shedontluv-U
Busy rn , off my notifications for 1-2 hours
- Joined
- Feb 21, 2026
- Posts
- 11,018
- Reputation
- 28,972
FINANCIALLY AESTHETIC · GUIDE 35/37
STABLECOINS, STAKING, LENDING & DEFI: YIELD RISK
FA-7.3 · Crypto & Digital Assets
◆━━━━━━━━━━━━━━━━━━━━◆
RISK FRAME
Yield is never just a number it is payment for smart-contract, issuer, liquidity, custody or market risk.
Stablecoins: A Promise of Stability That Is Not Guaranteed
A stablecoin (a crypto asset designed to track a reference value) is a digital asset programmed to achieve greater value stability compared to other cryptocurrencies (such as Bitcoin or Ether). Depending on their type, some stablecoins peg their value to an asset such as a currency (e.g., the U.S. dollar) or a basket of assets and are backed by reserves of assets whose value is often expressed in fiat money (e.g., U.S. dollars). In practice, under certain conditions, an investor should be able to exchange a stablecoin for the asset to which it is pegged. Other stablecoins use algorithms that trigger buys and sells to stabilize their value. Like Bitcoin, stablecoins are not legal tender.
Some stablecoins have failed to deliver on their promise of stability and have experienced sudden and significant price drops. Although they promise less volatility than other cryptocurrencies, stablecoins remain risky.
Stablecoins, whose value is supposedly backed by other assets, have grown significantly and play a pivotal role in the sector by providing bridges to the traditional financial sector.
Stablecoins are types of tokens whose value is backed by other assets (asset-referenced tokens) or by one or more currencies (e-money tokens). This peg is maintained in various ways: either by establishing a reserve fund (such as for Tether (USDT) or USD Coin (USDC), the two main stablecoins, which are backed by the dollar), thereby guaranteeing the peg; or through decentralized mechanisms (such as MakerDAO’s Dai, whose parity with the dollar is ensured by reserves consisting of other crypto-assets, which are managed via smart contracts);; or through algorithmic systems, where arbitrage opportunities allow the available supply to be created or destroyed in order to automatically ensure price stability, as is the case with Neutrino USD (USDN). Some stablecoins are not actually backed by reserve assets, but their available supply is automatically adjusted via smart contracts based on demand, in order to maintain a stable value (e.g., Basis Share). Stablecoins play a pivotal role in the development of the entire crypto-asset ecosystem, enabling the settlement of a large portion of transactions within the crypto-asset ecosystem (approximately 75% of transactions involve a stablecoin) and facilitating bridges to traditional currencies.
The risk of depegging: when the peg breaks
Stablecoins present specific risks. First, the de-pegging and subsequent collapse of the value of the algorithmic stablecoin TerraUSD (UST) in May 2022 served as a reminder of the persistent fragility of this type of asset, whose peg - maintained in a decentralized manner - is particularly vulnerable to a massive exodus of investors. Beyond algorithmic stablecoins, there are serious concerns regarding the peg of major stablecoins (notably USDT and USDC), which is backed by a reserve fund. The safeguards provided by these stablecoins - particularly regarding the composition and liquidity of the fund, the legally responsible entity, and liquidation procedures - still appear to be largely insufficient. Thus, the temporary decoupling of the USDT price on May 12, 2022, following the collapse of TerraUSD - which occurred after various incidents and legal actions against Tether for false statements regarding its reserve fund - has heightened concerns regarding the governance, risk management, and operational resilience of stablecoins.
Stablecoins pose significant risks both to the crypto-asset ecosystem - given their central role (USDT - or Tether - is involved in 50% of all crypto-asset transactions) - and to the financial sector as a whole. Indeed, to maintain their peg, these entities are heavily invested, through their reserve funds, in traditional financial markets, particularly in short-term funding markets (T-bills, commercial paper, certificates of deposit, cash). They could thus place significant strain on the economy’s financing if their value were to collapse due to significant redemption requests and flash sales triggered by a loss of investor confidence. Stablecoins also pose risks to monetary sovereignty, as they create alternative units of account to traditional currencies and a money supply outside the control of central banks, which can, among other things, limit the effectiveness of monetary policy measures.
Staking: Staking Your Crypto Assets to Validate the Network
Other validation mechanisms exist, notably proof of stake, used by the Ethereum blockchain. Instead of attempting to solve a mathematical equation as quickly as possible, crypto holders wishing to validate transactions via proof of stake can delegate a portion of their crypto holdings (a stake) to third parties who act as validators. Validators combine the stakes from all holders and then stake these cryptos on the network according to the coded rules of the blockchain protocol. The validators then compete to forge (validate) the next transaction block. The winner is selected based on factors such as the amount staked, the time elapsed since the stake was placed, and chance. The winner is usually rewarded with cryptos.
Some registered crypto-asset trading platforms offer staking as a service to investors who want to generate income from their cryptocurrencies.
