Crypto Onchain Returns vs Real World Asset Yields Comparison

An interesting trend I am observing recently has been the increased focus of crypto projects looking at capital allocation to real world asset (RWA) yields as a form of sustainable long term and uncorrelated return for their treasury management objectives.

From the?establishment of Lido’s Treasury Management Committee?to?MakerDAO’s $700mil short-term US Treasuries allocation increase, marquise crypto names are starting to realise the benefits of smart treasury allocation.?Given my previous study of onchain data shows that $125bil out of $130bil stablecoin remains undeployed and unallocated, the wave of onchain capital flowing into RWA yields is likely to accelerate.

But is RWA the only game in town? What opportunities have the existing projects been allocating to? Let’s dig in.

Onchain Yields or Real World Asset Returns

Before the arrival of the term RWA, there was just crypto. If you are looking for yields, you would simply look at which tokens to allocated to onchain. However, this changed with the emergence of decentralized finance and the arrival of RWA. It is against this backdrop, the two current approaches to capital deployment for crypto projects for treasury management have developed. One focuses on onchain only opportunities while another offers a broad range of financial assets that are uncorrelated to the crypto market.

I have written about onchain yield markets previously including various markets’ AUM and yield numbers. You can read more?here.

History of Onchain Yields

The history of treasury allocation to onchain yields traces back to 2020 DeFi summer with the crypto project?Gnosis looking to grow its treasury with onchain yield farming strategies?where they provided their ETH and USD stablecoin capital as liquidity to DeFi projects in exchange for earning that projects’ token emission incentives.

This was immensely popular at the time because this type of yield has the characteristics of rocketing up in dollar value during a bull market. Of course it also crashed down quickly once the buying pressure runs out at an ever increasing price or when the general sentiment turned. Many DeFi projects died after the initial excitement faded. This type of yield also has the drawback that token incentives usually decreases each year as projects run out of their own tokens to give out as incentives. It was both unstable and unsustainable in nature.

GnosisDAO Onchain Only Allocations

Karpatkey was born?in Nov 2021 out of Gnosis and was tasked to “select market opportunities” for an 150k ETH allocation from the GnosisDAO. Below is the official proposal to spin out Karpatkey from Gnosis. With ETH hitting its all-time-high price of $4.8k, this 150k ETH allocation was worth $720mil at the time.

Current Portfolio Breakdown

Using the latest figures from?Karpatkey’s weekly report, the total AUM as of 8th May 2023 is $269mil. $246mil or 91.6% of this amount is held on Ethereum, with ETH making up 71.5% or $182mil of the total AUM, while the balance remain on the Gnosis chain.

Should you hold 72% of your assets in ETH? Well that depends on your objective and priorities. For example, do you need your assets to generate enough to cover your expenses as the first priority and are your expenses denominated in ETH or another currency? Do you know what is the 1 standard deviation drawdown number of ETH and if the ETH price crashes by say 50%+, does that prevent you from being able to operate business as usual?

Between Nov 2021 and May 2023, the Ether price decreased from $4,800 to $1,800, a 62.5% decline. The AUM value went from $720mil to $269mil, also a 62.5% decrease. The dollar value of GnosisDAO’s treasury tracked ETH price movement with 100% correlation.

The return generated by onchain yield opportunities based on the assets held is summarized below:

One thing to bear in mind when looking at these numbers is that the average return number is variable. It varies hour by hour depending on a variety of factors. To understand what positions constitute the 5.35% return this week and the 4.80% return last week better, let’s look at a breakdown of AUM allocations.?Below is a list of positions above $2mil:

The top 5 positions that make up 80% of the total AUM on Ethereum are:

Together they produced a weighted average annualized return of 3.10% in the past week. While the top 2 positions make up $140mil or 56% of the portfolio and are both leveraged yield farming strategies based on wstETH and GNO, they differ greatly in the yield generated. 4.5% is very different from -0.2%.

Leveraged yield farming is a strategy where you collateralize your asset, e.g.?wstETH?and GNO, to borrow another asset, e.g. DAI stablecoin, in order to use the asset you borrowed to generate additional yield whether that is through purchasing more wstETH or providing liquidity using DAI.

