Author: Christian Hsieh, CEO of Tokenomy
This paper highlights the emerging fixed income investment opportunities in the crypto market. We take a closer look at different yield earning options created by increased activity of lending and borrowing in cryptocurrencies, in both centralized and decentralized networks.
History of Crypto Lending
Before 2017, the concept of trading crypto on credit was not common at all in the crypto space. Investing in crypto was like investing in a commodity, where price appreciation is the only source of profitability. When derivative exchanges started to offer crypto contracts on leverage, Bitcoin miners became frequent users of derivatives. Like traditional commodity producers, miners use derivative contracts to lock in the future value of their freshly minted coins and hedge against price declines. Professional traders and speculators also started trading crypto contracts on margin to enhance their returns. The derivative market started to generate implied interest rates for Bitcoin and USD, which facilitated the rapid development of a crypto lending and borrowing market.
In 2018, the cryptocurrency space started to transform itself from a market designed for individuals to one that is institutionally accessible. Since then, derivatives volumes grew over 25x while bid-ask spreads fell 10x . Institutions started to have the option to operate via more sophisticated trading infrastructure and custody solutions. The market matured from a manual, expensive, and bitcoin-denominated network to a fully electronic, cost-efficient, and stablecoin-led ecosystem.
As the cryptocurrency space became more institutionalized, so did its lending markets. Borrowing and lending activities started to rapidly develop, resulting in a yield generating fixed income market for top cryptocurrencies such as Bitcoin, Ethereum, and popular stablecoins like Tether and USDC. Today, trading companies can access more than $10 billion in stablecoin and bitcoin lending markets , with the source of capital coming from both retail and institutions.
Illustration of Crypto Lending Process 
A Fixed Income Market Emerges
The development of the crypto lending market has led to more efficient costs of capital, benefiting all market participants. Institutional traders can access tighter spreads and retail investors can get higher yields. In an environment where traditional banks are offering saving rates close to zero, this only pushes investors to look for yield elsewhere in alternative asset classes.
Average CD Rates: 1984-2020 
In the past few years, there has been a massive influx of capital into the ecosystem. For instance, global crypto lending and trading firm, Genesis, witnessed a stellar rise in its total loan originations to $21.2 billion since it started operating in March 2018. The average loan size from institutional crypto lenders grew by 538% from $590k to $3.2 million in Q4 2020 compared to the previous quarter . The total value locked (TVL) in decentralized lending protocols adds another $10 billion liquidity into this equation . This rapid influx of demand solidifies the case for the further evolution of the crypto space.
USDC Yield: December 2017 – December 2020 
With the rapid demand for borrowing and lending, there is a new wave of lending platforms that are emerging. Most of these platforms support the fixed deposit lending model, where the funds are accepted for a specific time with predetermined interest rates. This is a great option for long-term investors as they can continue to generate yield while holding on to their crypto assets. There are both custodial lending platforms and non-custodial lending platforms in the market, with various lending periods.
There are a few global lending platforms that have built good reputations and stayed ahead of the development curve. Crypto investors can earn yield through lending their assets to these platforms, such as BlockFi, Celsius Network, or Amber Group.
BlockFi allows users to deposit their coins into their web wallets and accrue interest accordingly. The platform supports major cryptocurrencies, offering deposit rates of up to 6.0% for BTC, 5.25% for ETH, and 8.6% for USDC deposits at the time of publication [the rates are subject to market movements] . Coins can be deposited and withdrawn anytime, with interest payments made once a month. For one withdrawal a month, withdrawal fees are waived. BlockFi is backed by well-known venture funds and has over $4.5 billion in assets under management. The crypto funds are in the possession of the Gemini Trust Firm, the GUSD issuer that is regulated by the New York State Department of Financial Services.
