Can stable assets have a 20% yield?
Owners of cryptocurrency USTerra thought they could. This summer, its market cap collapsed from over $18bn (CHF 17.5bn) to almost zero.
As a stablecoin, the value of each USTerra coin was meant to be pegged to one US dollar. As of 8 September, it trades at four cents on popular exchange Crypto.com.
To incentivise investors to buy USTerra and fellow coin Luna, their inventors, Terra, had a “fully decentralised fixed income instrument” called the Anchor Protocol offering holders 20% yearly yields.
‘They collapsed as they were basically Ponzi schemes,’ said Stefan Schwitter, head of asset management at Crypto Finance Asset Management, a Zurich-based subsidiary of Deutsche Börse.
‘The reputation of decentralised finance (DeFi) has been tainted, and it needs to regain trust.’
In fact, yield-bearing cryptocurrency investments come in a variety of forms, some of which are attracting the gaze of professional investors.
One interested party is Philip Bagdasarianz, head of asset management at PWA Private Wealth Advisors, a family office in Cham.
‘We were looking into yield-earning crypto before Luna blew up. That event has shown some weak spots which we can now learn from.’
He is currently monitoring the sector and plans to take a deeper look in the future.
According to a recent survey by the World Economic Forum, only 29% of retail investors said they do not understand cryptocurrencies, whereas around 40% said they do not understand bonds or stocks.
By contrast, professional investor Bagdasarianz thinks it is hard to assess the risks for non-crypto specialists, and such investments would need to be explained to clients very carefully.
‘The crypto asset market is still a baby.
'Crypto is like an investment universe parallel to the traditional one, within it there are high and low-risk options with various risk drivers still not fully known to us. The price and value finding mechanics are still in the making.'
Despite the market’s youth, there are already broadly four kinds of cryptocurrency investment that deliver a yield, according to Schwitter.
1. Centralised lending
This means lending to a centralised platform and receiving about 2% in yield per year. The centralised nature makes it easier to assess counterparty risk. A cautionary tale is Celsius, which Schwitter said is an example of a bad counterparty. It has filed for bankruptcy, owing users around $4.7bn.
2. Decentralised platforms
Most decentralised platforms are funds pooled together to provide liquidity. Instead of a centralised entity, decentralised platforms operate via a smart contract. This is a programme stored on a blockchain which runs when predetermined conditions are met. Terra offered a decentralised finance lending protocol, and its collapse has impacted the wider market, Schwitter said.
‘In the aftermath of the Terra/Luna debacle, a lot of questionable DeFi and lending protocols went bust. What is left now is well-operating protocols that currently yield no more than 4%.’
Owners of stakable crypto coins can earn rewards on top of their value. Schwitter compares it to collecting dividends for owning a stock. Crypto Finance offers staking on a range of protocols, with rewards up to 14% per year. The rewards are dependent on the blockchain, which means they do not depend on the provider. However, investors are vulnerable to the massive volatility in cryptocurrency coin prices.
‘We are also currently exploring securitized ways to offer crypto yield to our clients, whether through our regulated funds or dedicated income products,’ added Schwitter.
4. Selling options
By selling options, investors can extract yield from cryptocurrency’s volatility, which he said is still much higher than in equity markets.
‘Depending on how aggressively this strategy is implemented, yields anywhere from 10-50% per annum can be achieved, with the commensurate risk of course,’ he said.
Picking a portfolio
Opinions differ on the role which crypto investments should have in a portfolio.
For Bagdasarianz, the most attractive out of the four options outlined by Schwitter are decentralised platforms and staking.
However, he would not use digital assets as a direct fixed income replacement until he knows more about their return profiles.
‘If a yield-earning crypto investment was counter-cyclical to our fixed income portfolio, that would be nice. Currently, these products’ correlations to the rest of the market are, however, not clear to us.’
PWA’s clients have significant alternative investment baskets, and yield-earning crypto could potentially fit into the lower-risk part of this, he said.
Schwitter’s clients include institutional investors and family offices. He tells them that some crypto yield can go in their high yield debt bucket.
‘As with other investment classes, crypto yield can be more or less attractive, depending on market regime. Right now, good quality high yield is probably more attractive than good quality DeFi yield. That will change though as the crypto market regains its footing.’
PWC Switzerland’s Adrien Tharin and Jean-Claude Spillmann think yield-bearing crypto products can be an interesting addition to a diversified strategy, but their role depends on the type of product.
Tharin is co-head of digital assets and Spillmann is head of asset management, wealth management and banking regulatory for the legal practice.
‘Low interest layer one staking will generally be considered less risky than participating in liquidity pools through a DeFi unregistered platform.’
Layer one is a base network, such as bitcoin, and its underlying infrastructure. By contrast, layer two protocols are created by developers to offer additional functions and depend on the first layer.
There are now many crypto specialists that wealth managers can work with.
‘Although the blockchain technology is intended to ensure that trust does not (necessarily) come from central authorities, it is still advisable for less experienced investors in the digital assets sector to work with regulated providers.’
Spillmann and Tharin said that in some cases attestations such as a smart contract review might serve as a substitute for regulatory approvals.
They also consider counterparty and technology risk, and the strength of the regulator that a product issuer is licensed by.
‘Yield-bearing products are currently often issued in offshore jurisdictions with rather low regulatory requirements. Other than, for example, in the area of collective investment schemes, there are considerably fewer regulatory requirements and consequently there is also less standardisation.’
The financial arrangements of even the biggest crypto lenders can be controversial. One provider, Tether, said it has assets under management of $67bn, entirely backed by its reserves. Last year, Bloomberg wrote that these included a little-known bank in the Bahamas and lending to other crypto companies, including now-bankrupt Celsius.
However, Swiss wealth managers do not have to look as far as the Bahamas for crypto partners, with a variety of Swiss regulated operators available.
Schwitter’s firm Crypto Finance is registered as an asset manager, and crypto-specialist licensed banks Sygnum and Seba are based in Zurich and Zug, respectively.
Switzerland is one of the leading jurisdictions for digital assets in general, Schwitter, Tharin and Spillmann agree, but the jury is still out for yield products, the PWC duo say.
‘Whether Switzerland may become a leading hub for crypto yielding products is dependent on the further development of the regulatory framework, the practice of Finma and also tax aspects.’
Development of the regulations concerning DeFi could also be an important element, they say.
For Bagdasarianz, this might be enough for him to invest – just not yet.
‘The industry is trying to create safe yielding products, I think we will get there in one or two years.'