Would you sell your bitcoin holdings for twice their current price? Really think about it for a second, deeply. If the bitcoin price reached $17,000, would you calmly cash out, or hope to ride the bull market to even greater heights?
Wherever you land on the spectrum of bitcoin belief, the cryptocurrency market is obviously volatile. Prices bounce and dip in every direction. These gyrations make the strange digital asset endlessly fascinating – and maddeningly risky. Introducing financial derivatives into the bitcoin ecosystem adds another layer of complexity, but stakeholders have portrayed the products as stabilizing forces. Earlier this month, even the San Francisco Federal Reserve suggested that cryptocurrency derivatives tamed the market:
"The rapid run-up and subsequent fall in the [bitcoin] price after the introduction of futures does not appear to be a coincidence. Rather, it is consistent with trading behavior that typically accompanies the introduction of futures markets for an asset."
As cryptocurrency investors chase their next high, new-fangled products have quickly been developed to meet the demands of the ravenous crowd. This week, LedgerX introduced "LedgerSavings," which the company described as "an innovative product that uses an underlying call overwrite strategy. The offering targets a 16% per annum yield with a potential 2x exit at maturity in the event BTC doubles from current spot prices."
Descriptions like that are apt to make a customer's eyes glaze over … but the highlighted "16% return / 2x Exit" might tempt some into the purported investment opportunity.
The premise is this: If a customer owns bitcoin and wants to "earn a return," then they can bet that the price of bitcoin will not double before a certain date.
Other people take the opposite side of the bet and they pay a small fee for a chance to buy bitcoin at a fixed price (approximately double the current price). Stay with me here.
If bitcoin increases in price by 2x (or more), then the original customer receives a cash payout roughly equivalent to double the current price. In this instance, the other bettor receives the bitcoin (which could be worth more than double the current price).
If bitcoin does not double in price, then the original customer receives the fee paid by the bullish gamblers (what LedgerX calls "interest") and the original customer receives their bitcoin deposit back at the end of the contract. The bullish options buyers go home empty-handed. Of course, LedgerX takes its cut regardless of what happens.
Note: The underlying price of bitcoin will be changing throughout the duration of the contract as well, so investors must remember that they are also exposed to the risk of holding bitcoin for a set timeframe.
There is nothing objectionable about the financial product itself. Covered call options are popular in the stock market and many people use them to great effect. However, the idea that people are "earning interest" on their bitcoin holdings is fundamentally flawed for a few reasons:
1. The "interest" is distributed in USD, not bitcoin.
This is not a small sticking point. This "interest" transaction occurs entirely in dollars, not BTC. Don't get confused. LedgerX isn't minting new bitcoins out of thin air, and the "interest" comes from somebody (the other bettors).
2. The "interest" that people earn is based on an accepted risk.
Although LedgerX is promising a 2x payout if bitcoin rises to twice its current value (or more), what they paint over is that bitcoin depositors would miss out on further potential gains if the price exceeds twice the current valuation. It's implied, but not explicit – people considering this financial product must understand what signing up for these ostensibly interest-bearing products really means.
It's worth noting that at high prices, the bet seems less risky. In more concrete terms, at a price of $8,500 per bitcoin, the 2x bet might be more palatable. The increase from $8,500 to $17,000 is much greater in absolute terms – and probably less likely to happen – than an increase at lower prices, say from $1,000 to $2,000. At these lower prices, volatile markets could sooner result in dissatisfaction.
3. This is not a "savings" account.
The language LedgerX uses to describe this financial product might make it sound nearly riskless, as though a person were holding dollars in an FDIC-insured savings account at a bank. Its name even includes the word "savings." To be 100 percent clear, this is not a savings account. The price of bitcoin could double, or more. Sure, a customer would receive that 2x payout in USD, but the gain itself is capped. It's critical to understand that this is a "savings product," not a savings account.
Altogether, LedgerX inappropriately conveys a limited risk by suggesting that people can earn "interest" through LedgerSavings "without having to know anything about derivatives." There is nothing wrong with the bitcoin-linked financial product. However, customers should be aware of the upside risk of this new instrument and the risk of tying up crypto-capital for long periods of time.