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The Muscular Portfolios Newsletter — No. 36 — July 3, 2021
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Crypto staking: high yield or high risk of loss?
 By Brian Livingston
Cryptocurrency has been in the news a lot lately. Starting the buzz was a digital artwork that was purchased in a Christie’s auction in March for $69 million using crypto. This sale was the subject of my Apr. 16 newsletter (link). Christie’s event was followed by a wave of mainstream media coverage about digital coins of all kinds.
Readers have asked me about a new money-making system called crypto staking. You purchase digital tokens, which might come with a requirement to hold them for months or years. In exchange, you receive a promise of rates of return that may seem unbelievable.
A related arrangement is called crypto interest-bearing accounts. Again, you must purchase coins and you’re promised a stream of payments.
This business isn’t a niche market any more. Crypto staking currently generates $9 billion per year worldwide, according to a JPMorgan report. The authors expect staking to generate $40 billion annually by 2025. That’s a tiny sliver of the $303 billion that will be paid out in FY 2021 by US Treasury securities, according to Congressional Budget Office estimates. But $9 billion is nothing to sneeze at.
Holding crypto isn’t exactly what you could call investing. Prices repeatedly soar and then crash, making crypto stakes more like gambling. Just in the past nine years, “bitcoin has endured 14 selloffs of more than 30%, six of more than 50%, and three of more than 80%,” according to a Wall Street Journal article by Paul Vigna (citing a Visual Capitalist analysis).
We’re currently in another selloff, often called a crypto winter. This year, bitcoin vaporized more than 55% of its value in just 10 weeks: Apr. 13 to June 21 intraday (Yahoo Finance data).
Remember the general rule: “If it sounds too good to be true, it probably is.” But with open minds, let’s see whether there’s anything in crypto that justifies handing over our hard-earned savings.
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Well-regulated high-yield bond ETFs pay up to 5.73%
Before we consider crypto programs, we need to know what to compare their offers against.
Figure 1 lists several bond ETFs sorted by yield (the 12-month payout as a percentage of the current market price). The blue rows indicate that investment-grade corporate bond ETFs are distributing up to 2.36%. The violet rows reveal that high-yield bond ETFs — which are more risky but nowhere near as crash-prone as bitcoin — are yielding more than double: up to 5.73%.
These ETFs are regulated by the US Securities & Exchange Commission (SEC). No one will insure you against declines in the market, but SEC oversight does provide investors with some protection against outright fraud and scams.
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Figure 1. SEC-regulated high-yield bond ETFs with defined maturity dates (to protect against interest-rate risk) are yielding up to 5.73% today. Source: iShares website as of July 1, 2021.
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The funds listed in Figure 1 — and in Chapter 23 of the book Muscular Portfolios — are defined-maturity bond ETFs. iShares calls them term ETFs. Such ETFs are also issued by Invesco (formerly Guggenheim). The bonds in term ETFs all mature in the same calendar year: 2022, 2023, and so forth. High-yield term ETFs from iShares are new since the book went to press in 2018.
Term ETFs protect investors from interest-rate risk. When interest rates rise, the market prices of all existing bonds fall. If yields rise during the next few years, as expected, ordinary bond funds — which have no maturity date — will lose value. If rates remain high, you might never recoup your loss.
For example, the yield of 10-year Treasurys hit an all-time low of 0.32% on Mar. 8, 2020, according to a CNBC article. The yield is now over 1.4%, and rates appear to be in a long-term uptrend.
To avoid interest-rate risk, individual bonds and term ETFs have maturity dates. On these dates, bonds and term ETFs give you back 100% of your original principal (less any defaults). Because of this date-certain payoff, you don’t care whether rates rise before then. Term ETFs are designed for investors who want a monthly income with a predictable value at the term’s end.
High-yield securities are often called “junk bonds,” but this putdown exaggerates their risk.
As Figure 23-6 of the book shows, in 2008 only 0.66% of US bonds rated BB — the top of the high-yield category — missed even a single interest payment by more than five days (the definition of a default). By comparison, 0.61% of BBB-rated companies — the low end of the investment-grade category — experienced a default in 2008. The minimal difference between 0.66% and 0.61% during the annus horribilis of the global financial crisis is hardly a cause for concern.
