Understanding the Risks and Rewards of Crypto Structured Products: A Comprehensive Guide

Darwinbit
9 min readAug 28, 2023

At the heart of cryptocurrencies lies a spirit of innovation. From blockchain technology developments to financial instruments, they provide leading-edge solutions that unlock new opportunities. One such innovation is crypto structured products — but what are they?

Simply put, crypto structured products are the digital asset industry’s answer to wealth management. Similar to crypto derivatives, they derive their underlying value from a cryptocurrency such as Bitcoin or Ether. However, they are packaged investments that offer investors a tailored risk-return, which can be customized to meet individual investor requirements.

Over the years, crypto structured products have been growing in popularity among retail and institutional investors. This growing demand is primarily driven by the potential for higher returns and the opportunity to mitigate risk while participating in the often volatile cryptocurrency markets. Major crypto players offer a range of crypto structure products that cater to varying risk appetites. Even in the world of traditional finance (TradFi), major financial institutions and hedge funds have included such products in their offerings.

Yet, it is essential to bear in mind that crypto structured products, just like any financial instrument, also come with their fair share of risks. The dramatic price fluctuations that characterise the cryptocurrency market can lead to significant gains but can result in substantial losses. Additionally, other factors like regulatory changes can compound the complexity of investing in these products.

In this article, we discuss the risks and rewards of crypto structured products, providing you with real-world scenarios that illustrate these points further. We will also share practical strategies to manage these risks and leverage the potential rewards for maximum benefit. Ultimately, we hope to equip you with the necessary knowledge to make informed decisions about whether these products align with your investment goals and risk appetite.

Understanding the Risks of Crypto Structured Products

The thrilling world of Web3 presents many exciting investment opportunities, from initial coin offerings (ICOs) to Decentralised Finance (DeFi), Non-Fungible Tokens (NFTs), and of course, crypto trading. While these crypto investments offer an enticing potential for higher returns, they come with an array of risks. As an investor, it is critical to do your due diligence when investing in any crypto product. Let’s delve into the various risks of crypto structure products and how they can impact an investor’s portfolio.

Volatility Risk

First of all, there is volatility risk. The prices of cryptocurrencies are notoriously volatile, with sudden and significant price swings being a common occurrence. This volatility can result in substantial losses if the market moves against the investor’s expectations. For instance, a sharp drop in the cryptocurrency’s price, due to black swan events such as the LUNA crash, can lead to heavy losses for investors holding structured products tied to that cryptocurrency.

Market Risk

Next, we have market risk. This encompasses many factors that can adversely affect the overall crypto market. These include economic conditions, geopolitical events, and changes in investor sentiment. For example, inflationary pressures and rising interest rates would result in a decrease in spending. In turn, this decrease in demand could lead to a decrease in cryptocurrency prices. Alternatively, a major security breach at a cryptocurrency exchange, such as the 2014 case of Mt. Gox, could trigger a market-wide sell-off. Ultimately, this would negatively impact crypto structured products and could potentially lead to losses.

Regulatory and Legal Risk

Regulatory and legal risks are also significant concerns in the crypto space. As cryptocurrencies become more mainstream, they attract increased scrutiny from regulators globally. New laws or regulations, such as the Regulation on Markets in Crypto-Assets (MiCA) in Europe, could have far-reaching impacts on the value and viability of certain crypto structured products. Furthermore, the lack of a clear regulatory framework in some jurisdictions can lead to legal uncertainties and potential disputes.

Complexity Risk

As much as crypto structured products are tailored to various investor needs, they still come with a layer of complexity, which can be difficult to understand especially for new investors. This complexity risk arises from the intricate combinations of derivatives and payout formulas. Investors may struggle to fully understand the product’s structure, the underlying assets, and the associated risks, leading to potential misjudgments and unexpected losses. Hence, it is critical that investors have a solid understanding of each product’s terms and conditions, underlying calculations and the fine print on its mechanics.

Counterparty Risk

Finally, there’s the point of counterparty risk. Since structured products are typically unsecured debt, investors face the risk of the issuer defaulting. If the issuer becomes insolvent, investors will be considered unsecured creditors and will have no preferential claims to any assets held by the issuer. Furthermore, there might be no liquidity guarantee, adding another layer of risk to the investment.

All these risks can individually or collectively exert significant pressure on an investor’s portfolio. Understanding them is crucial for making informed decisions and managing potential losses in the world of crypto structured products.

The Potential Rewards: Higher Returns and Diversification

On the flipside, crypto structured products offer a myriad of rewards, making them appealing to investors. But what makes them so popular? Let’s take a look at several advantages of crypto structured products.

Generating High Yield and Returns

The potential of realising high yields and returns make crypto structured products undeniability attractive. With the power of leverage, investors can harness large price swings in the notoriously volatile cryptocurrency market to earn significant returns. For example, Darwinbit’s Twin Win is a leveraged structured product where investors can earn up to 50x leverage, should they accurately express their view of the market.

Potential for Diversification

Another advantage of crypto structured products is the opportunity for diversification. These instruments enable holders and investors to access and hedge their positions in previously out-of-reach assets. What’s more, the mix of underlying assets can be customized according to each investor’s specific needs, risk profile, and expectations. This flexibility makes it easier to build a diversified portfolio that can withstand market fluctuations.

Limited Potential Losses

Along with offering higher potential returns and diversification, crypto structured products also limit the potential for losses. Even in bearish markets, these products can deliver positive yields. For instance, a Bearish Shark Fin product provides a higher yield when the final price of the underlying assets falls within a preset range. If the price exceeds the preset range, a guaranteed minimum annual percentage rate (APR) is used, generating a lower but guaranteed return.

