Last week, Blockworks Co-founder Mike Ippolito talked interest-bearing opportunities in a low-rates world with industry experts in “The Search for Yield Comes to Digital Assets”.
Coinshares Chief Strategy Officer of Meltem Demirors, CMS Holdings Principal and Co-founder Dan Matuszewski, and Circle Co-founder and CEO Jeremy Allaire discussed the impact of low interest rates, why crypto rates are relatively higher, and how institutions will deal with the emerging competition.
The Impact of Low Rates
Historically low interest rates came as a response to the 2008 financial crisis, but have stuck around for the COVID pandemic and beyond. It’s an environment driving major changes in the way investors think about growing their capital.
“Today overnight rates are effectively zero, and around the world sovereign debt, which has long been considered the best and most secure form of yield, those rates have turned negative. 25% of sovereign debt in the world today is negative yielding. In this environment, as governments try to encourage spending, we’re seeing rates at all time lows and where governments have expressed a desire to keep rates low to encourage more risk taking behavior,” Demirors said.
“The challenge that creates is inflation is targeted to be 2 to 3% a year, but real inflation is probably much higher than that; some estimates put it at 5 to 6%. If you have your capital in an account yielding no interest, or just a few points of interest, you’re not even keeping pace with inflation.”
To keep pace with rising inflation and earn a return that will satisfy institutional clients, organizations are being pushed into uncharted territory.
“Low interest rates push people up the risk curve. Fixed income investors become equity investors, equity investors become venture investors, venture investors become crypto investors, and you see the biggest changes happening further up that curve, because capital moving into them has a larger effect compared to safer investment classes,” Matuszewski said.
“Even outside that, people are taking a look at moving outside the current system, and that has pushed a lot of capital into crypto. There’s an abundance of capital because money has to go somewhere, so it just keeps moving further out the risk curve. Everyone is being forced to take more risk, and crypto is risky, so it’s a net beneficiary of that.”
Crypto Yield Products
With money flowing in, crypto capital markets are maturing at a breakneck pace, and offering some of the highest yields available. And despite the generous returns, risk is largely collateralized across the crypto landscape.
“A lot of the yield that’s generated in the crypto ecosystem today is generated through fully collateralized lending opportunities, which can be less risky than other fixed income yield generation we see in other areas,” Demirors explained.
“There are two reasons right now the ‘risk free rate’ in crypto is high. There’s a limited amount of capital available to go net-long crypto assets, and demand for that capital is about double what’s available,” Matuszewski added.
“Rates get high because there just aren’t that many people willing to lend capital to invest in crypto. We know there are traditional pools of capital that lend at a much lower rate, but they won’t lend to people in the crypto industry like ourselves. We can only borrow at a high rate because we’re viewed as being in a segment that’s very risky, and they’re worried about us from a principle risk perspective.”
Despite a risk profile that might not be suitable for some businesses today, dollar-denominated yield opportunities that leverage a crypto component are seeing substantial interest. As of November 17, 2022, Circle Yield is not accepting new loans. We are evaluating future updates to the program.
“We have a waitlist for companies to get into our USDC yield service, and it’s interesting to see; really diverse industries, really different types of firms, and lots of different corporations that aren’t necessarily ready to put Bitcoin on their balance sheet, but if there’s positive opportunities in dollar denominated instruments, they’re quite keen to look at that,” Allaire said.
“When we talk about the institutional sectors here, I’m really excited about basically every corporation having some of their working capital allocated into these kinds of markets. If you’re at all an internet savvy company, you’re going to be using this as a payments and treasury infrastructure.”
Institutional Changes
Providing financial services has been an institutional prerogative for hundreds of years, but retail investors and customers are getting a new leg up as crypto continues to grow.
“What’s exciting to me is that by changing the distribution pipeline, the equality of access when it comes to high yield investments gets so much bigger. We’re changing distribution when it comes not only to financial products and services, but financial opportunity, and there are lots of products being built around these yields allowing all types of people to start getting 6 to 7% interest back on their hard earned cash,” Demirors noted.
“If you think about the assets institutions today hold, they’re really just stewards for capital that belongs to the public, and that relationship is going to start to change. Most of the erosion of net interest margin, the difference between rates institutions offer and the rate they pay you, is first chasing profit, but second all the internal costs like their infrastructure, compliance checks, sales operations, you’re paying for all that. In DeFi, you pay for none of it.”
And despite the monumental changes in how value is transmitted and what customers may come to expect, there’s a good chance many of the incumbent players will adapt and evolve, rather than being left behind.
“I think you’re going to start to see a blurring of servicing and integrations between traditional finance and crypto. Banks are in the business of lending money, and that will still be needed in crypto, but I think the two worlds start to merge as time goes on,” Matuszewski said.
“We’ll look back on it and say ‘That used to be the old way of doing things, and now we have this new way.’ This isn’t the first time there’s been a change in the way financial business is conducted. So I’m bearish on the current system, but bullish on the existing players being able to survive and move into the new paradigm.”
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