Why Use DeFi When I-Bonds Yield More Risk-Free?

The idea of “new” money has been compelling to many, especially during a time of low yields for “old” money in the form of savings accounts, CDs, and bonds.

With interest rates rising and I-bonds yielding above 9%, some are starting to take a second look at some of these old-school savings vehicles — especially since they appear safer than some of the decentralized finance (DeFi) products on the market.

Let’s take a look at DeFi vs. I-bonds and consider how different assets can play a role in your portfolio.

Why Are People Interested In I-Bonds?

First of all, in May 2022, a new yield was announced for I-bonds: 9.62%. I-bonds are designed to protect against inflation (the “I”), so when inflation is high, I-bonds yield more. Up until very recently, we’ve been in a relatively low-rate environment. Inflation has been fairly low, so I-bonds haven’t been yielding much. That all changed as inflation began to skyrocket toward the end of 2021.

On top of this historical level for I-bonds, it’s worth noting that Treasury securities are considered some of the safest investments out there. U.S. bonds are considered safe because they’re backed by U.S. taxpayers — one of the most stable tax bases in the world. I-bonds earn interest for 30 years, providing a long-term potential for earning.

Rather than risk their money with DeFi products, some investors like the idea of high returns from a safe source. Buying I-bonds right now offers a chance to see a high yield without the risk that often comes with DeFi.

Drawbacks To I-Bonds

It’s not all sunshine and rainbows with I-bonds, however. There are some challenges to investing in I-bonds, depending on your approach.

First of all, that 9.62% yield isn’t set in stone. I-bonds adjust every six months. In November 2022, the inflation rate will be considered again, and the yield will either rise or fall. Currently, the I-bonds issued right now have a base rate of 0%. So, if inflation disappears, so does the high yield.

Next, there are rules about how long you have to hold I-bonds. You need to keep your I-bonds for at least one year. If you sell your I-bonds before having them for five years, you forfeit three months’ worth of interest. So, if you decide to move your money after a short period of time, you could face consequences.

Finally, you’re limited as to how much you can buy in I-bonds. For the most part, each purchaser is limited to $10,000 in I-bonds annually. If you use your tax refund to purchase I-bonds, you can get another $5,000, bringing the yearly total to $15,000. However, some of those bonds will be in paper form. So, if you have a larger chunk of capital you want to earn a high rate of return, I-bonds probably won’t fit the bill. 

Why Are People Struggling With DeFi?

The other part of this story, of course, is the fact that people are starting to pull away from DeFi as a way to earn a high yield on their assets. 

Decentralized finance is the idea that there aren’t intermediaries — like the U.S. government — involved in your financial transactions and investments. In the last couple of years, DeFi projects and organizations, or those claiming to be DeFi, have offered very high yields.

Celsius and Voyager are two major organizations offering products that are similar to banking products and connected to DeFi. They also promised huge yields on crypto assets, along with the ability to take your profits at any time. No waiting around to cash in on your yields. 

However, Celsius and Voyager have both announced major problems in the last few weeks, including filing for bankruptcy protection. Before the bankruptcy, though, both organizations announced they would be halting withdrawals, leaving many customers stuck with their assets unavailable to them.

Some might contend that neither of these organizations is truly DeFi. There are plenty of other places where you can get involved with staking and yield farming. These projects and exchanges are truly decentralized and could potentially provide you with ongoing opportunities to put your crypto assets to work.

However, there is no protection if a decentralized exchange suddenly folds. Your crypto assets are potentially gone if they’re held on the exchange.

Cryptocurrency Price Volatility

Another reason that some investors are concerned about DeFi is due to cryptocurrency price volatility. Both the cryptocurrency and non-fungible token (NFT) markets have crashed, and prices continue to struggle — especially for NFTs.

Some cryptocurrencies have seen some measure of recovery in recent days, but overall prices are still down. Additionally, even in the good times, there’s a lot of volatility in crypto prices. That uncertainty and those price swings can impact the overall ability of DeFi projects to remain stable over time. Plus, it also impacts yields and returns. 

In times of uncertainty, people tend to look for more stable returns and look for safety. With cryptocurrencies still somewhat correlated to the stock market and with uncertainty about a potential recession by the end of 2022, some investors are more interested in safety. The idea that they can get a high yield — even for a limited period of time — with a safe investment vehicle like I-bonds is alluring.

Should DeFi Still Be In Your Investment Portfolio?

All of this doesn’t mean that you should completely divest yourself of all things crypto and abandon DeFi. In fact, there are still good reasons to include DeFi in your investment portfolio, as long as it matches your strategy and goals.

Some experts suggest that the current crypto winter might be good for the overall ecosystem. By weeding out the “weak” players, the remaining crypto projects might be stronger. It can also provide insight into which DeFi projects and blockchains will be viable for a longer period of time.

Another consideration is whether the “safer” investments like I-bonds can provide ongoing yield and income. While the yields might be attractive now, as inflation pulls back, the yields are likely to drop. In order to see higher returns over time, an element is often needed in a portfolio. Calculated risk is part of building long-term wealth.

Deciding Which DeFi To Include

Part of using DeFi in your investment portfolio is understanding which projects are more likely to succeed, and how you can potentially make money. Some items to consider include:

• What is the underlying use case for the project? What problem does it solve?

• What opportunities do you have to make money? Can you do so through staking and lending? Do you provide liquidity for transactions? 

• What are the potential yields?

• Are you allowed to take your profits regularly? Can you withdraw each day or every few days? How long are your assets locked up?

There’s no way to choose a “sure thing” when it comes to any investment, and that includes crypto assets, which represent a new asset class. As a result, moving forward requires careful vetting for your portfolio.

Additionally, you need to consider the risks, particularly the risk of failure. Many people thought projects like Voyager and Celsius were “safe,” but they turned out problematic.

Don’t forget to consider your risk tolerance as you look at different DeFi investments. Not every investment that seems like a good idea is the right one for you. You need to think about whether you can afford to lose the money. Some investors limit their risk by regularly withdrawing their earnings each week. Whatever you lock up, though, it should be an amount you can afford to lose.

Other Risks To Consider With DeFi

There are some other risks to think about when you put money into DeFi:

• Regulation: The regulatory framework for crypto assets is uncertain. The SEC seems to be cracking down on cryptocurrencies that they feel function as securities, and that can cause issues.

• Central Bank Digital Currencies (CBCD): Some central banks are considering their own digital currencies. If the United States issues a digital dollar, it could reduce the interest from a wider audience.

• Over-leverage by projects: Voyager and Celsius, along with the involvement of Three Arrows Capital, shows how over-leverage can be a problem, especially when the underlying assets are volatile and crash.

• Lack of insurance: Finally, you could lose your investment due to lack of insurance coverage. For example, if a broker fails, you don’t lose the value of your stock investments due to SIPC insurance. With a traditional bank deposit, you’re protected from bank failures by FDIC insurance. Crypto assets currently aren’t protected this way. Even if you buy crypto through a broker, your crypto assets might not be covered by SIPC insurance.

Bottom Line

A good portfolio is one that fits your needs and goals. It should be reasonably diverse and include assets appropriate to your risk tolerance. 

In general, there’s nothing wrong with including I-bonds in your portfolio and using and investing in DeFi. Consider whether speculative assets like those associated with DeFi are appropriate for you. Some experts recommend limiting your exposure to speculative assets to between 5% and 15% of your portfolio, so consider what’s best for you.