Breaking Down Barriers to Yield

Do institutions need to embrace digital assets so we can create more yield opportunities? Or should they get out of the way? Is there a middle ground?

That was the topic of discussion at a recent Blockworks webinar where Coinshare’s Meltem Demirors, Circle CEO Jeremy Allaire, and CMS Holdings’ Dan Matuszewsk dove into the impact of a low-yield environment. They also debated how new opportunities from digital assets on blockchain can help retail investors chase yield.

Climbing the risk curve 

There’s nearly $20 trillion in sovereign debt around the world that has close to zero yield, explained Coinshare’s Demirors. 

“Fixed income has been decimated because yields are coming down across the board,” she said. “It’s a challenge to keep pace with inflation — the real rate of which is between 5% to 6%.”

And what’s Demirors been hearing from institutions that steward capital? “We need to do something.”

Because an era of low interest rates has created a rush to preserve capital from the devastating effects of inflation, people and institutions are climbing up the risk curve, said CMS Holdings’ Matuszewsk.

“Fixed income investors become equity investors, equity investors become venture investors, and venture investors become crypto investors,” he said. “The biggest inflections happen up that curve as the capital moving into it has a larger effect.”

Less layers, more yield

While fixed income investors, equity investors and the like have some flexibility in the investment products they chase retail investors are left at the mercy of savings accounts that pay on average 0.05%.

But through digital assets there is a solution to this: stablecoin based savings accounts that pay between 6% to 10% for deposits. 

So how is it that these providers are able to pay such comparatively high rates? Because there’s not enough capital to go around. Many traditional pools — such as institutional investors — simply won’t lend to crypto traders.

“There’s about a trillion dollars of additional capital that wants to be net long, but of that $1 trillion there’s only about $500 billion that’s willing to supply that,” Matuszewsk said. “Rates get really high because there are traditional pools of capital that are cheaper, but they won’t lend to crypto traders. There’s so much excess demand for leverage that’s not met by the traditional system, and the only way this is going to change is if we get more dollars in the system.”

So how can the traders afford to pay off such high-interest rate debt? Yield farming. The astronomical returns that yield farming can provide mean that the appetite for high-priced debt is there and, in turn, retail investors are able to earn interest that exceeds traditional savings accounts. 

So if this is so successful, where are the institutional investors? Circle’s Allaire says he’s working on getting more corporations to put some of their working capital into these markets. “We’re very much on the path to that in the coming years,” he said.    

Now that’s institutional investors, the adjective. What about institutions? The noun; the established banks. 

For the most part they are just getting in the way and creating dead weight. It’s again one of the reasons why lean startups like Compound or BlockFi can pay out such comparatively high interest rates. 

“How do we obviate the need for institutions that are trying to insert themselves as brokers of trust and effectively they’re just matching on either side of the book,” Demirors said. “Most of the erosion of net interest margin comes from chasing profit and all of the internal costs. How do we put that on-chain [to] disintermediate and dematerialize the legal compliance and complexity for lending?”

All this is possible because blockchain allows for a structural change in the distribution pipeline for financial products and services, Demirors explained. While at one time you had the layers of sovereign banks, big banks, product companies and consumers now you can go from a DeFi protocol directly to the end consumer. 

“This will completely change the nature of lending across a number of segments,” Demirors said. “I want to build a technology company that offers products in a wrapper that can be touched by institutions thus obviating the need for some of these institutions.” 

Yield crushing institutions 

The profitable era when all “capital allocation is managed by autonomous machines on the internet,” as Allaire put it, isn’t quite with us yet. There’s still a lot to do between now and then. 

There still is a significant amount of risk that deters many investors, such as protocol risk, as Matuszewsk pointed out, referencing the hack of the MakerDAO protocol and the subsequent crash of Ethereum. 

“This can be very nested in DeFi. Risk is hard to quantify, it’s an unknown unknown,” Matuszewsk said. 

Duration matching and rate markets are also an issue. As this is a totally new category of finance, one of the challenges that’s come up, as Demirors explained, finding large pools of cash that want to be locked up for a long period of time is tough as there’s not yet a corresponding robust rate market. 

“It gets difficult to match expectations of yield because yields in crypto are highly fluid. If we go into a market correction the rates on cash could flip,” Demirors said. “The groups you end up attracting are prop firms and hedge funds who are looking for short term ways to put cash to use. It’s a little harder to attract institutions just because we don’t have that operating history.”

So institutions are going to be with us for a while. Yield will have the opportunity to sprout up on the comparative side through things like crypto savings accounts, but don’t expect this to appear within your bank’s app anytime soon. 

Listen to a full replay of the webinar here: The Search for Yield Comes to Digital Assets.