Cryptocurrencies often make headlines for their price swings. For example, Bitcoin fell by over 70% from its November 2021 all-time high. To manage this volatility, investors are increasingly using derivatives — financial products linked to other assets.
Trading derivatives can be a complex undertaking best left to professional investors. But structured notes offer a neatly packaged way for less experienced investors to profit off of crypto volatility.
Benzinga looks at structured notes and how they can reduce crypto risk.
What is a Structured Note?
A structured note is a hybrid security that combines elements of debt and derivatives into a single financial product. Structured notes try to provide a guaranteed return without putting the original capital invested at risk. These investment vehicles are usually highly customizable, catering to investor needs.
In crypto, structured notes are pre-packaged baskets of crypto derivatives. Crypto derivatives are financial instruments linked to the performance of digital assets (like ETH, BTC, USDT). Usually, a bond component provides payments and protects the original investment. Meanwhile, the derivative component determines any additional profits.
While structured notes have been around for decades in traditional finance, they are a relatively new addition to the crypto markets. As interest in crypto markets grew, investors rushed to add cryptocurrencies to their portfolios. Over time, adding alternative products like derivatives became more appealing.
The Chicago Mercantile Exchange (CME) was the first to offer crypto derivatives. In 2017, the CME began settling futures in Bitcoin and Ethereum as well as USD. Since then, many other derivative products have entered the market. But it wasn’t until 2021 that structured crypto products launched. Investors can choose from several structured crypto products to seek returns even in volatile markets.
How Do Structured Notes Work?
Structured notes are customizable investment packages that consist of two components:
- A derivative component
- A bond component
The derivative side “derives” its value from another asset — in this case, cryptocurrencies. The derivative’s return is based on the performance of the crypto market. The bond component protects the initial investment by returning the payment principal.
Structured products offer a chance to seek higher yields alongside capital protection. As such, they’ve traditionally been popular with wealth management clients. For smaller investors, structured notes provide access to investments that may otherwise be out of reach. They can be tailored to suit unique needs while distilling complex trades to a single simplified exposure.
The returns on a structured note or product depend on a set of predetermined rules. For instance, a structured note could pay out a specific percentage return as long as the linked asset achieves a predefined performance.
Crypto structured products bear many parallels to their traditional finance counterparts. However, they’re not issued by financial institutions like banks. Crypto structured notes can come in various types with different redemption structures.
How Structured Notes Help to Reduce Crypto Risk
Crypto structured notes enable investors to seek competitive profits while protecting their capital. Most crypto structured notes have built-in mechanisms to take advantage of price swings. As a result, investors can usually keep their original capital safe while earning a return, regardless of the market's ups and down.
While potential profits vary, crypto-structured notes allow investors to hedge their risks. Without directly buying crypto, investors can see returns even in volatile crypto markets. Whereas crypto investors could lose everything at a moment’s notice, structured notes are designed to provide some returns at less risk. Potential returns may be lower than in direct crypto investments.
Advantages of Structured Notes
Structured notes offer enhanced returns while offering capital protection. Here are a few benefits of structured notes:
- Principal protection: Crypto structured notes help you protect your capital regardless of market movements.
- Highly customizable: Structured notes can be designed to fit your investing goals and risk appetite.
- Tax efficiency: Structured notes can offer tax efficiencies depending on your country and tax regime.
- Volatility risk management: You can better manage the notorious risk of crypto price volatility.
- Market-sentiment agnostic: You have the potential to earn a profit whether the market sentiment is bullish or bearish.
- Indirect exposure to cryptocurrencies: Enjoy returns related to crypto investing without buying and storing crypto.
- Better regulation: Structured notes may be more regulated than the general cryptocurrency industry.
- Loss-limiting mechanisms: Crypto structured notes are designed to limit possible losses automatically.
Disadvantages of Structured Notes
Given the advantages of structured notes as an investment vehicle, it's easy to believe they are not without drawbacks. Any investment comes with risks, and you should be mindful of the following:
- Complexity: Beginning investors may struggle to understand how structured notes work and how potential rewards are calculated.
- Maximum gains cap: You could lose out on potential profit depending on the price of the underlying asset.
- Higher fees: Structured notes cost more to launch and build than other financial products. As a result, you may pay higher embedded fees.
Manage Crypto Volatility with Crypto Structured Notes
Crypto structured products combine interest-bearing assets and derivatives. They allow easier access to typically complex products by simplifying them into a single investment. The result is a customizable investment with a better risk profile and principal protection. Remember — volatility is both the bane and boon of crypto investing. While managing the downsides can be a nightmare, crypto structured notes may help.
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About Anna Yen
Anna Yen, CFA is an expert crypto writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about alternative investment topics ranging from derivatives to cryptocurrencies. Her work has been published on sites like the crypto exchange Bybit. After six years of personal experience investing in crypto, she prefers BTC, ETH, and SOL.