Encrypted asset lending is hot, please compare risk/reward, beware of risk

Lending your crypto assets on a decentralized platform and a centralized platform can be risky. Let us try to further assess the risks and rewards of lending with encrypted assets by comparing them with traditional financial assets .

Risk/return

Risk/reward is defined as the relationship between the gains made in an investment and the risks assumed in the investment. The following financial instruments basically follow the risk/reward rules, starting with low-risk and low-return, and slowly getting higher risks and higher returns:

Short-term debt → long-term debt → property → high-yield debt → equity

Let us make a hypothesis that all investment activities related to cryptographic assets fall to the far right of the above spectrum, which of course includes borrowing of crypto assets. Investing in crypto assets is often considered high risk, but in reality, most investments are made in very high return expectations, especially in the past decade, other asset classes rarely perform better. Encrypt the money market.

This alone is enough to stimulate many investors and speculators to jump into the cryptocurrency market and chase hundreds of times. However, the encryption market itself is no different from other markets, and it also follows the economic cycle. Especially when the market is uncertain, investors will turn to safe havens, which are low-risk investment alternatives.

In the bear market of 2018-2019, the encrypted asset lending platform was once regarded as a “safe haven” . Is the risk/reward of encrypted asset lending really worthwhile? Let's take a look at it:

Risk/return rate on July 31, 2019, due to financial market uncertainty, this trend has undergone some major changes during the end of July.

The above picture shows some of the most popular "securities" products in the encrypted lending market. You may have noticed that the top right of the figure is the crypto asset lending, which represents the highest risk, even higher than the crypto assets. – The reason for this may be that there are many additional factors such as the risk of counterparty in the cryptocurrency lending.

In essence, interest rates are determined by supply and demand, but for now, there is no denying that the crypto asset lending market has a certain degree of speculative nature, so we will see some crypto asset lending with an impressive annual rate of return ( Annual Percentage Rates) . Stabilized coins and Bitcoin basically have high interest rates (about 6-10%), except in special cases, such as DAI, which has an annual interest rate of about 12%, and even 15% in the Compound platform. Other crypto assets lending at a lower annual interest rate, usually between 0.1% and 2%, including ETH, BAT, REP, etc. It is important to note that any higher interest rate above this range is quite suspicious and requires special care.

Editor's Note: It is currently uncertain whether the encrypted assets are securities products, but for the sake of analysis, they are uniformly included in the relevant financial product categories. Also, if you want to learn more about how to determine the rate of encrypted lending platforms, it is highly recommended to read Roy Learner's article:
Https://medium.com/wave-financial/crypto-lending-too-good-to-be-true-fc010e7fc86c

Based on the above data, we compare it to traditional fixed-income securities so that we can better assess risk/reward.

For example, we use US Treasury bonds (10-year current yield of about 1.75%) as a benchmark. These bonds are generally considered to be risk-free because they are endorsed by US government-backed debt, so the possibility of default The sex is very low, you can even directly deposit the US dollar into the money market account based on the current exchange rate to get the same income. If the US Treasury bond is calibrated, is a 2% or even lower annual interest rate to ensure that the crypto asset lending is not affected by the counterparty risk? Obviously not, because people always expect higher returns.

Of course, the United States also has some high-yield bonds (sometimes these bonds are called "junk bonds") , and their yields can reach 6%. Although such bonds also have a large probability of default, they also get some Reliable company support, so compared to the more risky and undefined encryption lending platform, even with a 6% return on investment, the risk of traditional bonds is still low. And from this perspective, the risk/reward assessment method does not seem appropriate for investment products with an average annual return of 6% (or even lower) .

If you read Ari Paul's analysis article, you will find that the loan-to-credit yield of crypto assets should be about the same as or even higher (more than 20%) , and perhaps the annual rate of return to this level can justify the risk/reward. Sex. So far, only the DAI in the Compound platform is close to this number, and its annual yield has peaked at around 18%. However, because the DAI in Compound is a stable currency, it limits the opportunity for investors to participate in the market, but in fact can create opportunity costs.

Since borrowers don't want to touch too many unstable crypto assets, on some crypto asset lending platforms, we see that the most source of loans is stable coins – higher demand = higher returns (about 8% or even more) High) . Even so, the yield on stable currency borrowing is still much higher than the interest rates offered by most banks today, which is one of the reasons why so many suppliers (ie lenders) are flooding into the encryption lending platform.

But what is the opportunity cost of ensuring that most stable currency combinations that earn around 8% a year?

Encrypted assets with top ten annual returns as of July 31, 2019 (BSV and Tether are not included)

As we saw in the above table, the cryptocurrency market price has changed significantly since the beginning of this year. Looking at Bitcoin alone, you will find that its return rate has reached an astonishing 220% so far this year. For any investor who wants to allocate cryptographic assets in their portfolio, this is definitely the type of return on investment they expect.

However, since investing in the field of cryptographic assets poses significant risks, plus additional counterparty risk and opportunity cost, it seems unreasonable (not logical) to earn only 8% per year. There are also some alternatives with similar returns in traditional financial markets, and the risks are even lower. For those "HODLer", this "long-term" investment strategy has its advantages and disadvantages, at least to keep investors patient, keep their own crypto assets and wait for it to create the greatest return. In fact, everyone has their own investment strategies and risk appetites, but investors should be more cautious about the concept of “risk-free” income in cryptographic asset lending. A prudent investment attitude applies equally to the volatile crypto asset lending market. For example, if you lend bitcoin to an unknown counterparty, the other party promises to give you a 6% annual rate of return. If the other party is a hacker or a person who often defaults , then the investment may be The bamboo basket will be filled with water and become a 100% loss. Of course, if the blockchain and related technologies can really root in many industries and achieve subversive innovation, then the return on investment should be able to meet the expectations of investors. However, if you choose an investment strategy that adds an additional percentage point per year , you may miss the opportunity for high returns, and this is the biggest opportunity cost you will lose.

Final thought

Some people may now say that encryption credit and lending platforms have more advantages than traditional finance. For those who are eager to earn more interest income, crypto assets offer a good investment option without many constraints (no KYC / AML, credit check, etc.) , liquidity, transparency (decentralization) and simplicity . The author fully agrees with this point of view. The advantages of these platforms (especially the decentralized platform) are undeniable. In the future, there will be more innovative projects in this field. It will be very exciting to think of this.

Written by: Hassen Naas, founder of Naas Capital

Source: Chain smell