Business is booming.

Crypto’s evolution adds new risks to potential rewards

Currency trader Damian Mitchell had more than two decades of City experience under his belt when he received some unsolicited advice from his son.

“He said: ‘Dad, come on you’re an FX guy, why aren’t you looking at bitcoin?’ And I said, ‘well it’s not really a credible thing is it?’” 53-year-old Mitchell tells FT Money.

But the finance veteran then changed his mind. Today, he is involved not just buying and selling the most well-known tokens, such as bitcoin, but in making double-digit returns from a fast-growing specialised market — lending and borrowing crypto.

His son doesn’t let him forget where the idea came from. “Obviously, he reminds me of that continually,” he says, speaking from a hotel room in Las Vegas, where he says is on a “work-ation,” combining pleasure with his new passion for crypto.

Cryptocurrencies have exploded into a $2tn market, with millions of investors owning some form of digital assets. Even though prices remain very volatile and regulators repeatedly issue warnings about the dangers of crypto, personal savers are getting involved in the market, including in the UK.

Crypto trader Damian Mitchell at home in Chelsea
Former crypto sceptic Damian Mitchell is now heavily involved in lending and borrowing digital assets © Charlie Bibby/FT

Like Mitchell, some go beyond simply buying and holding in the long run — or HODLing to use the crypto sector’s jargon. They are moving into a wide range of tokens, including the non-fungible tokens (NFTs) popular in the art world. And they are learning about generating income from crypto assets, which do not normally offer a dividend-type return.

These activities are often complex, can be extremely risky and are usually unprotected by regulators. But as cryptocurrencies seep into mainstream investment, the opportunities to experiment with such moneymaking techniques are becoming increasingly common, even among retail investors.

Crypto’s critics see this development as yet more evidence of a bubble that is bound to burst. Fabio Panetta, member of the executive board of the European Central Bank, last month compared digital assets with a Ponzi scheme. “Crypto evangelists promise heaven on earth, using an illusory narrative of ever-rising cryptoasset prices to maintain inflows and thus the momentum fuelling the crypto bubble,” Panetta said in a widely-reported speech.

Regulators, including the UK’s Financial Conduct Authority, are also concerned about the risks. FCA chief executive Nikhil Rathi said last month: “As we have consistently warned, if you invest in crypto, you need to be prepared to lose all your money.”

But with global enthusiasm for crypto showing little sign of fading, the watchdogs are struggling to keep up. When they try to impose tough rules domestically, as with the FCA, operators often function from other countries — and lure clients into offshore transactions.

New markets bring new opportunities

When Mitchell’s son gave him that unasked for advice in 2014, few people dabbled in bitcoin. But by 2017 investors had started to take notice, as the price of the digital token skyrocketed and retail savers around the world suffered from a serious case of fear of missing out. Mitchell was one of them.

A trader since the 1980s, Mitchell had built a career on profiting from inefficiencies in currency markets as they migrated to electronic platforms. He was so successful that after working for big commercial banks, he set up a proprietary trading company, which is still operational today.

After investing in digital assets through a specialist hedge fund, he decided to experiment with hands-on trading: his inner trader was too curious just to sit by and let others navigate the highs and lows of the extremely volatile crypto market.

He soon realised that crypto was similar to currency trading: full of opportunities. “I’ve always loved my career with a passion so it was quite easy to go down the crypto rabbit hole and get super excited,” he says. “Whether it’s NFTs, staking, lending and borrowing there is always something new in crypto and that’s what’s exciting for me.”

Line chart of Rebased to 100 ($) showing Cryptocurrencies' rocky ride

The search for yield

It is a longstanding criticism of bitcoin that it doesn’t carry a yield. But by lending and borrowing bitcoin investors can earn returns, as they can with other digital tokens.

These activities take place via exchanges in decentralised finance (DeFi), an automated computer-driven marketplace where cryptocurrencies are lent and borrowed as well as traded. Prices are often very volatile, so that the opportunities for turning a profit — as well as the risks — are very high.