Celsius Network is an app with wallets for iOS and Android that supports various cryptocurrencies. In addition to the major cryptocurrencies, Celsius also endorses DASH, Stellar, ZCash, Bitcoin Gold, and more. They are offering an interest rate of up to 7.2% for ETH, 6.2% for BTC, 13.9% for USDC, and 9.2% for UMA deposits at the time of publication . Payments are made out monthly and coins can also be deposited and withdrawn at any time. Interest rates change for loans every week. In comparison, with an elevated interest rate, interest from CEL tokens (Celsius Network’s platform token) may also be paid out. The latest audit in December 2020 indicated the platform has $3.3 billion assets under management . The funds are insured by BitGo – a regulated trust company under the Division of Banking in South Dakota.
Amber was established in 2017 by a group of former Morgan Stanley institutional traders. Based out of Hong Kong, the company operates around the world with other offices in Taipei, Seoul, and Vancouver. It provides institutional clients market-leading fixed interest rate products, yield enhancement, and risk management tools. Amber currently serves more than two hundred institutional clients and is registered under the US FinCen and Canada FINTRAC. Its specialization is in offering customized investment products with up to 16% APR, flexible redemption schedules, and cross-margin functionality for capital efficiency . The funds are secured by Fireblocks and Bitgo.
There are new players entering the lending space as the demand increases. We expect to see traditional banks as strong contenders in the near future.
Interest Rates Comparison [Source: Messari.com]
Entering DeFi – an Innovative Way to Earn Yield
DeFi or Decentralized Finance uses smart contracts on blockchains (the most common being Ethereum) to completely bypass the traditional centralized financial intermediaries like banks, brokerages, or exchanges. This allows anyone in the world to access financial services as long as they have a smartphone connected to the internet. DeFi applications include the ability to borrow funds, take out loans, deposit funds into a liquidity pool, or trade complex financial products, all without asking anyone for permission or opening an account anywhere. Although being a very recent concept, DeFi protocols offer an innovative way for crypto investors to earn yield from various sources.
Yield can be earned through a few popular ways on DeFi protocols:
One of the first applications of DeFi is decentralized exchanges (DEX). DEXs are set up to allow automatic exchange of crypto assets in a peer-to-peer and a non-custodial way. For the DEX to function effectively, sufficient liquidity is required. Market participants can deposit crypto assets into a liquidity pool, and earn a portion of the trading fees as well as the platform token in return. The process of earning platform tokens in exchange for your liquidity is called liquidity mining. An automated market maker is a smart contract that creates a liquidity pool for investors to deposit their crypto in exchange for a fee. Examples of top liquidity pool providers are Uniswap, Balancer, Curve, or Kyber Network .
Another popular DeFi application is decentralized lending, where depositors can earn yield by making crypto deposits, while borrowers will pay interest for their loan. Initially, all protocols need to source new deposits, so they provide a high yield to attract crypto depositors. Earning interests on deposits is thus called yield farming. Smart “yield farmers” would move around different protocols to maximize their earning potential. For instance, a yield farmer puts some USDC into a DeFi lending protocol, and borrows out some USDT. The USDT could then be deposited by the farmer into another DeFi protocol to receive further rewards. This is the essence of yield farming. The terms yield farming and liquidity mining are sometimes used interchangeably, as certain protocols reward their own platform tokens (also refer to “governance token”) on top of the yield they pay to the depositors in order to incentivize more liquidity.
Although seeking yield in the DeFi space is currently more of a manual process, it is gradually becoming automated. This trend is led by algorithms that automatically help yield farmers to look for the protocol that pays the highest interest. One notable example is Yearn Finance .
Defi Lending and Borrowing Platform 
In blockchain networks, there is a new wave of protocols that operate in a Proof-of-Stake (PoS) mechanism to facilitate consensus and maintain decentralization in a more energy-efficient way compared to Bitcoin’s Proof-of-Work (PoW) consensus algorithm. The stakeholders of these PoS protocols simply need to hold (or “stake”) the protocol tokens in a crypto wallet to sustain operations and security of the protocol, and in return, they receive yield in the form of additional platform tokens.