In essence, crypto structured products are designed to ensure that investors have a safety net, even in the face of market volatility. This protective feature, combined with the potential for higher returns and diversification, makes these products a compelling option for crypto enthusiasts.

However, as we’ve discussed in previous sections, these rewards come with their share of risks. As such, it’s crucial for investors to fully comprehend these risks before diving into the world of crypto structured products.

Real-world Scenarios

Having explored the associated risks and rewards that crypto structured products offer, it’s time to bring those concepts into real-world scenarios. For this, we’ll use Protective Earn as an example to illustrate how it performs in different market conditions.

Case Study 1: Protective EarnI

Protective Earn provides investors with the advantage of flexibility. It allows investors to invest USDT and tailor their risk-reward combination by customising Auto Take Profit and downside Protection Prices. Let’s say Alice wants to invest in a Protective Earn product with BTC as the underlying asset.

Investment amount: 100,000 USDT

Initial BTC price: 30,000 USDT

Price Protection (95% of initial BTC price): 28,500 USDT

Auto Take Profit Price (115% of initial BTC price): 34,500 USDT

Tenor: 7 days

APR: 60%

In general, if the daily observation price of BTC is either below Price Protection or above Auto Take Profit, the order will be redeemed before maturity. Now, let’s explore the three different return scenario.

In the first scenario, the average price of BTC stays within the range of Auto Take Profit and Price Protection, throughout the 7-day tenor.

Alice will receive the principal plus APR for the duration of the investment. This is how much she will receive

100,000 USDT Invested x (1+7/365 x 60%)=101.15% x 100,000USDT Invested = 101,150 USDT. In total, her earnings are 1,150 USDT.

In another scenario, there is upward movement in BTC prices. A case in point was the the U.S. SEC’s approval of Bitcoin ETFs. This led to bullish sentiments among investors, causing BTC prices to rally. In Alice’s case, the average price of BTC exceeds the Auto Take Profit price on day 4, triggering an early return.

Alice will receive the principal plus APR for the duration of the investment. This is how much she will receive

100,000 USDT invested x (1 + 4/365 x 60%) = 100.66% x USDT Invested = 100,660 USDT. In total, her earnings are 660 USDT.

In the third scenario, the reverse happens, where there is downward movement in BTC prices. This could be caused by regulatory actions by government officials, such as China’s ban on cryptocurrencies, which caused the entire crypto market to plunge. In Alice’s case, the price of BTC drops by 5%, triggering Price Protection on the fourth day.

When protection is triggered, the principal of 100,000 USDT and accrued interest will be converted into BTC, based on the initial starting price and last observation price respectively. This is how much she will receive

  1. BTC principal = 100,000 USDT invested / Initial BTC price at 30,000 USDT = 3.33 BTC
  2. BTC Interest = 100,000 USDT invested x (4/365 x 60%) / last observation price at 28,500 USDT = 0.00021053 BTC
  3. Final BTC Alice gets = 3.33 BTC principal + 0.00021053 BTC Interest = 3.33964 BTC

How to Mitigate Risks and Maximise Rewards

The exciting world of cryptocurrency trading, while offering immense potential rewards, also comes with its fair share of risks. As we delve into the realm of crypto structured products, it is crucial to equip oneself with effective strategies to manage these risks and leverage potential rewards. This section aims to shed light on practical approaches that can help you navigate these intricate waters.

Managing Risks Associated with Crypto Structured Products

One of the fundamental principles of investing is to only invest what you can afford to lose. Cryptocurrencies are known for their dramatic price fluctuations, which means potential for significant gains, but also substantial losses. To manage this volatility risk, it’s important not to get carried away by the lure of high returns and keep your investments within a limit that won’t disrupt your financial stability.

Another way to mitigate risk is through diversification. Structured products can play a key role here as they offer exposure to multiple cryptocurrencies or a basket of digital assets. By investing in a diversified portfolio, the impact of an adverse event affecting a particular cryptocurrency can be mitigated, providing a more balanced and resilient investment strategy.

Additionally, it’s wise to avoid excessive leverage, especially if you’re new to the world of crypto structured products. While leveraged exposure can amplify potential gains, it equally amplifies potential losses. Therefore, adopting a cautious approach and limiting the use of leverage can help you manage the inherent risks better.

Maximising the Potential Rewards

The tantalising promise of higher returns is a major draw of crypto structured products. However, to effectively harness these potential rewards, a well-thought-out strategy is necessary. Tailoring your investment strategies to suit your specific investment goals, risk appetite, and time horizon can provide you with a robust framework for decision-making.

Structured products, due to their customizable nature, allow you to express your market views effectively and maximise profits from market movements. These products can be designed to meet a variety of objectives — whether you seek capital appreciation, regular income, or a combination of both. Herein lies the potential to fully leverage the rewards offered by crypto structured products.

In closing, remember that informed decision-making is the cornerstone of successful investing. Before incorporating structured products into your crypto trading strategies, it’s essential to understand their terms, features, and associated risks. Seeking professional advice can further add to your arsenal of risk management tools and investment strategies.

Conclusion

In our comprehensive journey through the world of crypto structured products, we’ve unravelled their intricacies, analysed their inherent risks, and explored their potential rewards. As the popular saying goes, always do your own research (DYOR) — have a clear picture of the risks, rewards and finer mechanics before delving into crypto structured products, or any investment for that matter.

Learn more about Darwinbit’s products.

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Darwinbit

Pioneering the Evolution of Digital Assets. Specializes in offering structured products, staking, and fixed income services.