Traders are garnering juicy returns by lending out cryptocurrencies as the fast-growing field of decentralised finance throws up new but highly risky opportunities to make money.
The number of consumer-oriented platforms offering yields on crypto balances have grown rapidly, with annual interest rates ranging about 7 to 12 per cent for various coins such as bitcoin and “stablecoins” including tether.
Traders can chase even higher rates through “yield farming”, the practice of scouring the world of decentralised finance — or DeFi — for the best yields available from more obscure projects and coins. These shortlived opportunities can advertise interest rates as high as several thousand per cent to pull in digital cash.
The popularity of complex yield-generating strategies highlights concerns over whether crypto customers fully understand the risks they are assuming, experts say. Recent research by the UK’s Financial Conduct Authority found that public understanding of crypto has fallen as digital assets have become more popular over the past year.
“The risk for some retail investors is that they see the ridiculously high interest rates but they don’t really understand what is going on behind the scenes,” said Fabian Schär, a professor at the University of Basel who studies decentralised finance.
Yield platforms, which often advertised their products as “savings wallets” or “interest accounts”, can appear to be a safe alternative to trying to play the market for cryptocurrencies. The mainstay for many platforms is lending out their customer’s digital cash at higher rates than they offer to clients, not unlike traditional banks. Some platforms also trade their clients’ funds directly, or offer loans to retail customers.
But these services are very different from the safety of a standard bank account, operating with relatively little regulatory oversight or protection for investors if they face losses. The high rates on offer in DeFi projects also carry considerable risks from faulty protocols, hacking or market swings.
Schär cautioned against venturing into DeFi — protocols that replicate many functions of traditional financial markets — purely in search of yields. “There is substantial risk involved and you may lose everything,” he said.
Strategies for earning interest on crypto balances have been around for several years, but they have gained a new appeal for customers in recent months as the market for digital currencies has tumbled. Bitcoin, the biggest digital coin by market value, has dropped from highs of over $60,000 in April to about $34,000 on Thursday.
Earning interest on crypto balances had gained in popularity among clients as a way to make money “when the market is not suitable for trading”, said Allen Ng, chief executive of Hong Kong-based crypto app Kikitrade, which recently launched an 8 per cent “savings account”.
Noah Perlman, chief operating officer at US-based Gemini, said offering interest products is “almost a no brainer in terms of allowing customers who are otherwise passively holding their crypto to earn interest”, attracting new customers to crypto. In terms of consumer protection, Perlman said “the regulation are a floor not a ceiling”.
Gemini Earn, which launched in February, had grown to roughly 100,000 customers and $2bn in assets, the company said, with a headline interest rate of 7.4 per cent.
More sophisticated traders have also seen the appeal of earning interest, rather than trying to play the market. “I was able to sell quite a bit of my stack at the top, so I’ve moved the stables into yield farms that are making me enough to live off,” said Taz, a crypto trader in west London.
He said stable coin yield farms that generate 25 per cent interest were the core of his income, but he also took some riskier bets. A recent investment of $10,000 has lost half its value over two weeks while generating $150 worth of daily interest. He is confident the price will eventually recover.
While still appealing, the rates available have declined along with market prices. At the extreme end of the spectrum, one farm advertised on the yield farming website PancakeSwap in May offered punters willing to stake the popular meme coin Doge a 101,513 per cent annual interest rate paid in the site’s own coin, called Cake. In comparison, US corporate bonds rated triple-C or below — considered to be highly speculative investments — yield 6.4 per cent, according to Ice Data Indices.
But releasing any gains made on paper from these mind-boggling returns often involves converting from niche coins back into traditional currencies, which can entail hefty fees. The rates available from yield farms tend to drop when they become more popular, since the protocol has less need to offer incentives to attract liquidity. Rates have also dropped on large platforms as demand to borrow crypto has fallen.
Major borrowers include crypto hedge funds involved in leveraged trading, and market makers or exchanges that need working capital or want to lend money to their trading customers.
“There has been a lot of activity in the credit markets related to the bull run,” said Asen Kostadinov, head of strategy at digital investing platform Copper.
For many lenders, balances have continued to swell as markets and borrowing activity dropped. Crypto lender Celsius, for example, said the assets on its platform had grown to $16bn from $10bn in March.
Clients often have very little visibility into what platforms are doing with their money. “One of the issues in the industry at the moment is the lack of transparency around lending,” said Ryan McCall, chief executive of Zerocap, a crypto investment manager for wealthy clients.
“As the book grows, platforms have to lend to counterparties that might be considered more high risk,” he added.
Coinbase earlier this week launched a US product offering 4 per cent yield on US dollar-pegged stablecoins. The exchange said the higher yields on offer elsewhere may be because assets are “loaned to unidentified third parties”.
Opaque lending in highly volatile assets raises serious concerns about risks to the sector, even though many platforms retain high levels of collateral.
“There is a lot of risk from interconnectedness. It’s the same counterparties lending and borrowing to each other,” said an executive at a crypto trading firm.
“A really sharp negative movement in the market could prompt a domino effect.” The executive said some of the riskier lending looked like “an accident waiting to happen”.
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