HomeServicesCompanyNews & InsightsCareersContactLogin
TodayLet's be in cashToday in a near futureImpact on Monetary and fiscal policyConclusion
Thursday, 5 September, 2019
The Digital Investor

Negative yields, cash and cryptocurrencies

The universe of investable crypto assets today, while small, is expanding. Imagine that in a near future this universe becomes reasonably large and liquid, or in other words, it becomes as mature as other alternative asset classes such as commodities and hedge funds. How would this world look like?

To shed some light on this scenario, we imagine a world similar to the one we are living in today and question how asset allocation would be affected and what would be the implications for policymakers.

Today

We are living in a world where most of the key financial and economic variables are running “low”. As far as the main economic variables are concerned, we find low rates of growth, low productivity, low inflation and even low unemployment. Within financial variables, we have low interest rates, low yields, low risk premiums and consequently low expected returns on investment.

In some countries, financial variables have even become negative. Major central banks such as the European Central Bank and the Swiss National Bank have implemented Negative Interest Rate Policies (NIRP). In combination with other policies, NIRP has weighed on the entire yield curve. For example, yields in Switzerland (up to 50 years), are negative (Exhibit 1)

Exhibit 1: Swiss government bonds yielding curve

Source – Bloomberg

Globally, there are currently USD 15.5tn negative-yielding government bonds outstanding (Exhibit 2). To put this figure into perspective, we first note that most negative-yielding bonds have a good rating (rated A or higher according to Standard and Poor’s as well as Fitch). Further, among the universe of government bonds rated A or better, negative-yielding bonds represent about 41%. This is not an anomaly anymore; it is a significant amount.

Exhibit 2: Global govt. debt outstanding with negative yielding

Source – Bloomberg

It is worth spending some time understanding why some investors hold these bonds. Indeed, to pay for losing money is not a good starting point for investing. That said, there are many valid reasons for investors to hold negative-yielding government bonds.

  • Firstly, as mentioned above, they are high-quality bonds and bear very little risk: they are thus considered low risk. They are also highly liquid. Modern portfolio theory says that it is crucial to allocate some money into a low-risk asset to reduce the overall portfolio risk.

  • Secondly, highly rated government bonds are safe assets, they increase in value when risky assets sell-off. If investors are pessimistic, it may be rational for them to invest in negative-yielding bonds as the expected risk-adjusted return is superior versus equities, for instance.

  • Thirdly, some investors may also judge that the world economy is set to experience a period of deflation. As deflation is a decline in the general level of price, if price declines by 2%, a negative-yielding bond which offers -0.5% will deliver a positive return of 1.5%. This is nothing but improved purchasing power from an investor’s point of view.

  • Finally, several large investors may have no choice but to invest in these bonds. Commercial banks and pension funds are forced to hold high-quality liquid assets in line with their investment policies. As listed above, there are many valid reasons to hold these financial instruments, but the central question of why to pay for losing money, at first sight, remains nonetheless unanswered. Cash is a safe, liquid, and non-interest bearing financial asset, which is a superior alternative. The key question is, therefore, why do investors not move to cash to avoid negative-yielding bonds?

Let's be in cash

The answer to this question is that we are not all equal against cash. In today's world, most of the existing cash is not physical, it is electronic. A deposit at a commercial bank is not backed by physical banknotes in a vault, it is simply a line item in the bank ledger. If needed, the bank client can go to the ATM and transform this electronic cash in physical cash - banknotes. Electronic cash is a promise to pay physical cash on demand.

Institutional investors such as commercial banks, asset managers, pension funds only hold electronic cash as holding physical cash is cumbersome. First, transaction processing times increase substantially whenever cash is involved, and second, it is costly to insure for transportation and storage. More importantly, this cash is not liquid anymore, as it cannot be wired instantly.

Given these issues, institutional investors prefer parking their cash in commercial banks, a significant portion of which is subsequently deposited in the central bank’s deposit account that charges negative interest rate (NIRP). Therefore, in the world of today: cash is not a genuine alternative to negative-yielding bonds. The world of tomorrow may well be very different, and this is because of cryptocurrencies.

Today in a near future

In addition to the traditional physical and electronic cash, cryptocurrencies offer two new forms of cash. In the first category, we find stable coins that are backed by and pegged to fiat currencies (e.g. tether, TrueUSD, Gemini dollar etc.), and in the second we find native cryptocurrencies (e.g. bitcoin, litecoin, ripple). Both these forms of currencies are zero-interest bearing and are reasonably liquid. In a near future, they may become highly demanded and will have large implications on monetary and fiscal policies.

A stable coin is a crypto token issued by an entity that holds cash either in physical or electronic form. A token backed by electronic cash will not be any better than electronic cash itself as NIRP will apply. However, if the token is backed by physical cash, NIRP no longer applies. There are surely costs associated with the transportation and storage of banknotes, but more importantly, this crypto token is liquid compared to physical cash. It can be traded 24/7 at virtually no cost. If this market develops rapidly, NIRP and other such negative-yield strategies may come under threat unless governments decide to forbid stable coins.