DeFi operates on a peer-to-peer basis, usually matched via exchanges.There is no central counterparty arranging the transactions or supervising credit. So, there is no protection if anything goes wrong and hacks and theft are rife. But Defi’s growth has been rapid, ballooning from $15bn at the end of 2020 to a peak of $110bn in September last year. Today it’s a market worth $76bn.

One particular currency fuels a lot of credit-linked business — stablecoins, digital tokens that enthusiasts claim bridge the gap between crypto and the fiat currency world, as they are designed to be backed by US dollars or other non-crypto financial assets.

Late last year Goldman Sachs analysts described it as “an experimental and unregulated alternative financial system” where users can earn a yield on their stablecoin holdings of “typically around 5 per cent — about 10 times the yields available on insured bank deposits.” Other analysts put the figure at 12 per cent.

The crypto world is short of dollars because few participants have access to traditional banks. Stablecoins, the closest equivalent of hard currency, oil the movement of money in crypto, with investors using stablecoins to hop from one exchange to another. As they are much in demand, investors are often ready to pay higher rates of interest to borrow them than other cryptocurrencies.

Some investors are even able to borrow cash using their cryptocurrency as collateral — via specialist lenders. These companies are not banks, but similar to pawnshops: investors can get as much as 80 per cent of the value of their crypto in cash loans. They risk losing their tokens if they can’t pay.

There is no escape from the dangers. Last month, Iosco, the umbrella organisation for global regulators, warned that DeFi is rife with risks, highlighting that lending and borrowing operations are also often riddled with conflicts of interest and offer only the illusion of decentralisation.

The loans are heavily collateralised — often with the borrower’s crypto. So, the terms are often unfavourable to the borrowers who have no control over liquidation processes that kick in if a loan falls into default.

Staking a claim

Newer blockchains, launched after bitcoin, offer another way for investors to generate yield by a process called staking — a means for validating transactions.

In bitcoin, this validation is normally carried out by the miners — the companies producing bitcoin, in a very energy-intensive way involving vast amounts of computing. In Ethereum, Solana, Cardano and other newer currencies, holders do the job in a less energy-intensive way: they put some of their crypto into a pool, in which computers check transactions. In return the holders can earn around 5 per cent a year.

Simon Peters, head of Western Europe for the UK’s most popular trading platform, eToro, says one of the biggest trends in recent months has been the shift in clients’ preference in what they want to hold in favour of tokens that enable staking.

Cardano has become the second most popular digital asset in the UK after bitcoin, according to Peters, as customers of the platform swapped from bitcoin, suggesting a shift towards staking. “It’s a way of taking advantage of not just potential price increases you might see in [the cryptocurrency], but also compounding your holdings,” Peters says.

Fast-moving markets

In two years, crypto has moved a long way from the time when the key issue for retail investors was whether to buy bitcoin.

“2021 was an absolutely transformational year for cryptocurrency adoption globally, and the UK is no different to that,” says Blair Halliday, head of UK for trading platform Gemini, owned by the wealthy American Winklevoss twins.

Some 18 per cent of UK adults own cryptocurrency — nearly half of whom invested for the first time in 2021, according to a Gemini study.

A survey by Coinbase, a rival platform, in April found that a third of UK consumers say they currently own crypto, or have owned some in the past. More than 60 per cent of those who already have crypto exposure plan on adding to their holdings, while only 11 per cent said they are planning on selling all or some of their crypto assets, the survey showed.

Bitcoin’s share of the total crypto universe has shrunk significantly in the past 18 months. In January 2021 bitcoin represented 72 per cent of the total global market capitalisation of digital assets. Now it is down to 41 per cent.

The crypto price falls since November have given investors added incentive to put their holdings to use. “A lot of people bought digital assets a few months ago in November when prices were at all-time highs,” says Michael Stroev, chief executive of Barcelona-based Nebeus, a digital asset lending specialist. “There was a significant drop in value, so now most retail investors are sitting there thinking: what do I do?”

