Deposits in lending vaults used to earn returns on crypto assets have topped $10 billion, drawing attention to the collateral and liquidity risks behind attractive rates.
According to data from the Financial Times cited by CoinDesk, the total value of assets deposited in these vaults rose from $4 billion at the beginning of last year to more than $10 billion. Fintech companies, digital asset treasury firms, and hedge funds are among the main investors using these strategies to put their stablecoins and other tokens to work.
How do crypto lending vaults generate returns?
Vaults on decentralized finance (DeFi) platforms use deposited crypto assets in lending strategies through smart contracts. Each vault has a manager who selects its lending strategy, sets risk limits, and earns a fee in return.
Returns generally range from 3% to 10%, and can reach 20% or more in riskier strategies. But the risk investors take depends not only on the return displayed on screen, but also on which loans their money is used for and what collateral backs those loans.
What happens if the collateral cannot be sold?
Loans may be backed by tokens with limited buyers, stablecoins collateralized by crypto assets, or tokenized private credit. If the collateral loses value or becomes difficult to sell when needed, vault depositors face the risk of losses.
Automatic liquidations triggered by a decline in collateral value can intensify market sell-offs. Hacks, software bugs, and mechanisms that incorrectly price assets are other potential sources of losses. While the public nature of smart contracts provides transparency, investors focused on high returns may overlook the risks underpinning those returns.
A lower return target for a Bitcoin vault
A vault launched in September on Pareto by Bitcoin-backed lending firm Two Prime targets an annual return of 1.5%–2% through institutional lending activities. The vault accepts Wrapped Bitcoin (WBTC), which represents Bitcoin, and requires a minimum deposit of 5 WBTC.
Two Prime allocated approximately $10 million of its own capital to the vault to cover potential initial losses. The example shows how vaults in the same market can differ in their return targets and risk-sharing arrangements.
Regulators are also examining how existing rules apply to these structures. The U.S. Securities and Exchange Commission (SEC) has asked questions about vaults holding securities, while European regulators have proposed bringing intermediaries that provide access to DeFi services under supervision.
Not investment advice.