This article was also published on e27.
Thanks to growing acceptance of Bitcoin and other cryptocurrencies in the mainstream, professional investors are by now fully cognisant of the upsides of investing in crypto.
Meanwhile, institutional grade investment products such as the Fintonia Bitcoin Physical Fund have made cryptocurrency safer and more efficient than ever before. No wonder we’re seeing an unprecedented number of professional investors buying into the crypto space.
Apart from investing in crypto tokens directly or through a fund, though, there is another way for investors to profit within the fast-moving cryptocurrency ecosystem. We’re talking about finding yield, or passive income, through crypto.
Yield farming in the crypto ecosystem
Given that cryptocurrency is a notoriously volatile field, how is it possible to generate a stable income from it?
Collectively known as “yield farming”, the below strategies all focus on generating consistent yield from your crypto holdings.
1. Lending: If you’re on a crypto exchange, you can lend your holdings to other users. This method is similar to how traditional fiat banking works. Others borrow your Bitcoin to make transactions, and, as the lender, you earn interest from them.
2. Staking: It is possible to stake your crypto holdings on a blockchain and get rewarded when ledger transactions are confirmed. However, this only applies to proof-of-stake blockchains like Ethereum, Solana and Cardano, not proof-of-work ones like Bitcoin.
3. DeFi protocols: Some decentralised finance (DeFi) protocols allow users to swap pairs of cryptocurrencies. If you can provide these token pairs, you can earn a cut of the fees.
However, all three methods have risks. Being largely unregulated, crypto exchanges and DeFi protocols could leave investors susceptible to scams, hacking, and theft.
While it is possible for professional investors to practice yield farming methods, we believe the possibility of major security breaches is risk too high for many professional investors to make them worthwhile.
On top of that, investing on unregulated platforms leaves you open to a slew of additional risks and hidden costs, especially if you’re managing larger amounts of cryptocurrency.
A safer solution for professional investors
Generating consistent income from cryptocurrency is a top priority for professional investors, but the lack of security and safety in the crypto ecosystem is a significant obstacle.
Given the difficulties in moving fiat currency in and out of the cryptocurrency ecosystem, the 1,000+ exchanges and overall cryptocurrency market inefficiencies, there is the opportunity to provide collateralised loans at higher risk-adjusted rates to ecosystem players who are profiting from these market inefficiencies.
That’s why Fintonia Group created the Fintonia Secured Yield Fund, an over-collateralised traditional private credit fund, as a solution to help professional investors solve this issue.
There is a great opportunity for professional investors (via the Fintonia Secured Yield Fund) to lend fiat money to cryptocurrency players, such as miners and crypto hedge funds, and earn interest from these borrowers.
At the same time, the borrowers’ Bitcoin is held as collateral so that the risk of default is kept minimal and margin calls made when the cryptocurrency price drops to pre-determined levels.
Essentially, fiat loans secured by borrowers’ Bitcoin holdings allow investors to generate an attractive stable income at low risk — all amid a volatile cryptocurrency environment.
The crypto ecosystem’s need for fiat
Savvy investors would have noticed that this opportunity is very much like a bond or bank deposit, where investors earn interest from borrowers. But the difference is in who’s borrowing and why.
In the case of traditional financial products, borrowers use the funds to run businesses or purchase consumer goods like houses or cars.
Meanwhile, cryptocurrency ecosystem players like Bitcoin traders, miners, and corporates are willing to pay much higher interest on fiat loans than traditional borrowers. We’ll explain why:
1. Arbitrage traders: Arbitrage traders and hedge funds profit hugely off the inefficient crypto market by taking advantage of price differences across exchanges and assets. However, they need large amount of fiat to settle their trades. As a result, they’re willing to pay high interest on fiat loans.
2. Crypto miners: Considering that each completed hash on the blockchain can generate a reward in the six figures, Bitcoin mining remains a lucrative industry. But miners need immense working capital to keep their operations running and would rather borrow fiat then sell their Bitcoin to pay operating expenses, given that Bitcoin returns have averaged 100%+ IRR over the last decade. Note that mining expenses such as electricity bills and hardware purchases are largely settled in fiat.
3. Corporates: More and more companies are holding Bitcoin in their portfolios, but they may still need cash for their requirements (e.g. purchase property, cars or equipment). We come in to supply fiat, secured by their Bitcoin holdings.
In summary, cryptocurrency ecosystem players are making significant profits, but fiat is still very much needed to grease the wheels. At the same time, some players lack access to traditional borrowing options such as banks, which further strengthens demand for fiat.
By meeting the crypto sphere’s demand for fiat, the Fintonia Secured Yield Fund allows investors to find much higher yields than that of traditional investment products.
Collaterised loans using Bitcoin: a star in today’s low-yield environment
Consistently high risk-adjusted returns of between 6% and 18% per annum through collateralised loans secured against cryptocurrencies stands out in today’s low-yield environment. It can generate four to ten times as much annual income as a mainstream corporate bond today.
Historically, high returns went hand-in-hand with high risk, but collateralised private loans secured against Bitcoin provide a much higher risk-adjusted return given the cryptocurrency market inefficiencies.
In addition, Bitcoin is a great form of collateral as it is highly liquid, easy to value, transfer and verify and is seen as a store of value. The volatility of Bitcoin can be managed by setting an appropriate loan to value (“LTV”) ratio (typically 50% LTV) and margin call ratios (typically at 70%, 80% & 85%).
Typically for every fiat dollar borrowed, collateral twice as much of the value of the loan is deposited in the form of the borrower’s Bitcoin. Should the value of their Bitcoin fall below a safe ratio due to price fluctuations, the borrower is obliged to top up within hours. Otherwise, the Bitcoin collateral can be automatically liquidated so that the loan can be repaid.
Bitcoin collateral is deposited with a licenced, insured custodian, and typically held securely in an offline cold wallet.
As an MAS-regulated fund manager that complies with Singapore’s strict practices, Fintonia Group uses best-in-class risk management techniques in our institutional-grade funds.
These funds, which were designed especially for professional investors, help to manage the security, legal, and financial risks around cryptocurrency investing. That’s how we can deliver high but consistent yields within the fast-growing crypto ecosystem, all without compromising the integrity of your investment.