Recent weakness in the bond market could potentially drive capital flows into crypto, given that the space offers relatively higher returns. Institutional interest in crypto has already picked up this year.
Concerns over a possible recession and a hawkish Federal Reserve recently caused an inversion in the U.S. yield curve, as bond markets experienced heavy selling. Data from Bloomberg showed that global bonds were priced at a discount for the first time since the 2008 financial crisis.
BlackRock, the world’s largest asset manager, recently said it was underweight on government bonds in the face of rising inflation and borrowing rates.
As such, with the debt market offering limited gains, institutional investors may set their sights on alternative means of returns. Crypto could be one of these pathways.
The case for crypto
Lending and staking on major DeFi platforms offers returns far superior to most staple instruments in the bond market. For example, Terra’s Anchor Protocol currently offers a near-20% annual yield on deposits. By comparison, U.S. 2-year Treasuries yield about 2.6%.
Crypto staking also behaves similarly to a debt instrument. Tokens are locked in for a period of time, while paying out interest. Solana (SOL), the largest proof-of-stake network by market capitalization, currently yields about 7% a year. That rate has already attracted financial instruments from established asset managers.
World no.2 crypto Ethereum (ETH) has blown up in popularity this year ahead of a switch to a PoS model. Goldman Sachs recently said it was considering offering specialized ETH options, citing growing institutional interest.
BitMex founder Arthur Hayes said he believes ETH’s shift to a PoS model could attract more institutional interest, given its similarity to a bond. The network’s falling energy requirements will also align it with corporate sustainability goals in major trading houses
But is it sustainable?
While crypto and DeFi do offer much higher returns than conventional debt, they currently do so on a much smaller scale. It is unclear if the space is equipped to handle capital at the size of the bond market, which is currently valued at $119 trillion globally.
Some platforms, such as Terra, have attempted to bolster their reserves in order to prepare for such a shock. But their reserves, which are currently around $3 billion, pale in comparison to the GDP-sized capital seen in bond markets.
Even now, DeFi and staking platforms are trimming returns on crypto deposits, due to a mass influx of deposits. High yields raise the chances of a platform-wide liquidation, which would equate to a default.
Incoming investors would likely have to weigh the risks between investing in emerging markets such as Argentina and Turkey, or in crypto, for those coveted double-digit returns.
Regardless, institutional interest in crypto is growing exponentially, given that the space still offers relatively higher returns. Whether this is sustainable remains to be seen.
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