Traders are making juicy returns by lending cryptocurrencies as the fast-growing field of decentralized finance offers new, but high-risk, money-making opportunities.
The number of consumer-facing platforms offering returns on crypto assets has been growing rapidly, with annual interest rates ranging from around 7 percent to 12 percent for various coins such as Bitcoin and “stablecoins” including Tether.
Traders can hunt for even higher rates through “yield farming,” the practice of scouring the world of decentralized finance — or DeFi — for the best yields available from more obscure projects and coins. These short-lived opportunities can advertise interest rates in the thousands of percent to pull digital money.
The popularity of complex revenue-generating strategies underscores concerns about whether crypto clients fully understand the risks they are taking, experts say. Recent research by the UK’s Financial Conduct Authority found that public understanding of crypto has declined as digital assets have grown in popularity over the past year.
“The risk for some retail investors is that they see the ridiculously high interest rates but don’t really understand what’s going on behind the scenes,” said Fabian Schär, a professor at the University of Basel who studies decentralized finance.
Yield platforms, which have often advertised their products as “savings wallets” or “interest accounts,” may appear as a safe alternative to trying to enter the cryptocurrency market. The mainstay of many platforms is to lend their customers’ digital cash at higher rates than they offer customers, similar to traditional banks. Some platforms also trade their customers’ funds directly or offer loans to private customers.
But these services are very different from the security of a standard bank account, which operates with relatively little regulatory oversight or protection for investors if they suffer losses. The high interest rates offered in DeFi projects also come with significant risks from faulty protocols, hacking, or market volatility.
Schär warned against venturing into DeFi – protocols that replicate many functions of traditional financial markets – solely in search of yield. “There is significant risk and you can lose everything,” he said.
Strategies for earning interest on crypto balances have been around for a number of years, but they’ve gained new appeal for clients in recent months as the digital currency market has plummeted. Bitcoin, the largest digital coin by market value, fell to around $34,000 on Thursday from highs of over $60,000 in April.
Earning interest on crypto balances has gained popularity among clients 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 gained 8 percent has introduced “savings account”.
Noah Perlman, chief operating officer at US-based Gemini, said offering interest rate products is “almost a no-brainer when it comes to enabling customers who otherwise hold their cryptos passively to earn interest” and new ones Attract clients to crypto. Speaking of consumer protection, Perlman said “the regulation is a floor, not a ceiling.”
Gemini Earn, which launched in February, has grown to about 100,000 customers and $2 billion in assets, the company said, with a benchmark interest rate of 7.4 percent.
More experienced traders have also recognized 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 moved the stalls to yield farms that give me enough to live on,” said Taz, a crypto trader in west London.
He said steady-coin yield farms that generate 25 percent interest are the core of his income, but he also made some riskier bets. A recent $10,000 investment has lost half its value in two weeks while generating $150 worth of interest every day. He is confident that the price will eventually recover.
The prices available, while still attractive, have fallen along with market prices. At the extreme end of the spectrum, a farm advertised on yield-farming website PancakeSwap in May offered players willing to stake popular memecoin Doge a 101,513 percent annual interest rate, which is invested in their own coin the website called Cake was paid. In comparison, US corporate bonds with a triple-C rating or below — which are considered highly speculative investments — yield 6.4 percent, according to Ice Data Indexes.
But releasing all of the paper gains from these amazing returns often requires converting niche coins back into traditional currencies, which can incur hefty fees. The interest rates available from yield farms tend to fall as they become more popular because the protocol needs to provide less incentive to attract liquidity. Interest rates have also fallen on major platforms as demand for crypto lending has fallen.
Major borrowers include crypto hedge funds involved in leveraged trading and market makers or exchanges that need working capital or wish to lend money to their trading clients.
“There has been a lot of activity in credit markets related to the bull market,” said Asen Kostadinov, head of strategy at digital investment platform Copper.
Balances at many lenders have continued to grow as markets and borrowing have declined. For example, crypto lender Celsius said assets on its platform had grown to $16 billion from $10 billion in March.
Customers often have very little insight into what platforms do with their money. “One of the issues in the industry right now is the lack of transparency around lending,” said Ryan McCall, chief executive of Zerocap, a crypto investment manager serving wealthy clients.
“As the book grows, platforms will need to lend to counterparties that could be seen as riskier,” he added.
Coinbase launched a US product earlier this week that offers a 4 percent yield on US dollar-pegged stablecoins. The exchange said the higher yields offered elsewhere could be due to assets being “lent to unidentified third parties”.
The opaque lending in highly volatile assets raises serious concerns about the risks to the sector, although many platforms are holding back heavy collateral.
“Networking involves many risks. It is the same counterparties that lend and lend each other,” said an executive at a crypto trading firm.
“A really strong negative move in the market could set off a domino effect.” The executive said some of the riskier lending was looking like “an accident waiting to happen.”
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