Collapsing Crypto Yield Offerings Signal ‘Extreme Duress’
The leverage mania in crypto is over, and yield-generating arbitrage opportunities have collapsed. Readers should carefully evaluate how companies can still offer yield products above risk-free rates.
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Speculation And Yields
This cycle has been supercharged by speculation and yield, leading all the way back to the initial Grayscale Bitcoin Trust premium arbitrage opportunity. That opportunity in the market incentivized hedge funds and trading shops from all over the world to lever up in order to capture the premium spread. It was a ripe time for making money, especially back in early 2021 before the trade collapsed and switched to the significant discount we see today.
At the same time, we saw contango yields (the spread between the futures price and spot price) blow out during that period. In a market environment where the 10-year Treasury yield was hovering below 1%, it was an attractive play for new market participants to come in and capture the spread rather than park money in traditional markets. Everyone was going further out on the risk curve. Yet, this led to the market price being heavily influenced by the futures price and less influenced by spot buying that would eventually have to wind down.
We’re in a much different world now where the futures basis is in backwardation (futures below the spot price) and the 10-year Treasury is well over 3% with certain bonds and short-term bills acting as a much more attractive place to park cash for yields. Why chase bitcoin- and crypto-native “yields” when they are below market rates?
The same story existed in the perpetual futures market where we saw 7-day average annualized funding rates reach up to 120% at peak. This is the implied annual yield that long positions were paying in the market to short positions. There were an abundance of opportunities in the GBTC and futures markets alone for yield and quick returns to be had — without even mentioning the bucket of DeFi, staking tokens, failed projects and Ponzi schemes that were generating even higher yield opportunities in 2020 and 2021.
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Data from some of the DeFi protocols emphasize just how much excess demand for borrowing there was back in March 2021. Shown below are borrow and deposit rates for both USDC and yearn.finance (YFI) reaching annual borrow rates of 48.74% and 159.15% at peak.
USDC on AAVE borrow and deposit rates back in March 2021
Source: Yield Samurai
YFI on AAVE borrow and deposit rates back in March 2021
Source: Yield Samurai
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There’s an ongoing, vicious feedback loop where higher prices drive more speculation and leverage, which, in turn, drive higher yields. Now, we’re dealing with this cycle in reverse. Lower prices wipe out more speculation and leverage while washing out any “yield” opportunities. As a result, yields everywhere have collapsed.