real investments then must pay an appropriate risk premium above the risk free rate.
Often, investors will use government bonds as a “good enough” proxy for the risk free rate. If the government can practically print money to pay for their obligations, the risk of a default is seemingly low (at the cost of inflation). We of course know that governments sometimes default on their debts, yet it’s often the best proxy we’ve got.
But perhaps that’s about to change?
With the introduction of the Liquity v2 protocol, we find a yield paying stablecoin managed by immutable smart contracts with user defined rates. There are some technical risks, such as bugs or stale price feeds, but as time passes these risks likely diminish due to battle hardening and ever increasing scrutiny.
Could we then end up in a situation where implementations of this protocol, such as Bold, USDaf, Nerite and others like it redefine what the risk free rate is?
That would have major implications for the borrowing rate governments can assume, as they are now not the only story in town, and might not even be the preferred source of “risk free investments”.
If these stablecoins, through the stability pool yield they pay, offer a better yield-to-risk ratio than the established “risk free rate” proxies, it will dramatically drive further blockchain adoptions. We’ve already seen stablecoins be the killer app on blockchains, but the major stablecoins don’t pay a yield today. And if they do, these yields are often tied to the previously mentioned government bonds, with complex and volatile governance processes mixed in.
Rational investors will choose the higher reward at the lower risk, and when we with blockchains and immutable smart contracts can deliver this with efficiency gains not possible in TradFi, the writing will be on the wall.
As an aside, much like renewable energy adoption is driven by capital markets and a better business case than traditional energy sources, Liquity v2 forks will drive investors onchain with a similar rationale. It simply presents a better investment case, making the transition unstoppable.
In the book “The Innovator’s Dilemma” by Clayton M. Christensen, he talks about emerging technologies initially often being unable to compete with established technologies across some dimensions like reliability, speed or capacity. But as they evolve and we learn to make use of them we come to a point where these emerging technologies eventually outperform across all relevant dimensions against the incumbent.
Personally, I believe Liquity v2, with immutable smart contracts, ultra low risk yield and user set rates is what we’ll look back at and say was a defining point in DeFi history. One where DeFi matured and evolved to directly outcompete TradFi and offered a more compelling story. It’s far from the end of that compelling story, but we’ve finally taken the training wheels off.
Not everyone knows about this yet, hence why I write about it, but good alpha can’t stay hidden for long. And as the knowledge spreads we can expect an S-curve type rapid growth moment in the near future, and I’m certainly looking forward to being part of that journey.