Sources of Returns and Interest Income in the Crypto Market

• Simon Schneider
  CEO
  Sygnum Europe

These strategies can be complex, but many are based on economic principles that are also found in traditional fixed-income and arbitrage markets, applied to a newer, more decentralized, and rapidly evolving asset class.

Essentially, there are two main sources of returns: The first comes from so-called perpetual futures, which are among the most heavily traded instruments in the crypto market. Similar to traditional futures, they allow for leveraged positions on the price of an underlying asset. Unlike traditional futures, however, they have no expiration date and can therefore be held indefinitely.

To ensure that the price still closely tracks the spot market, the so-called funding rate is regularly applied. If the price of the perpetual futures contract is above the spot price, long positions pay short positions. If it is below the spot price, the payment flows in the opposite direction. This mechanism ensures that the futures and spot prices continuously converge.

Funding rate strategies are based precisely on this principle and are among the best-known market-neutral approaches in the crypto space. Since demand for leveraged long positions has historically outweighed demand for short positions, funding rates have been positive over extended periods. As a result, long investors regularly paid short investors.

This premium can be captured by simultaneously buying the underlying asset and shorting the corresponding perpetual future. The strategy is designed to limit directional price risk. It aims to capture a funding premium, similar to classic cash-and-carry strategies in the commodities or fixed-income markets.

Basic principle, as in traditional credit markets

A second important source of returns that generates interest income is lending and borrowing. The basic principle is virtually the same as that of traditional credit markets. Investors provide capital in secured markets and can receive interest payments from borrowers in return. Borrowers must provide collateral whose value exceeds the amount of the loan. This can generate secured, variable-rate returns, the amount of which depends on the demand for liquidity and leverage in the market.

In recent years, a significantly broader range of alternative return strategies has emerged around these two core strategies. These include cross-venue arbitrage, which exploits price differences for the same instrument across different trading venues; basis and carry strategies using regulated futures; options-based volatility strategies; and on-chain private credit. Each of these strategies has its own risk and return profile. Together, they form an increasingly mature and differentiated range of sources of return.

Particularly striking is the growing professionalization of the market. Whereas individual, easily scalable strategies once dominated, the spectrum has become significantly broader and more sophisticated today. As a result, the asset class has become more attractive to institutional and professional investors and offers a wider range of opportunities than it did just a few years ago.

Outlook for Yield Strategies and Interest Income in the Crypto Market

Historically, these strategies have generated significant returns, although returns fluctuate over time and are not guaranteed. In recent months, however, there has been some compression in returns and interest rates. This was primarily driven by the growing participation of professional market participants and lower demand for leverage.

This was particularly evident in the funding rates, which have recently been hovering in the neutral range or even below it in many cases. This suggests that the major perpetual markets are now increasingly being used as professional hedging instruments rather than as vehicles for one-sided speculation. This, too, is yet another sign of the growing maturity and institutionalization of the crypto market.

Despite this trend, many of these strategies remain attractive compared to traditional sources of return. Since they are predominantly market-neutral in design, their returns stem from structural market premiums rather than from betting on rising or falling prices. Historically, this has resulted in comparatively low volatility as well as a low correlation with equities, fixed income, and even a traditional long portfolio of cryptocurrencies.

Traditional carry and funding strategies could regain importance if market conditions support a widening of yields relative to current levels.

Diversified Source of Returns

not only in terms of their returns. They can offer a differentiated source of returns with lower targeted market risk. As a result, they can both meaningfully complement existing crypto allocations and contribute to the diversification of traditional multi-asset portfolios.

Precisely because uncorrelated sources of return are becoming increasingly rare, such strategies are gaining in importance. Today, digital assets offer far more than just price appreciation. They open up a growing range of return sources and combine the yield characteristics of traditional fixed-income and arbitrage strategies with the diversification benefits of a young, increasingly institutional asset class.