Structured products have been utilized for decades in traditional retail finance, including wealth management, to fulfill a combination of investor needs in a single financial instrument.
Structured products are investment products linked to underlying assets, such as equities, interest rates, foreign exchange, bonds, commodities or funds, and use one or more derivative instruments, with the goal of offering attractive payoffs to investors that are differentiated from the return profile in the underlying asset itself.
Structured products can be used by investors with varying risk appetites to achieve a number of objectives, from risk mitigation to return maximization, in bull, bear or sideways trending markets.
The underlying mix of assets can be tailored to an investor’s individual needs, taking their risk profile and expectations into consideration.
In traditional markets, there is a long history of retail investors, financial institutions and corporates using structured products to fulfill specific investment objectives. Structured products are available for all asset classes, from stocks to interest-bearing investments, as well as bonds, raw materials, precious metals, currencies, real estate – and now cryptocurrencies.
In the world of cryptocurrency, structured products have not yet gained the prominence they have in traditional financial markets. However, with the sophistication of the digital asset sector increasing, the methodology of traditional capital markets structured products can increasingly be applied with the objective of achieving the same outcomes.
As such, we find ourselves at a perfect inflection point in the market to introduce crypto structured products built using the same methodology and with the benefits they can offer over direct cryptocurrency investing. These benefits include enhanced returns, downside protection, and risk mitigation, combined with a level of flexibility that makes crypto structured products an exciting alternative for investors with different risk appetites and objectives. Structured products can be tailored to suit a variety of market conditions.
With the acquisition of TroFi, Yield App is excited to position itself as the pioneer in the crypto structured products arena, bringing a comprehensive offering to our customers. With the combined expertise of the TroFi team and our CIO Lucas Kiely, who was formerly head of structured product trading at both Credit Suisse and UBS, we are perfectly positioned to bring this innovative crypto product suite to market.
What are structured products?
Structured products are investment products composed of an underlying investment, such as equities, interest rates, foreign exchange, bonds, commodities, funds or digital assets, and one or more derivatives, with the goal of offering attractive payoffs to investors that are differentiated from returns available in the underlying instrument.
Structured products can take a vast range of forms, but their defining feature is the combination of financial instruments in a single ‘structure’ to create a bespoke customized outcome. This structure makes them a highly flexible instrument adept at being tailored to suit different types of investors in bull, bear or sideways trending markets.
Why invest in structured products?
Investors may prefer to invest in a structured product – rather than directly in the underlying asset itself – if they are sufficiently attracted by an additional attribute such as downside protection or yield enhancement.
Customized cryptocurrency structured products can offer individuals and/or institutions ways to manage their exposure to digital assets, achieve targeted risk-return objectives, enhance returns, or take advantage of crypto price volatility.
A choice of risk/return profiles
Crypto structured products can provide investors with the opportunity to choose their preferred risk-return profile when investing in cryptocurrencies.
Structured products are highly flexible investment offerings, which can be divided into four main categories with a variety of potential returns and differing levels of risk. This makes them a suitable choice for investors who are seeking more control over their portfolio to achieve their objectives.
Protection
These solutions are aimed at investors with a low-to-moderate risk tolerance who require built-in principal protection. They are constructed in a way that allows the investor to partially or fully protect capital on the downside, while providing a limited, fixed, or unlimited return.Optimization
These types of solutions are preferred by investors with a moderate-to-high risk tolerance who want to boost portfolio returns in sideways markets.Participation
These types of structured products allow investors to take advantage of the performance of an underlying asset without over-committing capital, and are preferred by investors with medium-to-high risk appetites.Leverage effect
These strategies sit at the top of the risk spectrum, providing investors the flexibility to participate in the upside of the market with a leverage effect, while also offering some hedging protection.
How do structured products work in digital assets?
Crypto structured products work in much the same way as structured products based on traditional financial market instruments, utilizing derivatives to achieve specific financial outcomes. While derivative products in traditional financial markets are a mature asset class in their own right, they have only relatively recently become available for crypto markets.
The Chicago Mercantile Exchange, the world’s largest futures exchange, was the first exchange to offer crypto derivatives in 2017 on the most established cryptocurrencies. Since then, other exchanges have begun offering options and futures products whilst the market has expanded rapidly to include a wider range of coins.
Source: Financial Times
The first crypto structured products started to appear in 2021 and the market is continuing to develop rapidly. Most of them incorporate options, which offer the right to buy (call) or sell (put) a cryptocurrency at a predetermined price. There is no obligation to exercise an option, but a payment is required to secure that right.
Examples of crypto structured products: Sharkfin
Crypto structured products can take many forms depending on the payoff ogbjectives. With over seven times the volatility of equity markets crypto options typically offer larger premiums and therefore more customization options.
For example, crypto structured products allow an investor to express a view on the future performance of an underlying digital asset, such as Bitcoin. They can be used to earn yield from the extreme price movements of cryptocurrencies – Bitcoin has moved between roughly $51,000 and $16,000 during 2022 – powering volatility-driven yields as a result.
A straightforward example of a crypto structured product is called Sharkfin – based on the shape of its payoff graph (see below). Sharkfin is a type of structured product that allows investors to express a moderately bullish view on the future price of the underlying asset, such as Bitcoin.
The highest annual percentage yields (APYs), or returns, are achieved when the price of the underlying asset appreciates but does not exceed a predetermined upper level. However, if the price falls below the current level or rises above the predetermined upper level, the product still pays a guaranteed minimum coupon (i.e. annual interest).
If the price rises above the predetermined level, the investor receives the principal investment back in USDC, plus the minimum coupon (e.g. 15% as in the graph above). If the price falls below the buy level, the investment and the guaranteed coupon gets converted to the underlying asset (e.g. Bitcoin) at the buy level. As such, the downside of this product is that if prices fall, the investor is obliged to buy the underlying asset at a higher-than-market price.
What are the downsides of structured products?
The main concern is that their construction is often complicated and, therefore, difficult for investors to understand. This is particularly concerning when it comes to retail investors, who are likely to have a relatively lower level of financial knowledge than institutional investors. This is why we have a knowledge centre for our own crypto structured products offering.
It is also important to be mindful that there may be an opportunity cost to investing in a structured product, meaning that in some circumstances directly buying and selling a cryptocurrency in the market may generate a higher yield. As such, it’s important to understand the product’s construction, the expected payout and the downside risks in the event of price movements in either direction.
To learn more about our structured products offerings, the payouts in different scenarios and the risks involves, head to the knowledge centre on our website.
Bottom line
Crypto structured products can be an attractive alternative to direct investment in cryptocurrencies, generating alternative investment outcomes based on an investor’s personal risk-return profile. However, structured products are not always suitable for inexperienced investors, as they are complicated financial products that typically require prior knowledge and understanding.
That is not to say that crypto structured products are suitable only for investors with a high risk appetite. On the contrary, different structured products are constructed to suit different risk tolerances and market conditions.
For example, downside protection offered by some crypto structured products is likely to appeal to investors with lower risk tolerance, as they provide an opportunity to mitigate some of the downside risks of direct crypto investing.
As the crypto derivatives markets continue to develop, they are sure to become more prevalent, providing a wider range of choices from which to construct structured products. In turn, this will enable providers like Yield App to offer wealth management clients an increasingly diverse and customizable set of investment options.
Yield App is excited to introduce a brand new suite of crypto structured products following our acquisition of TroFi, which can be viewed on our dedicated website page.
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DISCLAIMER: The content of this article does not constitute financial advice and is for informational purposes only. The price of digital assets can go down as well as up, and you may lose all of your capital. Investors should consult a professional advisor before making any investment decisions.