Given the recent successful Ethereum upgrade that transformed Ether staking yields to blockchain’s risk-free rate equivalent of the 2yr US Treasury Bills, it is therefore not surprising to see Karpatkey adopting an ETH based leveraged yield farming strategy.

One thing to note is that the 4.5% APR number for the past 7 days is directly correlated with network activity levels. The recent Ethereum blockspace revenue uptrend as measured by the gas fee (see below) bodes well for the staked Ether yields if adoption/usage continues. You can read more about Ethereum’s three revenue streams that will determine its staking yield?here.

Combining the table with the notes below, we can see that over 80% of the wstETH in WSTETH-A vault is not being utilised as the collateralization ratio (CR) sits at 527%. It is likely Karpatkey made the conscious decision to have a large % of wstETH sitting idly as a buffer to reduce liquidation risk in case of price volatility.

From the third to the fifth biggest positions, this roughly 20% of the AUM is focused on liquidity provision and yield farming (token incentive) strategies. This means depending on the pool for which you provide liquidity to, the trading fee part of your return is largely determined by the asset popularity while the token emission incentive part of your return increases or decreases in value in dollar terms in correlation with the overall market historically.

Liquidity provision (LP) in wstETH-stETH pool on Uniswap yielded 4.6% annualized returns while LPing in GNO-WETH pool on Aura generated 0.5%. In general, the bigger the asset such as ETH and USDC, the more trading fee the pool will generate but also the more intense competition from other capital. If the amount ETH of a popular pool doubles, the returns for LPs given a constant trading volume drops by 50%.

Drawbacks of Onchain Yield Opprotunities

While Karpatkey clearly made best effort to diversify holdings across different opportunities and chains, our detailed look into the return profiles of onchain yield opportunities revealed two important drawbacks of current onchain yields universe: uncertain variable returns and correlated market risk across crypto assets.

Whilst the ETH staking yield has been performing well this year, we need to also remember that ETH has a historical vol of 50+, which means the price of ETH could easily increase or decrease by 50% in a year. Of course we may end up in a +50% price scenario but to capture that possibility it means we must also accept a scenario where we end up with -50% in our asset value. Whether 67% probability of a 50% drawdown is acceptable or not for a treasury is up to the decision of the project.

Additionally, given the $1bil+ lost in crypto exploits, the lack of insurance products and the inability of victim to pursue legal recourse, onchain yield opportunities bear the additional technology/smart contract/hack risk. Whether these risks are being adequately compensated by the corresponding yields is an important question to ask when allocating towards onchain assets.

So if you are looking for more predictable and steady returns, what other yield options do you have? Let’s look at how MakerDAO has allocated its stablecoin holdings.

Real World Asset (RWA)

Whilst the crypto total market cap is around $1.2tril, the market cap of all assets in the real world is an order of magnitude larger in asset value and product opportunities.

MakerDAO has been a pioneer in the RWA space. It started diversifying its PSM (Peg Stability Module) holdings away from 100% crypto assets in H2 2020. You can find my interviews with some of the pioneering RWA partners to MakerDAO such as?Centrifuge?and ConsulFreight?here.

MakerDAO Real World Asset Allocations

Currently MakerDAO holds just over 2.5bil of stablecoins.

How much of that is deployed and across what assets you may ask?

The above graph shows the evolution of deployment from MakerDAO towards RWAs. It started out with private credit covering trade finance and revenue financing and broadened out to bigger assets such as US Treasuries in 2022.

As of 15th May 2023, the total deployed capital towards RWA is closing on $1bil, with MIP65 being the largest at $802mil.?MIP65?was a proposal from 2022 May to allocate USD stablecoin holdings from MakerDAO towards short term US Treasuries managed by Monetalis Group.

Currently MakerDAO is the single biggest onchain capital allocator to RWAs. Below is a breakdown of its top 3 allocations.

