Understanding Risk with Donut

UNDERSTANDING DONUT

Understanding Risk with Donut

Educating our community on how we seek to balance risk and opportunity so they can include this emerging asset class in their financial future.

8 min read

At Donut, we believe any good investment starts with trust. By talking openly and honestly about digital lending markets we're building a community in which all investors understand this emerging asset class, its opportunities and its potential risks, and have the resources available to make decisions for their financial future.

As pioneers in web3 lending, it's our responsibility to set the standard in APY and transparency. Forthcoming is the only way forward.

Balancing reward and risk

Decision trees are modeling tools that map the factors leading to a decision. The risk vs. reward stage of a decision tree balances one’s risk with one’s opportunity, asking what is the risk if I try this and what am I missing out on if I don’t?

Every decision follows this framework. From biting the hot pizza when hangry, to accepting a new job offer, or even working your money harder with Donut.

At Donut, we make it easy to participate in the emerging digital lending economy by abstracting away the friction of using digital assets and delivering protected APY. Beyond earning a protected 6% APY, the opportunity available to Donut users includes:

  • Earning 35x more APY than the national average

  • Keeping funds liquid

  • Participating in the future of finance, before the masses

All investment opportunities entail some degree of risk and Donut is not FDIC insured. Even the most common investments run the risk of fluctuations, losses, or market failure. In the 2008 Financial Crisis, the S&P 500 lost about 10 years worth of gains in only a few weeks. Some of the most conservative investors faced major losses. This year alone, traditional and speculative assets saw significant drawdowns, some losing half their value. Despite these unprecedented events, Donut continued baking high APY and even increased the protected base APY for all users to 6%.

When evaluating Donut as the place to effortlessly work your money harder, it’s important to view the opportunity of Donut alongside any potential risks. Below is an introduction to the potential risks on Donut and how Donut’s risk management practices seek to protect users and their funds from them.

Partner platform risk

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We lend directly to prime brokers and institutional investors to earn you higher rates. With this, there is always a risk of partner failure. We seek to protect against the risk of partner failure by conducting extensive diligence on lending partners and protocols to ensure their health and sustainability, prior to onboarding them. This includes understanding how lending services operate, risk management procedures, and looking at the composition of borrowers and counterparty balance sheets for added security. We also engage in frequent dialogue with our partners to understand the health of loan loss reserves and current security measures. It’s also important that our partners have governance procedures in place that appropriately represent stakeholders.

We continue to diversify our lending partners, insulating ourselves from a single point of failure and abiding by the sage investment advice, don't pull all your eggs in one basket.

Our lending partners thoroughly vet borrowers too. Wyre, Genesis, and Abra vet borrowers by assessing their financials and what they plan to borrow the capital for, favoring those who run lower-risk strategies and have healthier balance sheets. As an additional layer of protection, our partners have liquidity and duration risk infrastructure to appropriately hedge their loan books.

This due diligence was stress tested during the market events of June 2022, as interest-bearing crypto accounts were met with bankruptcy. During these unprecedented events, Donut continued baking high APY without interruption.

Lending risk

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In every lending market, there is a risk that a borrower defaults. Donut seeks to protect from the risk of borrower default through overcollateralization.

To power our lending service, we partner directly and indirectly with regulated US custodians. Our trusted lending partners collateralize all digital asset loans, often by over 125%, which seeks to protect your principal and interest earned. If the value of collateral falls, borrowers are margin called and required to add more collateral or repay part of their loan. If a borrower does not top up collateral, our lending partners liquidate their holdings to ensure no principal is lost.

Throughout various market sell-offs (e.g. March 2020, June 2022), our overcollateralization mechanisms performed as expected with no principal loss on our Save and Build plans. Therefore rising or falling crypto prices don’t affect Donut’s APY, nor your funds. When crypto prices go down, your funds stay protected and continue earning 6% APY. When crypto prices go up, your funds stay protected and continue earning 6% APY. That’s market neutrality. 

Bear in mind, overcollateralization is not FDIC insurance. Once you're invested in other asset classes, such as ETFs, stocks, or crypto, this insurance does not apply. Funds on Donut, like ETFs, stocks, and all digital assets are not FDIC insured, and therefore not zero-risk. 

