Dear investors,
Hope you all are doing well and having a good time.
In this letter, we shall discuss about a secret fixed deposit scheme that can return an annual yield up to 12.68%. Yes, you heard the number right. 12.68%.
Many naïve investors are going gung-ho about this scheme, just because the word fixed deposit is mapped to safe investment, in our brains. Time and again, people tend to forget, higher returns come with greater risks.
Some of you might have already guessed, what I am talking about. It is the crypto currency fixed deposits, offered by crypto exchanges like ZebPay or VAULD.
Now before you start moving a big amount of your net worth into these assets, first let’s try and understand, what it is and how it works.
What is crypto fixed deposits ?
Just like, you depositing the money lying in your savings bank account into a fixed deposit to earn higher rate of return, you can deposit your crypto currency holding in a Crypto FD scheme and earn interest.
But, Is it really a Fixed Deposit ?
If you ask me, I don’t think it should be called a fixed deposit because it has variables which does not exist in a fixed deposit. It is basically a peer-to-peer lending platform with your deposit amount being subjected to stock market like volatility.
How does it work ?
You buy the crypto currency, deposit that in the wallet of the exchange. The exchange will lend the cryptos to the borrower and earn interest from them. The interest paid back in the same crypto that you have deposited with the exchange.
You will experience three kinds of volatility in your deposits.
First, the exchanges offer a floating rate of interest, so the interest is subjected to vary during the course of the deposit term.
Second, all currencies are pegged to US dollars, however, your investments will be in Indian rupees which will also bring in the exchange rate risk. In order to reduce the exchange rate risk, the exchanges are lending only to Indian borrowers, so that exchange rate effect is nullified. This might change in the future.
Third, the price movement of the crypto currency itself. Since you receive both interest and deposit back in the crypto currency units, the price moves will directly affect your holding and the rate of return earned. For example, if you have bought 10,000 rupee worth of Crypto and deposited it in the exchange wallet where 12% rate of return is expected, you would have earned 1200 rupees in a year. But in the meantime, if your crypto currency price has fallen by 30%, you can sell the 1200 rupee of interest only for 840 rupees, which will effectively make your return 8.4%. Cryptos being infamous for volatility, a significant fall might cause significant fall on your actual rate of return. But if the currency prices go up, you would have earned higher rate of return on your deposited money.
Is it worth the risk ?
In order to assess the risk, first one must understand the risks associated with the underlying asset.
Let’s understand the difference between traditional fixed deposits and the crypto fixed deposits.
In traditional FDs, the rate is fixed, while in crypto FD, the interest rate is floating and determined by the market.
In traditional FDs, you deposit the money with the bank which has a dedicated credit risk team to assess the borrower’s credit risk. In crypto, there is no credit profile check of the borrower. You will be lending your currency to an unknown person. The risk of defaulting on the interest payment is much greater and you would not have anyone to help you.
Banks as institutions are regulated by RBI. There is no regulatory body overseeing the for crypto exchanges.
Your traditional FDs are insured and guaranteed by RBI, while there is no insurance for crypto FDs.
Traditional banking systems deal with physical currency hence the actual damage caused by a cyber attack does not impact the cash holdings, while you might lose everything if the exchange is hacked. This has happened with few exchanges in the past, and will continue to happen in the future. The exchanges will have to constantly improve their security to keep up with the hackers.
Most importantly, the crypto assets carry significant regulatory risks. A ban on the crypto assets by the government can make your investments worthless overnight. Tax being the primary source of income for the government, it will try everything in its power to tax the gains from crypto assets. This will require the government to regulate the cryptos like any other asset that exists today.
There is also a significant risk of the start-up exchange companies going out of business. This is not new but many people tend to ignore this risk. You must consider the worst-case scenario where every person is trying to get out of the investment following some news. Do the exchanges have enough liquidity to make those the payments, if the question one must ask while investing.
Apparently, Indians have invested over 6 lakh crores in crypto assets according to Blockchain and Crypto asset council. It amounts to 43% of the estimated global crypto market capitalization.
So, should you invest?
Apparently, Indians have invested over 6 lakh crores in the Crypto based assets. That’s 43% of the estimated global crypto market capitalization.
Invest the money that you are willing to lose. It sounds silly because nobody wants to lose any money but what I mean is that don’t keep an amount that would significantly dent your financial position. I highly recommend investing up to 2% of your net worth and the investors who have the stomach to handle the losses, may invest up to 5% of your net worth.
Doing a postmortem of the situation would help in this case. Imagine, if you lose it all, how would you feel ? If it gives you chills, stay away from the Crypto FDs.
As for me, I have not invested in Crypto FDs because I see far lesser risk and greater reward in the businesses, or the stocks I own.
Well, that brings us to the end of this topic. I hope, this gives you have enough information to make a better investment decision.
