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In search of yield: analyzing interest bearing crypto products

Financial markets have been in a low interest rate environment for the past several years, as short term rates plunge towards, or below, zero. Currently, the US Fed Funds Rate, the overnight interbank lending rate, is targeting a range of 1.5-1.75%. While the US has a comparably high rate, other national central banks have taken more dovish stances. In its last meeting, the Central Bank of Japan held its key short term rates unchanged at -0.1%. In such a historically low interest rate environment, investors have looked towards high yielding assets, wherever they can find them, in search of some form of yield.

Figure 1: Fed Funds Rate over time

Data for chart sourced from Macro Trends

 

Over the past year, the number of digital currency related products that bear an interest payment, or similar, have grown. In this report, we diagram some of the highest yielding “passive” income digital currency products and compare these assets to those offered in the traditional markets.

 

Interest bearing digital asset products 

There exist various digital asset products with ‘interest’ payments. The increase of decentralized financial services (“DeFi”) has allowed for the proliferation of decentralized interest bearing products, which previously had existed in a limited capacity. For an overview of DeFi, read our full in-depth report on this topic that we published last quarter. 

There are three main types of yield bearing products within the digital assets space: staking, saving, and lending. Different types of products offer different yields, with lower risk products offering interest in the form of savings accounts while higher risk products requiring certain processes to be run in order to receive network rewards, which function similarly to regularly scheduled interest payments.

 

Digital asset staking 

Staking is a process whereby users hold funds in a digital currency wallet and run various functions in order to support the operations of a blockchain network. In return for their validations, stakers receive rewards distributed from the blockchain network.The yield stakers receive is dependent upon the network, as different processes are required for different blockchain networks. There exist various third party companies which stake assets on behalf of customers, for a fee, allowing rewards to pass onto customers with little or no involvement in the actual operational process.

While staking was limited to only a handful of digital currencies, today there are a number of proof-of-stake projects that have launched which allow users to “stake” their tokens in order to receive rewards from the network. Currently, stakeable digital currencies have a combined market cap of more than $20 billion. Additionally, the amount of capital that is staked across these various products has grown as the number of proof-of-stake projects increased. In the figure below, we diagram the amount of capital staked over time overlaid with TradeBlock’s ETX Ether Index. It is important to note that many of these networks have launched more recently and so there is noise earlier in the year. 

Figure 2: Amount of capital locked in staking over time

Data for chart sourced from TradeBlock and Staking Rewards

 

Currently, the average yearly yield for staking assets is around 13%. Staking yield can range from as low as a few basis points to more than 100% per year for certain assets, such as Livepeer which offers a 146% annual yield. Unlike other interest bearing opportunities, staking assets can suffer large capital losses. For instance, stakers of ATOMs, the native currency for the Cosmos Network, receive a yearly staking yield of 9.8%. However, over the past six months ATOMs have experienced a nearly 40% loss in value, as the overall digital currency market has slumped.

 

Digital asset savings accounts 

Recently, products have come into existence which offer nearly a ‘risk-free’ rate of return for digital currencies. The rise of stablecoins has allowed a number of decentralized and centralized platforms to offer interest on stablecoin denominated savings accounts. Similar to traditional bank deposits, stablecoins can be deposited at various firms which offer interest bearing accounts. Because stablecoins are pegged to the US dollar, there is limited risk of capital losses.

However, losses can still occur in these products. Risks arise if the deposit firm fails to properly and securely custody assets, there is a bank run, or the stablecoin becomes unpegged to the US dollar, which could trigger a capital loss in the asset. In the figure below, we diagram current savings rates across platforms offering rates on differing stablecoins.

Figure 3: Current savings rates across platforms

Data for chart sourced from Loan Scan

 

Digital asset peer-to-peer lending 

Various decentralized and centralized firms exist that allow users to lend digital currency assets to third party borrowers at market negotiated interest rates. Similar to traditional peer-to-peer lending firms, such as LendingClub, peer-to-peer digital currency lending firms allow lenders and borrowers to exchange digital currency loans.

Depending on the borrower, interest rates vary on peer-to-peer digital currency loans. While some of these loans carry risk of capital loss in the event of a borrower default, many such loans are over collateralized with alternative assets. In such a way, if a borrower fails to return the principal with interest to the lender, the borrower’s pledged collateral is liquidated to cover the lender.

 

Traditional interest bearing products 

The rise of staking, saving, and lending has allowed digital currency investors to receive attractive yields relative to traditional investment products. The average interest rate on one year CDs is currently 0.50% and the average dividend yield in the S&P 500 is 1.96%. Dividend yields and bond rates can change depending on various factors, including the risk of the investment. While the S&P 500 average dividend yield is 1.96%, Macerich (MAC), the beleaguered mall REIT, offers a considerably higher yield and currently the highest yield in the S&P 500 at 10.9%. In the figure below, we diagram a comparison between traditional and digital currency product yields, including the average dividend yield in US equity markets, staking yields, stablecoin savings accounts yields, and the yield on select low risk fixed income instruments.

Figure 4: Comparison of yield bearing products

Data for chart source from Federal Reserve, Yahoo Finance, Staking Rewards, and Loan Scan

 

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