Finally, native cryptocurrencies may well become mainstream, and their market liquidity may increase. In comparison to stable coins, cryptocurrencies are volatile. However, volatility is not an antonym of a risk-free asset. Gold is often perceived as a safe-haven asset, but its price is volatile. In the same way, cryptocurrencies may be both volatile and diversifying. It is difficult to attach negative interest rates to cryptocurrencies, and it is extremely difficult to completely forbid their use. As the market of cryptocurrency is growing and is 24/7 in nature, the liquidity potential is elevated. This is a genuine alternative to cash and obviously to negative-yielding government debts.

According to our scenario, the developments of other forms of cash assets may enable investors, in particular, institutional investors, to avoid negative-yielding government bond investments. As a result, the lower bound for interest rates in the future could well become zero.

Impact on Monetary and fiscal policy

If the world we just depicted above materialises in the next few years, central banks in Europe (Switzerland included) and Japan may have to go from NIRP to ZIRP, form a negative to a zero interest rate policy. Government bonds may no longer be priced at a negative yield. Both of these implications restrict monetary and government policies. In our scenario, NIRP will not be an option again, and the government will have to pay something to issue bonds, limiting their ability to get indebted.

It is therefore not improbable that the proliferation of cryptocurrencies could materially discipline central banks and governments. This is, in our view, one of the reasons these institutions are reluctant to let the cryptocurrency market develop

Conclusion

From an investor’s point of view, the addition of cryptocurrency is undoubtedly good as it potentially allows, among other things, to avoid negative-yielding bonds. For central banks and governments, it is not good news as it removes some policy tools from already depleted toolboxes. For society as a whole, the question is open. If you believe that NIRP has been effective and contributes to foster growth and inflation, cryptocurrencies are bad. On the other hand, if you believe that NIRP is ineffective or dangerous as it distorts prices, cryptocurrencies are good. Meanwhile, cryptocurrencies are here to stay, they are growing in importance, and will potentially change the way money is invested and managed.


Share:

Authors


Yves Longchamp
Head of Research
SEBA Bank AG
in
Rohan Misra
Research Analyst
B&B Analytics Private Limited
in
Ujjwal Mehra
Research Analyst
B&B Analytics Private Limited
in
Download pdf
Disclaimer

research@seba.swiss

Disclaimer

This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any financial investment or to participate in any particular investment strategy. This document is for distribution only under such circumstances as may be permitted by applicable law. It is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction.

No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained in this document, except with respect to information concerning SEBA. The information is not intended to be a complete statement or summary of the financial investments, markets or developments referred to in the document. SEBA does not undertake to update or keep current the information. Any statements contained in this document attributed to a third party represent SEBA's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party.

Any prices stated in this document are for information purposes only and do not represent valuations for individual investments. There is no representation that any transaction can or could have been effected at those prices, and any prices do not necessarily reflect SEBA’s internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions by SEBA or any other source may yield substantially different results.

Nothing in this document constitutes a representation that any investment strategy or investment is suitable or appropriate to an investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should exercise prudence and their own judgment in making their investment decisions. Financial investments described in the document may not be eligible for sale in all jurisdictions or to certain categories of investors. Certain services and products are subject to legal restrictions and cannot be offered on an unrestricted basis to certain investors. Recipients are therefore asked to consult the restrictions relating to investments, products or services for further information. Furthermore, recipients may consult their legal/tax advisors should they require any clarifications. SEBA and any of its directors or employees may be entitled at any time to hold long or short positions in investments, carry out transactions involving relevant investments in the capacity of principal or agent, or provide any other services or have officers, who serve as directors, either to/for the issuer, the investment itself or to/for any company commercially or financially affiliated to such investment.

At any time, investment decisions (including whether to buy, sell or hold investments) made by SEBA and its employees may differ from or be contrary to the opinions expressed in SEBA research publications.

Some investments may not be readily realizable since the market is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. Investing in digital assets including cryptocurrencies as well as in futures and options is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may under certain circumstances occur. The value of any investment or income may go down as well as up, and investors may not get back the full amount invested. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. Tax treatment depends on the individual circumstances and may be subject to change in the future.

SEBA does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific investor’s circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of individual investors and we would recommend that you take financial and/or tax advice as to the implications (including tax) prior to investing. Neither SEBA nor any of its directors, employees or agents accepts any liability for any loss (including investment loss) or damage arising out of the use of all or any of the Information provided in the document.

This document may not be reproduced or copies circulated without prior authority of SEBA. Unless otherwise agreed in writing SEBA expressly prohibits the distribution and transfer of this document to third parties for any reason. SEBA accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this document.

Research will initiate, update and cease coverage solely at the discretion of SEBA. The information contained in this document is based on numerous assumptions. Different assumptions could result in materially different results. SEBA may use research input provided by analysts employed by its affiliate B&B Analytics Private Limited, Mumbai. The analyst(s) responsible for the preparation of this document may interact with trading desk personnel, sales personnel and other parties for the purpose of gathering, applying and interpreting market information The compensation of the analyst who prepared this document is determined exclusively by SEBA.

