Providing collateral for crypto trading is risky. You can get totally wiped out. It is even more dangerous in crypto because there is no regulation on either side of the trade, collateral or lending. Without regs, risk is high.
Given the risk, the goal is to preserve the value of collateral. A strategy in investing to help maintain capital is diversification, an investment concept that has stood the test of time.
In traditional finance, it is cumbersome to compile a portfolio of assets and pledge them all for collateral. In crypto it is easy, fast, and cost effective.
As noted previously, the best source of collateral is probably short-term sovereign debt. Short-term sovereign debt is liquid, has low duration (low sensitivity to interest rates), relative price stability, and can be custodied in a bona-fide custodial provider. Historically, short-term sovereign debt collateral has been denominated in a single developed market currency like the US dollar, Euro, or Yen.
But in the world of crypto, there is a better way. With crypto a token comprised of multiple stable bonds can be created, including both developed and emerging markets.
Given that short-term debt does not carry BIS (Bank for International Settlement) ratings, other methods must be used to assess currency exposure risk. For after all, risk in currency devaluation is the big risk in this form of collateral.
Analysis focusing on a "Need for Money" (NFM) model can compensate for the lack of BIS ratings. Countries with a chronic NFM run the risk of devaluing their currency. Much of this can be mitigated by paying attention to a country's Current Account/GDP—a measure of money flowing out of the country versus flowing in, the Trade Balance—measure of import value vs export value, and Government Debt/GDP—a measure of how big a country's funding need is.
At the same time, S&P country ratings can be used. S&P ratings range from AAA to D, with AAA to BBB being denoted as investment grade. Using country ratings in a diversified portfolio allows for a correct amount of investment grade and below investment grade paper, with the concentration more towards investment grade.
This approach can produce an interesting, tokenized portfolio. A portfolio with short-term stable bonds from 15% Sweden (AAA), 5% Germany (AAA), 30% Mexico (BBB), 30% Brazil (BB), South Korea 20% (A) can provide a potential annual return of 7.55% gross (pre-USD adjustment). If the US dollar goes down, the return will be even greater. The weighted average of this portfolio is just slightly below investment grade of AA. The risk to this return is US dollar strength, or one of the portfolio currencies going through a devaluation. Given the outlook for the US dollar, dollar strength seems a little bit of a stretch at present.
The diversification of this token makes it a safer alternative than using only one stable bond or coin.
Etherfuse can provide all these bonds in tokenized form. If you are interested in knowing more about this approach to collateralization, reach out.
This blog is for educational and informational purposes only, covering general market trends, industry developments, and asset features. Nothing herein is investment advice, a solicitation, or a recommendation to buy or sell any assets. Etherfuse and its guests may hold stakes in some or all of the assets discussed.
