Why BlockFi Interest Rates Continue to Decline
Many were frustrated after Blockfi lowered their interest rates on BTC months ago, and just yesterday they announced a further decline in interest rates on all crypto assets.
Although this may be upsetting to people who had hoped to continously earn high yields on their crypto savings, let’s try to get a better understanding of where this yield was coming from, what the risks are to storing crypto on Blockfi and similar lending platforms, and where interest rates may go in the future.
Interest rates are the balance between supply and demand for any crypto asset. In other words, it is the price of money over a time period. The supply side comes from yield-seeking savers who forego consumption in order to consume more in the future, and the demand for borrowing money comes from yield seeking businesses who have a way to generate yield beyond what it costs to borrow.
In the crypto markets, most demand for borrowing crypto comes from arbitrageurs who need the cryptocurrency short term in order to capture a spread. This is most prolific in the Grayscale Trust Products as they have been one of the largest drivers of buying pressure in the market over the last six months. There are other arbitrageurs who seek to capture any spread between exchanges. Often times we see large spreads between exchanges especially in different countries, which creates demand for short term borrowing in order to sell bitcoin on one exchange at higher price and simultaneously buy on the other that is trading at a lower price.
When BlockFi was originally offering these high yields, it attracted savers such that excess supply of crypto to lend pushed prices(interest rates) lower. This is the same market dynamic occuring on the opposite side of the trade in the Grayscale Trust Products. The high premium of 1,000+ percent attracted so much interest that eventually that yield has to collapse (supply outweighs demand).
The problem with these types of high yield environments is that risk is often not properly identified. In the case of the Grayscale trade, for awhile it was easy money. But, when word travels around that there is all of this easy money to be made, people become overconfident and size aggressively.
Currently, the ETC trust is trading at a 30% discount to spot as people are stuck holding ETCG shares and there is no liquidity on the buy side for these shares. Buying Grayscale shares is risky in general because 1. you can’t actually use/access the underlying asset, 2. they charge a 2% management fee, 3. competition in the crypto etp/etf space can collapse demand for Grayscale shares, and 4. because of the first 3 points, the liquidity profile can deteriorate, meaning you may never be able to get out of this trade.
When you add borrowing crypto for a period of 6–12 months you also expose yourself to the upside volatility risk in price, meaning it’s possible that your liability in $$ terms increases by thousands of percent such that even if there is buy side liquidity to exit the trade, you still may end up losing.
Some of these crypto lending institutions have already gone bust. IHaveCred was a lending platform went out of business during the start of the bull market in cryptocurrency. Were they not prepared for the upside volatility? If you don’t understand where the high yield these platforms is coming from, I would be reluctant to send any of my cryptocurrency holdings to them. If you believe cryptocurrency has the chance to appreciate thousands of percent, attaining a 6% additional taxable gain isn’t worth the downside risk.
Where will rates go in the future?
I think that since it has been going horribly wrong for many who came late to the party in this Grayscale trade, these yields won’t be coming back any time soon. When borrowing crypto is for real productive activity instead of speculation and arbitrage, then eventually we’ll probably see rates return to the historical level of cost of capital (around 10%).