Austria: SEBA is not licensed to conduct banking and financial activities in Austria nor is SEBA supervised by the Austrian Financial Market Authority (Finanzmarktaufsicht), to which this document has not been submitted for approval. France: SEBA is not licensed to conduct banking and financial activities in France nor is SEBA supervised by French banking and financial authorities. Italy: SEBA is not licensed to conduct banking and financial activities in Italy nor is SEBA supervised by the Bank of Italy (Banca d’Italia) and the Italian Financial Markets Supervisory Authority (CONSOB - Commissione Nazionale per le Società e la Borsa), to which this document has not been submitted for approval. Germany: SEBA is not licensed to conduct banking and financial activities in Germany nor is SEBA supervised by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht), to which this document has not been submitted for approval. Hong-Kong: SEBA is not licensed to conduct banking and financial activities in Hong-Kong nor is SEBA supervised by banking and financial authorities in Hong-Kong, to which this document has not been submitted for approval. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Hong-Kong where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not “professional investors” within the meaning of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules made thereunder (the “SFO”). Netherlands: This publication has been produced by SEBA, which is not authorised to provide regulated services in the Netherlands. Portugal: SEBA is not licensed to conduct banking and financial activities in Portugal nor is SEBA supervised by the Portuguese regulators Bank of Portugal “Banco de Portugal” and Portuguese Securities Exchange Commission “Comissao do Mercado de Valores Mobiliarios”. Singapore: SEBA is not licensed to conduct banking and financial activities in SIngapore nor is SEBA supervised by banking and financial authorities in Singapore, to which this document has not been submitted for approval. This document was provided to you as a result of a request received by SEBA from you and/or persons entitled to make the request on your behalf. Should you have received the document erroneously, SEBA asks that you kindly destroy/delete it and inform SEBA immediately. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in Singapore where such distribution, publication, availability or use would be contrary to law or regulation or would subject SEBA to any registration or licensing requirement within such jurisdiction. This document is under no circumstances directed to, or intended for distribution, publication to or use by, persons who are not accredited investors, expert investors or institutional investors as defined in section 4A of the Securities and Futures Act (Cap. 289 of Singapore) (“SFA”). UK: This document has been prepared by SEBA Bank AG (“SEBA”) in Switzerland. SEBA is a Swiss bank and securities dealer with its head office and legal domicile in Switzerland. It is authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA). This document is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product.

SEBA is not an authorised person for purposes of the Financial Services and Markets Act (FSMA), and accordingly, any information if deemed a financial promotion is provided only to persons in the UK reasonably believed to be of a kind to whom promotions may be communicated by an unauthorised person pursuant to an exemption under the FSMA (Financial Promotion) Order 2005 (the “FPO”). Such persons include: (a) persons having professional experience in matters relating to investments (“Investment Professionals”) and (b) high net worth bodies corporate, partnerships, unincorporated associations, trusts, etc. falling within Article 49 of the FPO (“High Net Worth Businesses”). High Net Worth Businesses include: (i) a corporation which has called-up share capital or net assets of at least £5 million or is a member of a group in which includes a company with called-up share capital or net assets of at least £5 million (but where the corporation has more than 20 shareholders or it is a subsidiary of a company with more than 20 shareholders, the £5 million share capital / net assets requirement is reduced to £500,000); (ii) a partnership or unincorporated association with net assets of at least £5 million and (iii) a trustee of a trust which has had gross assets (i.e. total assets held before deduction of any liabilities) of at least £10 million at any time within the year preceding the promotion. Any financial promotion information is available only to such persons, and persons of any other description in the UK may not rely on the information in it. Most of the protections provided by the UK regulatory system, and compensation under the UK Financial Services Compensation Scheme, will not be available.

© SEBA / Grafenauweg 6, 6300 Zug, Switzerland

Research

more
Research
Are crypto-assets suitable for institutional investors?
07 November, 2019
For years, crypto-asset has been a confidential asset class for non-institutional investors. However, we observe growing “institutionalisation”. In this issue of The Digital Investor, we give a broad overview of the state of the institutionalisation process to assess whether it has reached a level of development that is advanced enough to attract institutional investors.
Read more
Research
Hello, crypto world!
24 October, 2019
Blockchain 101: A simple analogy with a famous board game. Whether you play chess or not, this publication is for you. We invite you to discover the crypto world through the game of chess. Don’t be afraid. No prior knowledge in either blockchain or chess is required.
Read more
Research
Switzerland tackles stable coins
17 October, 2019
The Swiss Financial Market Supervisory Authority (FINMA) published guidelines on stable coins (including Libra), thereby increasing regulatory certainty around these type of projects. The Swiss National Bank (SNB) assessed stable coins from a macroeconomic perspective, while the G7 handed off work on regulatory issues to the Financial Stability Forum (FSB)
Read more

Join us as we redefine finance.

Contact us
seba

SEBA Bank AG
Grafenauweg 6
6300 Zug
Switzerland

ServicesCompanyNews & InsightsCareersContact
Contact us
© 2019 SEBA Bank AG