At its core, the emerging DeFi lending market is built around a simple but powerful mechanism:
Depositors in DeFi provide USD liquidity.
Borrowers use that liquidity to fund leveraged crypto basis trades — typically the difference between perpetual swaps and spot prices across exchanges.
This means that DeFi borrow rates are determined by two supply/demand dynamics:
The demand for crypto leverage (e.g. via perps), and
The availability of capital from DeFi depositors.
For DeFi lending to achieve mass adoption and rival traditional markets, it must overcome two critical barriers: compliance and operational risk. Emerging solutions are paving the way, but widespread adoption of the following is essential:
Compliance infrastructure (e.g. Keyring) to ensure verifiable, compliant participants.
Regulated insurers to underwrite DeFi-specific operational risks at scale.
with these solutions in place, DeFi depositors face a simplified risk landscape:
Borrowing demand: Demand for USD against BTC/ETH collateral drives utilisation.
Funding rate: The cost/benefit of going long crypto through perpetual swaps.
Gap (jump-to-default) Risk: Collateral value crashing faster than liquidation processes can cover.
Liquidity Risk: Inability to exit if dominating a pool at high utilisation.
As concentration and rates risks are standard in functioning capital markets, gap risk emerges as the primary concern.
With compliance and operational insurance solved, the primary remaining risk is gap risk.
Gap Risk Manifested in credit models as the Jump-to-Default risk: The risk that collateral value crashes faster than liquidation mechanisms can respond.
In highly volatile events (e.g. a 30–50% crash in minutes), over-collateralised loans can still default.
However, with conservative Loan-To-Value (LTV) settings, automated liquidations, and insurance backstops, this risk becomes manageable and quantifiable, similar to how volatility risk is priced in options markets.
If DeFi deposits:
were properly insured and compliant
consistently offered yields higher than central bank debt (government bonds)
Even with some embedded gap risk, there could be a gradual reallocation of capital. European Government Bonds (EGBs), yielding* 2–4% and T-bills yielding ~4.3% could face marginal outflows toward DeFi lending opportunities yielding 6-10%.
This wouldn’t be a wholesale shift because systemic players (banks, insurers, pensions) remain tied to regulatory capital rules. But at the margin, flexible allocators, HNWIs, family offices, corporates, would move.
In fact, we are already seeing the beginnings of this in DeFi markets where groups like the TurtleClub are coordinating efforts from HNWI, Family Offices and Treasuries into such lending markets.
At present this seems to be viewed more like an alternative to private credit, due to the various, and significant, compliance and operational risks inherent but the removal of credit risk via smart contracts is extremely attractive. The DeFi rates markets, are also shielded from the direct effects of inflation mis-management and political risk. Political risk remains tied to regulators for now but the tailwinds are positive and significant so we can assume this risk will decrease dramatically, at least over the next 3-4 years.
*DE10y @ 2.535%; IT10y @ 3.637% and US10y @ 4.31% as of 3-May-25
Just as Eurodollars quietly shifted monetary power from national governments to market participants, DeFi lending could shift credit creation toward decentralised, crypto-collateralised systems over time.
The following excerpt, a 1971 article in the New York Times, captured how the Eurodollar system had already begun to operate like a recursive loop — not unlike leveraged strategies in DeFi today:
A foreign business — say, West German manufacturer— earns dollars by exporting goods to the United States. The business turns those dollars over to a German commercial bank, which exchanges them for marks at the Bundesbank, the West German central bank.
The Bundesbank adds those dollars to its reserves and then deposits the dollars with the Bank for International Settlements in Basel, Switzerland, to earn interest on them.
The B.I.S. lends the dollars it acquires in the Eurodollar market - say, in London - in order to earn interest to cover its interest obligations to the Bundesbank or other central banks.
The Eurodollars offered by the B.I.S. in London are borrowed by an Italian concern that pays them to a German company, which puts them in a German commercial bank. That bank exchanges the dollars once more for marks at the Bundesbank. And the Bundesbank adds the dollars to its re serves for the second time.
This recursive dollar loop exemplified how the Eurodollar system operated in practice
Eurodollars were offshore U.S. dollar deposits, outside U.S. regulation.
They created a parallel dollar liquidity system, governed by market forces rather than central banks.
Over time, the Eurodollar market grew larger than the domestic U.S. deposit base and shaped global liquidity.
