Crypto staking may look and smell like bank deposits, but aren’t worth the risk

CHUNG Khiaw Bank’s Geylang branch stayed open until shortly before 10.30 pm on Oct 3, 1974, hours after they were supposed to have closed, The Straits Times reported.

The branch’s bank manager had requisitioned S$3 million, delivered at about 8 pm in a Cisco van, to pay the long line of customers outside who wanted to withdraw their money.

Rumours about the UOB member’s financial health led throngs of small depositors to make withdrawals at the banks’ branches, with the volume of withdrawals only tapering after the Monetary Authority of Singapore (MAS) assured the public that the bank’s deposits were “safe and well protected”.

While bank runs may seem like a distant memory, we have seen new forms of interest-generating accounts spring up in recent years. However, depositors should weigh their risks carefully.

For instance, cryptocurrency exchanges like Crypto.com and Binance also offer staking services which earn a range of reward rates. When a cryptocurrency is staked, it becomes inaccessible to users as it earns rewards.

These exchanges use cryptocurrency like Ethereum and Solana that are staked with them to secure transactions on blockchain networks, earning rewards and distributing them to customers.

Customers using Crypto.com can stake cryptocurrencies for between one and three months, or for a “flexible period” and be able to withdraw the cryptocurrency at any time for a lower reward rate. Users can earn a reward rate of between 2 and 10 per cent per annum. Someone who stakes US$5,000 of Ethereum in three-month periods could earn 3.2 per cent per annum in “optimised rewards”.

In addition, Crypto.com users who stake the Cronos utility token, which is used to pay for services on the platform, can sign up for a Visa prepaid card. It will reimburse up to US$13.99 in Netflix and Spotify subscription fees for six months, and give 2 per cent cashback in Cronos if users stake S$5,000 of the tokens.

Although such accounts may look and feel like fixed deposit and high-yield savings accounts, I would argue that they lack an important feature of bank savings accounts: Singapore Deposit Insurance Corporation (SDIC) protection.

Under the deposit insurance scheme, insured deposits held in trust and client accounts of member banks and financial institutions are insured up to S$75,000 per account.

Such an insurance scheme was theorised by economists Douglas Diamond and Philip Dybvig as a way to reduce the potential for bank runs. The duo won the 2022 Nobel Memorial Prize in Economics for their seminal paper Bank Runs, Deposit Insurance, and Liquidity published back in 1983.

Imagine that you are a bank, and you would like to make loans to some companies so that they can use the capital to grow.

To do that, you first need to motivate people to save money with you. You offer them an interest rate that grows their money by, say, 1 per cent per annum. You then loan out the money to a company for five years, earning 2 per cent per annum in interest.

At the risk of grossly oversimplifying the banking process, you pocket the 1 per cent difference between the interest you pay to depositors, and the interest you receive from debtors. Congratulations, you have just made some money as a bank!

But what do your depositors see? If the bank has money loaned out for five years, how much money does it have to pay depositors when they need their money to buy lunch tomorrow?

If people begin to worry about the near-term liquidity of their bank deposits, then it is in their best interests to draw their money out. If everyone were to do so, the bank will not be able to pay everyone back at some point, as the money is still loaned out.

When these deposits are insured, depositors are assured that they will have the near-term liquidity that they need out of their accounts.

Banks under the international regulatory accord Basel III are also required to hold a certain amount of liquid assets. One such regulation requires banks to hold enough liquid assets to fund their cash outflows for 30 days.

As interest rates rise, it starts to make less sense for people to place their money in more risky savings accounts – like crypto staking accounts – for higher returns.

If one can get 3.85 per cent per annum in interest on less than S$30,000 in savings from UOB, by spending S$500 on their credit cards and crediting one’s salary into a designated bank account, there is very little reason to leave money in anything less safe for marginally higher returns.

And if a cryptocurrency exchange does offer far higher interest rates for staking, one ought to consider what sort of risks are associated with the company or the cryptocurrency. That is not even considering the wild swings in value that cryptocurrencies could be subjected to.

I had to take a dive deep into our archives to find references to a bank run in Singapore, but you need not look too far to see echoes of similar crises in the collapse of FTX and the Terra-Luna fiasco last year.

Ideally, savings should be risk-free. Take those risks with your investments instead.