Platforms such as Nebeus offer cash loans of up to 80 per cent of crypto holdings, which are held as security and liquidated if the borrower misses payments.

Stroev says the primary purpose of these loans is to increase the size of overall investments, whether into more crypto assets or other financial instruments. But some clients borrow to pay for household bills or essentials.

Regulators frown on such financial engineering, not least because it could indicate that some investors are overstretched.

But they have not stopped such practices developing deep into the retail market. In mid-April, a company called Nexo got the stamp of approval from a big consumer financial services company — Mastercard — with the joint launch of a credit card that allows users to use digital assets as collateral.

Antoni Trenchev, Nexo’s chief executive says that borrowing against digital assets is just a way to sweat holdings and generate income. “It’s exactly what Silicon Valley and Wall Street has been doing, not selling assets but borrowing against it,” Trenchev says.

Risks great, rules undeveloped

The risk of loss, including from fraud, is widespread. Elliptic, a specialist cryptocurrency data company, said in November last year that investors lost $12bn of funds in DeFi markets last year, with more than $10bn of those losses due to hackers and lost funds. This was on top of any money lost directly through swings in asset values.

Critics say such losses should make investors wary. “When you hear of a 9 per cent or 19 per cent short-term interest rate on an asset [stablecoin] that is supposed to have a stable value against the dollar, put your hand on your wallet,” says Robert McCauley, non-resident senior fellow at the Global Development Policy Center at Boston University.

The UK has seen a 116 per cent rise in cryptocurrency fraud reports, up from 3,983 to 8,614 from 2020 to 2021, according to law firm Pinsent Mason. This is the fourth successive year in which cryptocurrency-related fraud has risen by more than 100 per cent.

Oversight of crypto companies in Britain is limited amid a debate among policymakers about how to strike the right balance between promoting fintech and protecting investors.

Rathi said in his speech last month that the FCA was actively preparing for the day when it received new powers. Under existing regulations, it requires digital asset firms to register for money laundering checks, like other financial companies. Companies have complained that the regulator has been slow to give its approval, driving some companies abroad — from where they can still access UK clients.

But, except for a crackdown on retail crypto advertising, the regulator has not taken hold of specific industry practices. Specifically, as Rathi implicitly acknowledged in his speech, the FCA does not currently have powers to oversee crypto credit.

A middle road to crypto?

So what should retail investors be doing in crypto, if anything? Between throwing everything you own into the market and doing nothing there is a middle way — dabbling in crypto enough to have the chance to earn a profit but not going in so deep as to face unacceptable risks.

This is what Stephen Corlett, 68, a recently retired engineer who lives in Cheshire, is doing. While reshuffling his pension investments into low-cost products just over a year ago, he became curious about cryptocurrencies after reading about them. After some research, he decided to take the plunge and invest a small percentage of his savings into digital assets.

“I read about the environmental impact of bitcoin so after looking into it I decided to play around with proof of stake and bought Cardano because it uses much less energy than bitcoin,” Corlett says.

Corlett opened an account on and invested £2,000 “about a year ago”. At one point, his digital portfolio was worth twice as much, but it soon became apparent that investing in cryptocurrencies is not necessarily smooth sailing.

“It’s actually really difficult to find out what or who is influencing the price of bitcoin. And, generally, the value of other crypto [assets] tends to go up or down with bitcoin, which is a bit disappointing,” he says.

Corlett’s investments are currently back to where they started in value. His dalliance with staking also left him underwhelmed, noting that the amounts he earned as a reward were disappointingly meagre.

But he continues to hold his crypto assets, just in case, even though he thinks that until digital assets find a use in the real world their potential value will remain limited. He says: “I can’t really see crypto as a serious investment at the moment.”

Corlett’s words will be music to ears of the cautious investor — and the worried regulator. But his views will not stop others from taking bigger risks in the hope of bigger returns, both in terms of crypto products and of techniques.

Borrowing and lending are common in most other financial markets. So if crypto markets have a future, they are likely to develop in crypto too. But who will profit, when and how remains to be seen.

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