Do you hold crypto assets on a registered platform that offers a staking service? This activity involves many risks. Before delegating funds for staking, take the time to:
- Understand that if the validator makes a mistake or fails to perform their validation duties properly, the amount you’ve staked with them could be forfeited or reduced;
- Carefully read the disclosure describing the risks associated with staking. Among other things, find out whether the platform repays investors for staked crypto lost due to the validator’s acts or omissions, how risks will be mitigated, or how losses might be allocated to investors;
- Keep in mind that the amount of crypto you have staked may be locked up during the validation cycle, which means you would not have access to your staked crypto to carry out a transaction (such as selling it) during this period, regardless of what happens to its price;
- Take into account the fees applied by the platform for staking services.
The joint report by the EBA and ESMA from January 2025 describes crypto staking as a service that generates income in crypto in exchange for locking up crypto to support the technical validation operations of Proof of Stake (PoS) consensus blockchains. Lending and borrowing (crypto lending and crypto borrowing), staking, and exchange (exchange) of crypto-assets are reportedly the main services used within DeFi in the European Union.
Lending and Borrowing: Smart Contracts Without Intermediaries
The concept of smart contracts has enabled the emergence of an ecosystem of financial applications deployed on blockchain infrastructure: this is known as decentralized finance (DeFi). One such application allows users to borrow and lend crypto-assets in exchange for another crypto-asset deposited as collateral - typically a stablecoin - in a manner similar to repo transactions in traditional finance. Platforms such as Aave and Compound deploy a smart contract that executes the transfer of ownership of crypto-assets and determines an interest rate without the need for an intermediary.
This collateralization system is intended to limit credit risk for the lender, but it does not eliminate it. Risks to the lender exist if the value of the collateral collapses, if there is contagion among the various crypto-assets deposited as collateral, or if the platform is subject to cyberattacks.
The EBA-ESMA report conceptually distinguishes three classes of services:
- Crypto lending - collateralized loans: the provider (lender) transfers crypto assets/funds to the user (borrower), who deposits crypto assets/funds as collateral; the borrower agrees to repay the principal and interest at maturity.
- Crypto borrowing - unsecured borrowings: a user (lender) transfers crypto assets/funds to a service or another user (borrower); the borrower agrees to repay the principal and interest at maturity.
- Crypto staking: generates crypto income in exchange for locking up crypto to support the technical validation processes for Proof of Stake (PoS) blockchains.
The report presents and assesses the specific risks associated with these services, such as excessive leverage, information asymmetries, risk exposure to money laundering and financing of terrorism, and systemic risks. In particular, users may receive insufficient information about the terms and conditions of these services (including fees, interest rates paid or returns, and changes to collateral requirements). However, the EBA and ESMA have not identified any risks to date from a financial stability perspective.
How Are Rates of Return Set in DeFi?
Interest rates on major DeFi platforms are set automatically by a mathematical formula - encoded in each platform’s smart contract and publicly available - based on the amount deposited and borrowed for each crypto-asset. The formula is simple: it is an increasing function of the utilization rate - that is, the ratio of the amount borrowed to the amount deposited.
Interest rates cannot be negative. They can rise to nearly 80% in the event of an imbalance between borrowers and lenders. They increase slightly at low utilization rates and very sharply beyond an inflection point determined and encoded in the smart contract by each platform. All parameters vary from one platform to another and from one token to another, particularly depending on the risk associated with each crypto-asset. The deposit rate is generally equal to the borrowing rate multiplied by the utilization rate.
Some platforms offer additional compensation to their users in the form of so-called governance tokens. The Compound platform, for example, distributes its own tokens (COMP) to its users based on their lending and borrowing volumes. These tokens, whose value fluctuates, can then be resold to generate additional profit, a practice sometimes referred to as “yield farming.” In 2023, this represented a median additional interest rate of approximately 1.9%.
In practice, interest rates fluctuate based on the supply and demand for tokens - that is, the amount of tokens deposited and the amount borrowed. Several recent articles examine the factors specific to crypto-asset markets that influence these interest rates and highlight the importance of speculation, as DeFi allows for high levels of leverage.
Why Crypto Returns Have Nothing to Do with Guaranteed Savings
One might expect the interest rates on stablecoins - which manage to maintain a near-fixed parity of $1 - to be close to rates in traditional money markets, once the risk premiums specific to the crypto-asset market (risk that the platform will default, be attacked, or that parity will be broken, etc.) are taken into account.
However, interest rates in DeFi are generally very disconnected from interest rates in traditional financial markets. In early January 2022, the average one-day interest rate on a stablecoin borrowing on the Aave v1, v2, and v3 platforms and Compound v2 and v3 was nearly 5%, while the Fed’s rate was zero.
In practice, DeFi rates appear to be driven primarily by demand for crypto-assets. The transmission of monetary policy to these rates is therefore very limited and currently plays only a secondary role in determining DeFi interest rates.
This observation is crucial: the return offered by a lending or staking platform is not a savings rate regulated by a central bank, but rather the result of an imbalance between the supply and demand for crypto-assets, largely driven by speculation and leverage. A high return primarily signals a market imbalance or a risk premium, not a guarantee of a safe return.