The open secret of high-yield investing is that many banks and other financial institutions are prohibited from buying bonds rated BB, B, CCC, or lower. Companies with less-than-stellar ratings must therefore offer much higher payouts to attract investors who have no such prohibition.
The top-yielding fund in Figure 1, IBHE, yielded 5.73% over the past 12 months as a percentage of the fund’s July 1 closing price. That yield doesn’t include capital gains. The price of IBHE rose about 7.5% in the 12 months ending June 30 — extra value — as recession-wary investors poured money into the certainty of bonds.
IBHE devotes 45% of its holdings to companies rated BB, BBB, or better (including cash equivalents). Its BB-rated issuers include such well-known corporations as Sprint, Ford Motor Co., and HCA Healthcare. These companies may not be top-rated AAA firms with the huge cash reserves that impress Standard & Poor’s and other rating agencies. But the issuers in IBHE overwhelmingly honored their bond payouts right through the pandemic-induced recession of 2020.
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Disclosure: A family trust I manage holds shares of BSJP, an Invesco high-yield term ETF, as part of following the book’s End Game Portfolio. In addition, I personally own shares of the asset-class ETFs that the Muscular Portfolios website currently recommends.
For more info on how term ETFs protect investors from interest-rate risk, see an article by The Balance. For specific term ETFs, see iShares’ page and Invesco’s page.
This is NOT a recommendation to buy high-yield ETFs. Many 401(k) programs, pension plans, and other accounts do not allow the purchase of any high-yield securities. Some tax-deferred plans don’t even allow ETFs or stocks. The ETFs in Figure 1 are listed solely as a yardstick to compare against the yields of crypto programs, which have a far greater risk of loss.
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The rewards of crypto staking are all over the map
If crypto issuers are offering payouts that are higher than regulated high-yield bonds, you might assume that the crypto products are riskier than high-yield bonds. In fact, many crypto promoters have entirely disappeared with investors’ money — with little or no hope of recovery.
In crypto staking, you deposit dollars, pounds, euros, or some other hard currency to buy a certain cryptocurrency. You then enter into a binding contract not to withdraw a certain amount of your holdings for a specific period — perhaps three months to 15 years. (Exception: Some currencies, such as cardano, require no lockup period.)
Figure 2 shows the five cryptocurrencies with the largest staked values, according to a Staking Rewards scoreboard. The website lists 218 yield-bearing tokens. A total of $146 billion worldwide is held in staking at present.
The top five tokens, with about $70 billion in staked value, represent almost half of all crypto staking at this time. (By comparison, US dollars in bank accounts and in circulating currency worldwide total $19.9 trillion. About $2.1 trillion of that is physical bills and coins, says How Stuff Works.)
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Figure 2. The five cryptocurrencies with the largest amounts “staked” have attracted billions of dollars and other hard currencies. Source: Staking Rewards as of June 30, 2021.
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The first three coins in Figure 2 — cardano (ADA), ether (ETH), and solana (SOL) — have staking programs that currently offer maximum “rewards” in the range of 6.21% to 7.23%. Those interest rates are not that much higher than the 5.73% that SEC-regulated high-yield ETFs offer.
Meanwhile, polkadot (DOT) and hex (HEX) promise 13.3% and 38.12%, respectively. That’s more than most publicly traded companies could ever offer. More on hex later.
All staking programs have some serious issues:
- You get rewards in tokens, not in dollars or any hard currency. Transferring your tokens into the currency you use to buy groceries may be a hassle.
- Your locked-up coins may plunge in value, giving you a negative return. In many cases, the lockup period you agreed to cannot be cut short if your tokens are becoming worthless and you want out.
- Any given cryptocurrency may be a total scam. The Satis Group, a digital investment bank and advisory firm, studied initial coin offerings (ICOs) that raised money in 2018. The group reported that 80% were outright frauds by shadowy individuals who never intended to provide any long-term value to ICO buyers.