Stablecoin risk

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Stablecoins are digital dollars that are 1:1 with the US Dollar. On Donut, We convert your USD to USDC stablecoins and put those dollars to work in lending markets seeking to provide you a protected base APY of 6% or more. 

When we say a stablecoin is pegged to the dollar, we mean that one stablecoin should always be worth $1. A depeg happens when the value of a stablecoin falls under $1. Should a stablecoin depeg, overcollaterization doesn’t protect funds because it's not the value of the collateral losing value, it's the lent asset itself. The best way to protect from this risk is to use fully collateralized stablecoins, which Donut does.

Donut uses USDC, a fully collateralized fiat-backed stablecoin that is accepted as one of the safest stablecoins across the industry. Whilst theoretically possible, USDC maintains its peg with a fully backed reserve of cash deposits and US treasuries. USDC’s issuer Circle also regularly conducts audits, releases monthly attestations by Grant Thorton, publishes weekly reserve breakdowns, and is fully regulated by the NY department of financial services.

Technology risk

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Decentralized finance (DeFi) is a catch-all term for the financial products and systems that utilize smart contracts to validate transactions. Donut, and countless other DeFi businesses, rely on Ethereum's infrastructure to deliver value to customers. Therefore, if a smart contract (such as one governing a lending-borrowing agreement) were to fail or break due to a bug, then Donut and all financial services in the space relying on it would fail as well.

This type of failure, however, is unlikely. Ethereum is a hub of innovation in the DeFi space, supporting trillions of dollars in transactions each year, and has the most active developer ecosystem and applications built on top of it over any other blockchain. Our DeFi partners are also frequently audited by 3rd parties. 

Seeking to further reduce technology risk, Donut also holds direct relationships with lending partners that are void of smart contracts.

How secure is Donut? 

Understanding the potential risks is only a part of safe investing—the Donut team seeks to make sure all information and transactions are as secure as possible. To complement our risk management practices, we secure your account at the highest level with the following implementations:

  • Data Security: All user data is encrypted using the bank-grade AES-256 standard, the industry standard for protecting data and used by Google Cloud.

  • Account Security: All accounts are protected at the highest level with a personal PIN number and two-factor authentication (2FA). This ensures that access to your account is as secure as other finance and payment apps such as Venmo or Robinhood. 

  • Account Connect: We manage all bank connections securely with Plaid, the industry leader in bank integrations. This is the same banking integration used by hundreds of financial services including Venmo and American Express.

  • Banking: For USD deposits and withdrawals, we've partnered with Evolve Bank and Trust, an FDIC-insured and accredited bank providing banking solutions to fintechs across the country.

  • Fund Conversion: A partnership with Wyre, a best-in-class crypto payments platform, enables us to easily convert your funds to stablecoins. Dozens of leading cryptocurrency businesses, including Ledger and Metamask, trust Wyre's architecture to support their services.

  • Custody: Funds are securely lent to prime brokers and lenders via our wallet partner, Fireblocks, which stores over $400 billion in digital assets.

So what happens next?

There's a lot to consider when making your first move in digital lending markets, and we hope this introduction has helped clarify some of the potential risks alongside the opportunity of Donut. While we can’t speak to the practices of other digital lending platforms, we are proud that over 40,000 users have chosen Donut as the place to earn a protected base APY of 6% on more than a quarter billion dollars.

Looking ahead, we remain committed to being a beacon of stability for everyday investors that want to earn more on their money.

We encourage all members of our community to be mindful when investing and understand the potential risks, no matter how unlikely they may be. We're here to help you discover new ways to save smarter, work your money harder, and grow your wealth. If you have any questions, you can always message us in-app or send a note to [email protected] 

Getting started with Donut

Donut is available in the United States and can be downloaded from the App Store or Google Play Store.

Donuts with friends

Increase your APY +6% for 6 days every time a friend you refer makes their first deposit on Donut. Head to the Boosts section of your app to start introducing friends to the future of finance.


Real talk 🚨

Any saving and investment strategy puts your capital at risk and Donut is not FDIC insured.

The above information is intended for informational purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

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Digital currency is not legal tender, is not backed by any federal government and Donut accounts are not FDIC insured. While Donut and its custodial partners make every effort to keep your money safe and covered, please note that any investment entails risk. The interest rates featured on this page vary according to the dynamics of digital currency markets and are subject to change at any time.