June 04 2021

Blue Pill or Red Pill?

We always have a choice. The same in investments. Red pill, you stick to the harsh reality of your directional portfolio. You live and die by your volatile bets on assets, hoping it will take you to the moon one day. Blue pill, you enter a machine-generated dream world, where software effortlessly harvests high yields on the back of low-volatility assets. The world of DeFi credit.

If betting on AMC, Game Stop or yolo-ing in BTC is your thing, swallow the red pill. You’ll get the thrill and anxiety of seeing your fortune rise and fall. In today’s market, stock picking is back on the agenda, and you might get lucky. This is an illustration of a few bigger trends at work though.

The 10-year-on gradual decrease in interest rates has led to a joint equity and bond bull market run. As rates reach rock-bottom, your typical 60/40 portfolio will not do much for you anymore, and you are probably looking at an inflation-adjusted return of 2% p.a. over the next 10 years. Long-term investors have taken refuge into less liquid asset classes, such as private equity or venture capital. This is not a new trend and the illiquidity premium, first coined by David Swensen, has also been compressed.

Where do you go then? Cryptos are a new tempting asset class. But again, with 30-day volatility of 100% and 160% for BTC and ETHE, a huge correlation across all crypto coins, and daily drops of 30%+, you’d better develop a strong affection for roller-coaster rides. What if you want the fun, without the burn? Luckily for you, DeFi has built stable assets, some pegged to the USD. This ensures a low-volatility asset base that you can leverage through yield harvesting protocols that are in strong demand for such supply.

You end up with, on the one hand, stable assets that are pledged to a group of selected high-growth protocols – by “high growth”, we mean protocols that attract millions of daily liquidity. On the other hand, the growing set of 2.5m DeFi users are ready to pay handsome interests for such supply. In the middle is the birth of a new DeFi high-yield credit market. It is high-yield because risks exist in regulation overhang, or contracts, but also because the risk-adjusted 20%+ APY are just mind-blowing compared to any other yield you get in traditional assets.

Think of it, but this blue pill might well have an after-taste of red after all. A controlled chance of burn, with all the fun.

360 Advisory – Markets