Coinbase (COIN 6.00%), America's leading cryptocurrency custodian and exchange, announced a new program that pays a 4% annual percentage yield (APY) on the stablecoin USD Coin (USDC -0.05%). USDC is the world's second-largest stablecoin (behind Tether) and is backed by real U.S. dollars held in a bank. Since it can be redeemed at any time for one U.S. dollar, its price stays stable, hence the term "stablecoin."
If one USDC is equal to one U.S. dollar, why is Coinbase offering such a generous 4% interest rate? By comparison, the typical savings account pays far less than 1% per year on U.S. dollars. Let's dive into the details of Coinbase's USDC interest rate to determine just how "risk-free" it really is.
Coinbase and Circle were the two principal founders of Centre, the institution in charge of USDC. In May 2018, the consortium published the Centre whitepaper. According to the whitepaper, Centre is intended to provide:
A mechanism for issuing members to mint and burn/redeem asset-backed fiat tokens, or "stablecoins," to address price volatility
Protocols to enable global stablecoin transaction interoperability on public blockchains using state channels for increased throughput and scalability
Network membership rules and smart contracts to govern, audit, and manage the licensed network participants that mint, transact, and redeem stablecoins
Put another way, Centre was set up to make a fiat token that provides liquidity and stability to the crypto world.
The relationship between the U.S. dollar and volatile cryptocurrencies
You may be thinking that it's rather ironic that a fiat currency like the U.S. dollar is playing such a critical role in the crypto economy. After all, this relationship goes against the passions articulated in the Bitcoin (BTC 5.24%) whitepaper. Reeling from the Great Recession, Bitcoin's founders were specifically trying to replace the U.S. dollar and the financial institutions that served as third-party intermediaries. However, Bitcoin doesn't need to replace fiat currency to be successful. In many ways, Bitcoin's value will be more compelling if it can thrive in the existing financial framework.
Institutional adoption, a hedge against inflation, and a globally recognized and secure store of value are just some of the reasons why famed growth investor Cathie Wood sees Bitcoin growing exponentially over the next decade. Her thesis, and others like it, have nothing to do with Bitcoin replacing the U.S. dollar.
A successful relationship between the U.S. dollar and cryptocurrency is the message that companies like Coinbase are trying to drive home when they talk about USDC. As Coinbase notes in its reasons for building USD Coin: "We want everyone to enjoy the stability of the world's fiat currency, the U.S. dollar. USD Coin allows unbanked and under-banked individuals in any country to hold a U.S. dollar-backed asset with nothing more than a mobile phone."
Understanding USDC's risks
Nothing in this world is free. And that applies to USD's 4% interest rate.
In the fine print, Coinbase was clear that it is not a bank offering a U.S dollar savings account. And therefore, USDC is not FDIC or SIPC insured. While this stipulation may sound scary, it actually makes perfect sense. USDC may be tied to the U.S. dollar, but the U.S. government has nothing to do with USDC. Since USDC isn't legal tender, it's not going to be insured by the U.S. government. However, issuers of Centre's USDC stablecoin are regulated and licensed financial institutions that are required to report their reserves every month, ensuring that each USDC is truly backed by one U.S. dollar.
The second biggest risk with USDC is that it is an Ethereum (ETH 3.99%) token hosted on the Ethereum blockchain. That means that it comes with all of the uncertainty associated with the Ethereum blockchain, such as cyber threats, as well as the feared "51% attack". A 51% majority interest could theoretically block commerce, implement fraudulent transactions, and disrupt the entire network. Given Ethereum's size and diversified interest, this would be incredibly difficult to pull off. But it is a risk, nevertheless.
The third risk has to do with the interest rate itself. Coinbase reserves the right to change the 4% APY. This presents a challenge to investment planning, as well as to retirees who may depend on a stable return to supplement their income.
The crypto world is becoming more sophisticated, which opens the door to new financial products. Investors would do well not to take interest rate offerings for granted. A quick Google search, and you'll see double-digit interest rates on stablecoins by unaccredited platforms. As Coinbase mentioned in its press release, it's important to read the full terms and conditions to make sure platforms aren't loaning your stablecoins to shady sources.
Despite Coinbase being one of the more reputable platforms, it's probably best not to invest in USDC solely for its interest rate unless you believe in the future of Bitcoin and Ethereum. USDC may not be volatile, but it's tied to the crypto world and all the risks that come with it. However, for investors looking to complement their crypto wallets with a cash position that earns a sizable interest rate, Coinbase's USDC offering looks like a very attractive deal.