At $1.57bil, MakerDAOs has roughly allocated 60% of its assets to these three RWA positions. Once fully deployed, the short-term US treasury allocation alone will generate over $60mil a year. In contrast to onchain yield opportunties, the US Treasury return is both certain (or as certain as it can be in the real world) and non-correlated to the general crypto market.

Curiously though the return on private credit portion is quite low when compared to the Treasury portion and prevailing market condition. The leveraged loan market is closing on 10% while the rest of private credit market in crypto, such as Goldfinch and Credix, are all offering 10%+. Of course there is no free lunch when it comes to yield. The higher yield here reflects more risks associated.

Below are the income streams from MakerDAO’s currently deployed assets.

As you can see clearly from the graph that MakerDAO’s revenue was highly correlated to the crypto asset prices from 2020 until late 2022 at which time the income dropped dramatically due to the depressed crypto market condition. Since then MakerDAO has shifted its focus to RWA assets for more predictable and uncorrelated returns.

While the allocations to RWAs have yet to be fully deployed, the bulk of return generated has overwhelming come from RWAs. Below chart shows RWA returns making up an increasing share of the total income for the project. What is even more important to point out is the diversified nature of MakerDAO's assets. Not only does it have RWA but also crypto assets such as ETH and WBTC.

Using the?most recent financial report from 2022, MakerDAO’s annual operating expense was running at $45.7mil. When its short term US Treasuries allocation of $1.25bil is deployed fully, the return on this portion of RWA allocation alone would cover this number and making the project self-sustaining. This is not even including other sources of income.

Coincidentally, short term US treasury products have exploded in popularity recently, reaching $1.5bil in inflows, and became the biggest RWA asset class for onchain stablecoin liquidity.

Now if I were to ask you to allocate $10mil across assets both onchain and RWA so that you can have predictable and attractive fixed-returns while limiting drawdowns and capturing potential explosive upside, how would you construct a portfolio to achieve that?

I will write more on that topic in a future post. But as a simple framework, you should work backwards. Start with the fixed-return amount from a cashflow perspective. If your top priority is to have your annual expense of say $800k covered then you should allocate an amount to a fixed-income product that returns at least that much without taking on excessive risks. Then look for the lowest risk option of capturing an upside that is attractive enough to you.

When considering different yield opportunities, always ask if there is a lower risk option that will generate the same return you are being offered at.

Summary

Currently the risk and return profiles of onchain and RWA differ greatly in terms of predictability of yield, correlation with crypto market and assets as well as legal recourse enforceability.

Onchain opportunities for most liquid assets are in low to mid single digits. They are variable and correlate to the broad crypto market conditions. They also come with the additional smart-contract/hack risk. Although they do give a higher likelihood to capture any explosive upside.

By contrast, RWAs offer more product selections and sophistications. Projects can tap into highly liquid and risk-free US treasury rates for fixed returns or they can provide capital for private credit's double digits returns should they want to trade more credit and duration risk for higher fixed returns.

While it is possible for Gnosis DAO Treasury portfolio to 4x in value to $800mil+ if Ether 4x in value, it is also possible for it to suffer a 50%+ drawdown to see the Treasury shrink to $100mil given ETH’s historical volatility profile. Whether this kind of drawdown and a $100mil Treasury is acceptable is a question that can only be answered by the DAO/project itself. I have written about framework for DAO treasury allocation in the context of extending runway and maintaining sovereignty previously. You can read more?here.

MakerDAO on the other hand has made an explicit choice to implement an RWA allocation strategy to prioritize predictable fixed cash inflows that covered its annual expenses. Through its $1.6bil+ allocation towards RWA credit assets, MakerDAO has become profitable and self-sufficient through its operations.

It is important to note that due to the fixed-income nature of US Treasuries and private credit, MakerDAO is not going to have any luck in seeing its allocation double in value. Nor will it have to deal with the possible scenario where the value of its PSM vault halves in value due to its RWA allocation and its stablecoin DAI depeggs as a result.

How to allocate between the two investable universes depends on the investment objective. If you have thoughts to share or are interested in diving into the topic further, please leave your comment below or connect with me.

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.