- Crypto coins are binary files that hackers can steal. SelfKey, which sells a “digital wallet” to hold crypto, reports that $292 million worth of cryptocurrency was stolen from 12 crypto exchanges in 2019 alone.
- Managing your account yourself doesn’t necessarily protect you. Crypto binary files require special digital wallets with extra-long account numbers. Wallets can be held at an exchange or in your possession. Hackers can steal your coins by, for example, using a Trojan horse app to silently change the account number in your Clipboard when you copy-and-paste a transaction. In a scan, the consulting firm 360 Total Security found more than 300,000 computers that are infected with this kind of Trojan, according to a Laptop Mag article.
- Most crypto exchanges are not insured and won’t cover your losses due to fraud or hacking. In one of the most notorious cases, the Mt. Gox exchange was drained of $45 million by a hacker over a nearly two-year period from September 2011 to mid-2013, as described by a Medium article. The exchange went bankrupt, and depositors were never fully compensated. (Some exchanges that do carry insurance against fraud include Crypto.com, Coinbase, and Gemini Trust, but many others do not, according to a Crypto Vantage article.)
- Most crypto exchanges have nothing like FDIC coverage. In a well-regulated financial system, by contrast, even gigantic bank failures can result in innocent depositors receiving full compensation. The largest bank receivership in US history was the failure of Washington Mutual and its acquisition by JPMorgan Chase in 2008. Although unsecured bondholders and shareholders lost money — as is common in bankruptcies — depositors were protected by the Federal Deposit Insurance Corp., which brokered the arrangement, according to a Wikipedia article.
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How do crypto promoters explain their huge promises?
Some crypto programs do have business models that could conceivably support high interest rates for people who stake crypto or hold interest-bearing accounts. One of the most common models is for a coin promoter to make loans (in cryptocurrency) to credit seekers. In theory, high interest rates on such loans could support generous payouts to depositors — higher than any ordinary bank could offer.
One example of such a business model is dai, a cryptocurrency that is run from Copenhagen. Dai is a stablecoin, a type of crypto that is intended to maintain the same price as the US dollar. In theory, this fixed exchange rate avoids the volatility and severe crashes that are typical of bitcoin and other tokens.
Consumers acquire dai by depositing ether into a dai account. For every $150 of ether in the account, a user can borrow up to $100 of dai, acccording to a Wikipedia article. The interest paid by such borrowers can conceivably cover the cost of paying rewards to ordinary depositors.
Why would a person deposit, say, $150,000 worth of ether in order to borrow just $100,000 — in effect from themselves?
The reason is that if you convert ether into some other currency, the result might be a capital gain. Such a profit would legally obligate you to declare the gain and pay capital-gains tax on it. Receiving a loan, however, is not a taxable event. You could use the loan proceeds as desired with no tax liability. (Let’s leave aside the question of how many people actually decide to declare crypto gains, and whether the interest on the loan doesn’t function like a tax.)
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How does hex claim a 38.12% yield to its stakers?
This brings us to hex, the cryptocurrency in Figure 2 that’s listed as offering an astronomical 38.12% reward for buying hex and then staking the currency.
In the Staking Rewards table above, the exclamation point in hex’s row leads to an important footnote: “Rewards based on the annualized average daily payout.” In other words, the dollar value of the tokens paid out in the future might be much less generous than the value that was paid out yesterday.
Hex’s interest page explains that the organizers will create 3.69% more hex each year until an arbitrary number of tokens is reached. In theory, “the interest percentage is a minimum of 3.69%,” the page says. In reality, giving stakers another 3.69% batch of tokens does not represent a 3.69% interest rate on one’s original investment. That would assume the price of hex has remained the same for years and didn’t go down.
The company’s shares page makes this assumption explicit: “Share price only goes up.” I’m sorry, but this simply isn’t correct. The price of hex fell more than 27% — plummeting into a bear market — in just eight calendar days last month, based on June 17–25 closes, according to a Nomics chart of hex.
The grants of additional hex tokens are determined by the length of time you lock up your hex — as long as 15 years — and the quantity of hex you purchase and stake. Shorter and smaller stakes generate lower numbers.