Key Reminder: No Deposit Protection
Although certain cryptoassets (cryptos) can be used as a form of payment or a medium of exchange, they are not legal tender in Canada.
In Canada, only the Canadian dollar is legal tender. The AMF reminds you that transactions involving cryptos are not covered by deposit insurance.
Crypto-asset exchanges and loans do not benefit from the protections that cover modern bank deposits, such as deposit insurance systems or liquidity support from central banks. As a result, due to their role in transforming liquidity and maturities, they are exposed to the risk of massive withdrawals by investors during periods of liquidity stress or a loss of confidence in their reserve levels - much like money market funds, for example (which are therefore subject to specific regulations).
For example, amid severe tensions linked to the collapse in the value of crypto-assets, the lending firm Celsius (nearly 2 million users and approximately $25 billion in assets under management as of late 2021) faced massive withdrawals (roughly half of its assets under management in just a few months) and was forced to freeze its assets in June 2022 due to a high risk of insolvency. This risk is exacerbated by the fact that liquidity is generally provided by only a few players: more than half of the deposits on major platforms reportedly come from just a few individual accounts, making them extremely vulnerable to sudden movements and thereby posing a risk to the entire ecosystem, particularly given the lack of transparency in liquidity management.
Liquidity Risk and Forced Liquidations in DeFi
The liquidity of crypto-assets is extremely volatile, and many crypto-assets see their value plummet, sometimes to the point of disappearing entirely. When the price of crypto-assets falls, the collateral deposited in decentralized finance (DeFi) applications decreases accordingly, requiring the liquidation of positions when investors are unable to restore the required collateral level. Liquidation events on DeFi platforms - whose one-year probability is estimated at 24% by the IMF - have thus been on the rise for several months (the platforms Aave, Maker, and Compound had already faced liquidations totaling approximately $300 million in November 2021) due to the market correction. For platform users, these events result in capital losses and a sharp increase in transaction costs.
Exchanging a cryptoasset for legal tender can be difficult. Not all exchange channels, such as trading platforms, are regulated by official regulatory bodies or central banks. Speculation on cryptoassets can widen bid-ask spreads.
Technological, Protocol, and Counterparty Risk
Crypto assets may be vulnerable to hacking and theft. The security of digital wallets and crypto exchanges and trading platforms is not guaranteed. Users are exposed to theft and the total loss of their assets.
In the DeFi sector alone, approximately $2.5 billion is estimated to have been lost in 2021 as a result of hacks or protocol manipulations exploiting vulnerabilities. Individual risks related to cyberattacks (phishing, identity theft, ransomware, etc.) are also high, with each successful cyberattack reportedly resulting in a median loss of 30% of the targeted user’s deposits.
The EBA and ESMA note that the number of hacks and the value of stolen crypto-assets have generally correlated with the size of the DeFi services market. Given that flows on decentralized exchanges account for 10% of global spot crypto-asset trading volumes, DeFi protocols pose significant risks of money laundering and financing of terrorism.
The EBA and ESMA believe that so-called “maximum extractable value” (MEV) practices in DeFi markets are widespread and that addressing their negative externalities would require technical solutions. MEV is the maximum amount of value that a blockchain miner, validator, or other agent can create by altering the order of transactions during the block-production process. MEV extraction is detrimental to DeFi users because it diverts a portion of the value intended for users and investors to MEV extractors.
The crypto-asset ecosystem is particularly volatile and poorly regulated - numerous cases of fraud and market manipulation are estimated to have amounted to $14 billion in 2021. The financial risks are also significant, especially for retail investors unfamiliar with the complexity of the ecosystem. High levels of leverage, the riskier profile of market participants, the low transparency of most exchanges, the intense pursuit of returns, and the “gamification” of finance - which fuels retail investors’ interest in these complex assets - all contribute to an increased risk level. These frauds and financial risks are exacerbated by the lack of audits and oversight governing the sector, as well as the lack of recourse in the event of losses.
DeFi Remains a Niche Phenomenon but Is Under Regulatory Scrutiny
The EBA and ESMA note that DeFi remains a niche phenomenon, with the value locked in DeFi protocols representing 4% of the total value of the global crypto-asset market. Based on available information, it appears that EU consumers and financial institutions interact with these services to a very limited extent.
The draft European Market in Crypto-Assets (MiCA) regulation aims to regulate the issuance of crypto-assets by overseeing crypto-asset service providers. The draft regulation also sets forth specific rules for stablecoins, which are identified as the ecosystem’s main vulnerability, including the establishment of an equivalent and transparent reserve fund, a user’s claim to the reserve, and rules for managing the reserve’s liquidity.
SURVIVAL RULE
Trace where the yield comes from, how redemption works and what can break before chasing the headline rate.
CURRENT-RULES CHECK
Legal protections, tax rates, reporting duties, deadlines and product rules change by country and over time. Use the jurisdiction labels in this guide and check the linked official source before acting.
- BIS - Stablecoins and financial-stability risks - International - institutional stablecoin analysis.
- BIS - DeFi lending and intermediation - International - institutional DeFi research.
- Investor.gov - Crypto assets - United States - crypto-asset risk.
