Executive Summary: While bonds are characterized by predictability and typically lower yields, cryptocurrencies provide the potential for higher returns (as well as volatility). One technique crypto investors use to generate wealth is “staking,” or pledging crypto assets towards transaction validation to earn a return.
Even though bonds and crypto assets are different assets, they offer a similar annual yield today. Bond yields depend on various factors, including interest rates and credit rating, while crypto staking involves earning rewards through network validation–a process that carries its own risks.
In this piece, we’ll show how bond yields vs. staking returns stack up against one another.
What is Yield?
Yield is a critical metric in investing, referring to the income generated by an investment over a given period. Experts express yield as a percentage of the investment’s current market value compared to its original cost.
For example:
- Stock yield includes price appreciation and dividends paid. If a stock is bought at $100 and sold at $120 with a $2 dividend, the yield would be 22%.
- Bond yield is more variable. Nominal yield, for instance, is straightforward as in a Treasury bond with 5% annual interest on a face value of $1,000, resulting in a 5% yield. However, floating interest rate bonds have variable outcomes based on underlying interest rates, such as a bond paying a 10-year Treasury yield of +2%.
- Cryptocurrencies may provide higher yields with more volatility. That’s because yield from cryptocurrencies is a relatively new concept, often associated with decentralized finance (DeFi) protocols. Investors can earn a yield on cryptocurrencies through staking, liquidity provision (yield farming), and other approaches. This yield is a reward for participating in network security or a return on providing crypto liquidity.
What Are Bonds and Bond Yield?
A bond is a loan from an investor to a borrower, such as a government or corporation, for a fixed period. The yield represents the return an investor expects to receive from the bond over its term to maturity.
Some of the more essential factors for understanding bond yield include:
- Coupon yield or coupon rate is the rate of interest that a bond pays annually and implies a fixed interest rate set when the bond is issued.
- Current yield depends on the bond’s price, reflected by dividing the coupon rate by the current market price.
- Yield to Maturity (YTM) is a more comprehensive calculation of a bond’s yield, considering the time value of money, maturity value, and payment frequency.
For example, if a bond has a face value of $1,000 and makes yearly coupon payments of $100, its coupon rate is 10%. If the face value of the bond increases to $1,038, then the coupon rate would fall to 9.6%.
Note that bond yields and prices share an inverse relationship: as bond prices rise, yields fall, and vice versa.
Several factors influence bond yields, including:
- Interest rates – As interest rates rise, the price of existing bonds drops, increasing their yield and vice versa.
- Credit rating – Bonds are rated by approved Securities and Exchange Commission (SEC) services from AAA (low risk) to D (high risk or junk bonds), affecting the bond’s yield.
- Economic factors – Overall economic health, inflation, and governmental monetary policy influence yields.
An important concept is the yield curve, which plots the yield of different bond maturities. It can take ordinary (upward-sloping), inverted (downward-sloping), or flat shapes, reflecting other economic conditions.
In the recent low-interest-rate market environment, the yields on bonds have generally been lower than historical averages. Still, they are increasing along with interest rates:
Bond yields have been falling for years but have recently turned higher due to central bank monetary policy.
What Are Crypto Yield and Staking?
Crypto staking is a method to accumulate more cryptocurrency by making funds available for transaction validation. By simply locking currency in a specific wallet for a predetermined duration, the underlying blockchain network uses this “staked” cryptocurrency to validate transactions and contribute to its security. As a reward for this service, stakers receive additional cryptocurrency, essentially making it a form of passive income without the need for trading or crypto mining.
Specifically, staking applies to blockchain networks using variations of the Proof of Stake (PoS) consensus mechanism. Under PoS systems like those currently used on Ethereum, users put up a “stake,” or volume of tokens or coins, to earn the privilege of validating transactions. Validation then provides a chance at some yield in the form of that coin or token. Staking is comparable to earning interest on a fixed deposit but with higher risk and potentially higher rewards.
It’s important to distinguish between staking and yield farming, another passive income method popular in DeFi. Yield farming strategies involve the provision of liquidity for decentralized platforms to operate.
The staking reward in terms of annual percentage yield (APY) differs from blockchain to blockchain, ranging from 4% to 20%. For Ethereum, it usually fluctuates between 4% and 5.5%.
Some DeFi protocols, such as Lido, help crypto holders stake without locking their crypto value. They provide substitute tokens while the staked amount is locked, assisting users in exploring yield farming opportunities and multiplying the potential return.
Bonds vs. Staking: Comparing Dovetaling Yield Rates
As of this writing, the bond yield rate has come much closer to crypto staking yield, as central bankers have rushed to raise interest rates to curb skyrocketing inflation, pushing bond yields higher. Thus, the US government and corporate bonds rated AAA offers an annual yield between 4% and 5%.
Moody’s Seasoned AAA Corporate Bond Yield.
By comparison, Ethereum’s staking yield has been hovering between 4% and 5% (after a short spike) since it adopted the Proof of Stake algorithm:
The annualized daily staking yield is obtained when staking on the Ethereum blockchain.
This isn’t a standard around all bonds, however. Lower-rated corporate bonds provide higher yields. For example, CCC-rated bonds can exceed the 12% mark. Similarly, cryptocurrencies that are more volatile and riskier than Ethereum can provide higher yields that can exceed the 8% mark and go much higher. However, there are significant differences in staking rates between one currency and the next.
Here are the staking rewards of major Proof-of-Stake cryptocurrencies:
The yields of these two different asset types got much closer only recently. Despite the overlapping yield figures, the two types of assets live in significantly different universes, and you should consider the following nuances:
- Risks – Bonds, especially government bonds, are much safer than crypto staking. Fixed-income products have traditionally been the safest. One of the risks related to crypto staking is the high volatility of crypto assets. When the price of the staked digital currency declines dramatically, the yield might not even cover the loss caused by depreciation.
- Security – While the underlying blockchain technology might be the synonym of security, staking often involves dealing with centralized third parties prone to risks such as hacking attacks or fraud. Investors should do their due diligence before registering a staking platform. Elsewhere, bond investing is generally secure if conducted with reputable brokerage firms.
- Opportunities – Despite the higher risks, staking cryptocurrencies can provide returns far exceeding the staking reward. For example, the same volatility can be a favorable factor multiplying the return when the price of the staked coin goes up. Also, many staking platforms provide substitute tokens to explore yield farming opportunities in DeFi while the staked crypto is locked. This can multiply the return on investment.
Investor Takeaway
Bonds typically offer more predictability and lower yields, suitable for risk-averse investors. Conversely, crypto staking may yield higher returns but comes with increased volatility and risks, appealing to those seeking potentially greater rewards.
That being said, crypto staking can become a regular and profitable approach to long-term wealth creation akin to investment in bonds. It just requires more patience, an understanding of the crypto market, and the willingness to show patience over time… just like bonds.
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