One anonymous hex owner has reported to me that in January 2020 — just after the official launch of hex — early adopters could buy one T-share (a hex unit of value) for as little as $0.50. By December 2020, a T-share required $72.74.
Last week, in late June 2021, obtaining a T-share would run you $1,488. (T-shares are priced in hex, not dollars, but a transaction last week for one T-share would involve 18,149 hex at a dollar value of $0.082. Hex closed lower at $0.0765 on July 1.)
Holding hex was very profitable for those in the know who bought shares early. But the situation isn’t as favorable for anyone who might buy in now. How high or low hex will go someday is anyone’s guess.
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What about an SEC-regulated crypto exchange?
To be sure, there are crypto projects that are managed by known professionals, compliant with securities laws, and fortified against hack attacks.
One of the best-known crypto exchanges is the Gemini Trust Co. Founded in 2014 by Cameron and Tyler Winklevoss — twin brothers who famously tangled with Mark Zuckerberg at the dawn of Facebook — Gemini complies with regulations of the New York State Dept. of Financial Services.
With more than 100 employees, Gemini operates in the US, UK, Canada, South Korea, Hong Kong, and Singapore. Besides trading bitcoin, ether, litecoin, zcash, and other coins, Gemini supports dai and its own stablecoin with the symbol GUSD.
The company publishes a monthly audit by BPM LLP, a top-50 accounting firm, and its US dollar deposits and GUSD are covered by the FDIC (Federal Deposit Insurance Corp.). Gemini also carries a $200 million insurance policy on its virtual currency through its in-house insurer, Nakamoto Ltd., which pays out in case of employee theft, computer fraud, and fund-transfer fraud, according to a Reuters article.
Figure 3 shows the 10 cryptocurrencies offering the highest APY (annual percentage yield) for interest-bearing accounts at Gemini.
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Figure 3. Interest-bearing accounts at Gemini Trust Co. do not require lockup periods but do require a purchase of ether or another supported cryptocurrency to fund an account. Source: Gemini Trust Co. as of June 30, 2021.
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You’ll notice that the floating-value cryptos — filecoin through aave — offer annual percentage rates of 4.48% or less. Because crypto assets require you to hold a position in coins that could plunge in value, those accounts offer no benefit over holding IBHE, which currently yields 5.73% and is tied firmly to the US dollar.
As is the case at other crypto exchanges, the highest APY at Gemini is paid out only when using stablecoins as the asset. Both the Gemini dollar coin and dai offer 7.40% interest. As collateral, stablecoins have an advantage for crypto exchanges. Stablecoins have minimal fluctuation in value against the US dollar, so exchanges don’t need large reserves to insulate themselves against crypto volatility.
Again, this is NOT a recommendation to use Gemini, GUSD, or dai. The existence of Gemini simply points toward the day when digital currencies are well managed, compliant with regulations, and safe for individual investors to buy.
That day is not yet at hand. Why should consumers have to investigate every aspect of a digital currency just to assure themselves that it isn’t a scam? No amount of due diligence can guarantee today that a token is truly valuable and won’t turn out to be a con game by criminals.
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Predictions are difficult, especially about the future
The world desperately needs a universal digital currency to solve two severe problems that face individuals in our modern, interconnected age:
- International remittances. The World Bank estimates that citizens worldwide sent $715 billion of crucial support payments across national borders to relatives and others in 2019. But these transactions cost the senders an average of 7.45% in fees and can take an agonizing five business days to arrive, according to a European Commission report.
Digital currrency exchanges could provide more speed at lower costs.
- Inflation and national currency mismanagement. Billions of people around the world live under regimes that blithely steal their countries’ resources or pay for pet projects by printing money. For instance, Venezuela’s opposition party has alleged the misappropriation of 300 tons of gold from the country’s treasury by President Nicolas Maduro, according to AFP.
In Lebanon, inflation in the lire hit 85% in 2020 after a central bank scandal and general political incompetence, as reported by Borgen Magazine.
Millions of people are trying to use crypto to insulate themselves from monetary debasement. A universal digital currency could make this service trustworthy and more widely available.