A similar pattern is re-emerging in what might be termed DeFidollars, where stablecoins and crypto-collateral drive a recursive, extraterritorial dollar credit system that bypasses traditional regulations to enable market-driven credit creation through decentralised, crypto-collateralised mechanisms.
Eurodollars (then) | DeFidollars (now) |
|---|---|
Offshore dollar deposits outside U.S. control | DeFidollar deposits outside U.S. control |
Created a parallel yield curve | Crypto-influenced funding curves |
Driven by regulation arbitrage | Largely unregulated markets drive arbitrage |
Forced adjustments to monetary policy | Could pressure gives demand and FX stability |
The important difference is that DeFi lending would be fully collateralised, transparent, and programmatically enforced, whereas Eurodollar markets were opaque and unsecured.
Unlike the opaque, unsecured Eurodollar markets, DeFi lending’s transparency and programmatic enforcement could amplify its disruptive potential.
Building on the DeFidollar parallel, where market-driven systems bypass traditional controls, Eurodollar participants profited by exploiting structural asymmetries, strategies that DeFi platforms can replicate:
Eurodollar deposits avoided U.S. capital controls, reserve requirements, and deposit insurance costs. Banks could lend USD offshore at higher rates than they paid depositors, sidestepping U.S. regulation entirely.
DeFi Parallel Decentralised lending apps operate outside Basel rules, using smart contracts to offer dollar-denominated loans collateralised by crypto, capturing spreads without a banking license.
Eurodollar dealers profited from pricing liquidity risk, especially in an opaque, bilateral interbank system. Access to dollar liquidity, especially in times of stress, commanded a premium.
DeFi Parallel DeFi lenders earn yields by pricing basis trade demand, with liquidity providers and vault creators manufacturing synthetic credit products, mirroring Eurodollar brokers’ offshore loan pricing.
Offshore banks reused Eurodollar deposits as reserves, creating more USD credit than existed in the U.S. system. Chains of interbank loans generated shadow leverage far beyond actual reserves, unchecked by central banks.
DeFi Parallel Recursive lending loops, leveraged vaults, and liquid staking derivatives build credit pyramids atop crypto collateral, offering full on-chain transparency unlike Eurodollar opacity.
The Eurodollar market birthed LIBOR, a global benchmark rate set by market participants, not central banks.
DeFi Parallel Lending protocols like Pendle shape crypto-native yield curves, pricing time and risk independently of state control.
These mechanisms highlight how Eurodollar markets thrived on regulatory and structural gaps, a playbook DeFidollar markets are adapting with greater transparency and automation. Yet, significant challenges remain for DeFi to scale these opportunities.
While DeFidollar markets offer significant profit potential, scaling these opportunities requires overcoming key challenges:
Gap Risk Management: The DeFi lending landscape is nascent in risk management practices. At present, and to our knowledge, no lending market has published its analysis on collateral limits with any sort of formal rigour. There needs to be a dramatic upgrade in the market risk management frameworks.
Liquidity Crunch Events: Sudden liquidity vacuums could still cause temporary disruptions.
Regulatory Retaliation: Governments could seek to restrict or heavily regulate large-scale DeFi lending activity if it threatens sovereign funding models.
Scaling Challenges: Deploying hundreds of billions into DeFi lending without yield collapse or system stress will require serious scaling of infrastructure and risk management tools.
To profit from the DeFidollar revolution, focus on owning the bottlenecks where value accrues, such as:
Programmatic Credit Issuance: Create automated, transparent lending systems that issue crypto-collateralised credit at scale, capturing spreads without regulatory overhead.
Yield Curve Creation: Develop protocols or platforms that shape DeFi-native yield curves, to price risk and time independently of traditional finance.
Risk and Compliance Infrastructure: Build tools, like Keyring, to ensure verifiable identities, manage gap risk, and integrate regulated insurance for operational stability.
With transparency, automation, and smart collateral as core strengths, DeFidollars could forge a more resilient shadow banking system than Eurodollars. Just as the Eurodollar market enriched intermediaries who mastered its asymmetries, the Defidollar era will reward those who dominate issuance, risk management, and infrastructure.
Alex McFarlane
Connecting Eurodollars to “DeFidollars” is an astute observation, really cool how you show history repeating itself. After reading, it seems logical that once the things hit a critical mass, yield-hungry capital is going leave sovereign debt and jump into the "defidollar" market. There's some serious alpha here, thank you for sharing it.