Navigating around multiple PoS protocols can also be a lot of work for passive investors. There are entities like Staked (staked.us) enables users to lock assets into their individual crypto wallet and earn yield from 30+ protocols paying an average yield in the high teens. Proof-of-Stake is steadily gaining popularity and now represents approximately 15% of the total crypto market cap. Top PoS names like Ethereum2.0, Polkadot, Cardano, Tezos, Cosmos, etc. have led the crypto development space in 2020 .
All DeFi protocols serve different purposes in the ecosystem, but the focus on yield-capture is a common thread binding everyone together. While it brings benefits, yield can be fickle and volatile, especially in a relatively young and evolving ecosystem. Smart contract risk, cybersecurity risk, and technology risk still exist today but should be reduced over time as the infrastructure improves. Smart investors would size their investment exposure into these protocols gradually to accumulate profits overtime.
Macroeconomic Backdrop Sustains the Crypto Thesis
2020 was a year of COVID-induced global crisis with investors remaining cautious around traditional portfolios. With a gloomy economic outlook, ultra-low interest rate policies, and more government stimulus on the way that drives up inflation expectations, the traditional fixed income market is no longer able to provide sufficient returns for investors as it did historically. The $128 trillion fixed income market (with $18 trillion of them yielding negatively) might need to reallocate some of its capital to optimize investment returns. As hedge fund legend Ray Dalio recently shared in his views on Bitcoin, “the new paradigm that we are living in, with many government bonds no longer offering the same return or diversification characteristics and currencies facing greater risk of depreciation, could propel development of alternative storeholds of wealth faster than might otherwise have been the case.” 
Negative-Yielding Debt is on the Rise 
Institutional investors are already allocating assets into Bitcoin, treating it as a digital store of value to hedge against fiat currency devaluation and asset price inflation. This trend will likely continue to push Bitcoin prices higher. It is only a matter of time when these investors start to take advantage of the crypto fixed income market and facilitate further development into a more mature and dynamic financial market. The coming of regulated stablecoins and CBDC initiatives by governments around the world will also accelerate this process. We can expect traditional banks to start to develop the expertise to deal with crypto assets custody and provide trading and lending services in the foreseeable future.
Choosing the right platform along with understanding the nuance of each offering is critical for investment success. With the accelerated tech infrastructure and an accommodative compliance environment in place, crypto fixed income markets will likely to thrive in the coming decades.
The Tokenomy team is excited about the crypto fixed income market outlook and has built an easy-to-use crypto asset management platform to help investors get exposure to this unique asset class. Through Tokenomy Earn, investors can access various yield earning opportunities provided by top lenders, yield providers, and custodian partners, without signing up for multiple accounts across different platforms. Users can easily manage all their assets and adjust portfolio allocations from fixed deposits to staking projects all in one place, in a safe and secure way.
 Crypto Market Structure 3.0, Arjun Balaji, October 2020
 Interest income and lending are bitcoin’s killer apps, Forbes, May 2020
 Crypto Lending, P2P Lending
 Historical CD Interest Rates, Bankrate, Jan 2020
 Digital Asset Market Report, Genesis, Q4 2020
 Total Value Locked in DeFi Lending, DeFi Pulse
 USDC Rates, LoanScan, Jan 2021
 Interest Rates, BlockFi, Jan 2021
 Celsius Network
 Audit Confirms Celsius Has $3.3B in Assets, The Chain Bulletin, December 2020
 Amber Group
 Top 10 Liquidity Pool Providers in 2020, CoinMarketCap, August 2020
 Yield Farming Ranking, CoinMarketCap, January 2021
 Guide to Decentralized Lending and Borrowing Protocols, Coinjoker, October 2020
 Proof-of-Stake Was Bigger Than ETH 2.0 in 2020, Coindesk, December 2020
 What I Think of Bitcoin, Ray Dalio, January 2021
 World’s Negative Yielding Debt Pile Hits $18 Trillion Record, Bloomberg, December 2020
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