But instead of a single, safe, universal means of exchange emerging, more than 18,000 different digital coins have been created to date. Over 9,800 of those are deadcoins, meaning that not a single trade has been seen in any exchange worldwide for over 12 months, according to Nomics. That means the percentage of much-hyped crypto coins that are now worthless is an astonishing 54%! Pathetic.
As soon as a truly universal digital currency gains acceptance, all the others will sooner or later fade away. Bitcoin will trend toward a value of zero when a faster, cheaper, better means of exchange is perfected. The rush by entrepreneurs to invent “the dominant digital currency” explains why 18,000 coins have been launched to convince ordinary people to hand over billions of dollars’ worth of hard currency. Many of those people will never see their money again.
At this point, it’s impossible for me to recommend anything about crypto that looks like a rock-solid investment. But if you’re still interested after reading all the above, please consider this: Keep 95% of your savings in a core portfolio of safe, stable assets. Never risk more than a satellite portfolio of 5% on trying to shoot the moon.
Do you own any crypto? Let me know your experiences. Use this email link or simply reply to this message. (Please delete the newsletter from your reply.) Thanks for your, um, interest!
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Web developer wanted for iframe consulting
Regular readers of this newsletter know that the Muscular Portfolios website shows, free of charge, which ETFs have the best probability of going up in the next 30 days.
The ranking tables update every 10 minutes during market hours — but don’t trade every day! Trade only once a month, ideally on the last trading day of the month. The reasons are explained in Newsletters #27 and #28.
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Figure 4. On iOS devices, the table rows render with extra-large fonts that are unaligned, pushing a few rows off the screen.
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We need help with a problem. The tables look fine on browsers and other devices, but on iOS/iPhone the fonts are too large, pushing the rows out of alignment and off the bottom of the screen, as shown in Figure 4.
The tables are generated by ETFScreen.com and displayed on the Muscular Portfolios website using a technique called an iframe. The CEO of ETFScreen and I have looked at the code, but we can’t find the error. (Hat tip to reader Doug D. for sending us the screen shot above.)
For general iOS users, the workaround is to simply look at the tables within ETFScreen. The ranking tables are native there, not encapsulated in iframes. Please see:
Mama Bear Portfolio, Papa Bear Portfolio, Baby Bear Portfolio.
But if you’re a Web developer, we’d like you to look at the underlying problem. If you can suggest a fix immediately, great! But we’re happy to hire you for a few hours, if that’s what’s necessary to get this display issue corrected.
To apply for the job, send us an email and attach whatever you have in the way of a résumé or curriculum vitae. Use this email link or simply reply to this message by July 31, 2021.
In the body of your email, you must state your hourly rate and whether you have an affordable “friends and family” rate for small businesses. Or you can just tell us what’s wrong, if it’s that simple!
This could be the beginning of a beautiful relationship. Thanks in advance. —Brian Livingston
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News from the leading edge
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Anom: A $2,000 smartphone that let the FBI listen in
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About the author: Brian Livingston is a successful dot-com entrepreneur, an award-winning business journalist, a contributor to MarketWatch and StockCharts, and the author of Muscular Portfolios (2018, BenBella Books). He is also the author or co-author of 11 books in the Windows Secrets series (1991–2007, John Wiley & Sons), with over 2.5 million copies sold. From 1986 to 1991, he worked in New York City as the assistant IT manager of UBS Securities; as a consultant for Morgan Guaranty Trust (now JPMorgan Chase); and as technology adviser for Lazard Ltd. He was the weekly Windows columnist for InfoWorld magazine from 1991 to 2003. During portions of that period, he was also a contributing editor of CNET, PC World, eWeek, PC/Computing, Datamation, and Windows magazine, and the editor of E-Business Secrets. In 2003, he founded the Windows Secrets Newsletter, which grew from zero to 400,000 email subscribers. He served as its editorial director until he sold the business in 2010. He is president emeritus of the Seattle regional chapter of the American Association of Individual Investors (AAII). Stipple illustration by The Wall Street Journal.
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