A type of structured product whose return is linked to the performance of its underlying assets.
A Crypto-Linked Note (CLN) refers to a debt instrument that does not pay a fixed interest rate. Instead, it is a type of structured product whose return is linked to the performance of its underlying crypto assets. The crypto assets tied to a crypto-linked note can be a crypto, a basket of cryptos, or a broader crypto market index.
Crypto-linked notes are essentially debt instruments that are split into their principal and interest components. For the principal component, a typical crypto-linked note could be principal protected. It usually consists of a zero-coupon bond that is paid upon maturity.
It means that the investor will be guaranteed to receive a certain percentage original amount invested. In relation, CLNs offer investors some exposure to crypto markets, while also offering a safety net by ensuring principal repayment.
Crypto-linked note does not offer a fixed interest rate or yield to maturity. Hence, the interest component is staked in crypto-asset options. When the note matures, the final payout to investors will amount to the original principal plus whatever the payoff is on the crypto-asset options. CLNs are also short-term investments, typically 1-4 months in term length. Most CLNs are held until maturity instead of being traded on the secondary market.
Growing significantly, the CLN market now offers many features that appeal to different investor profiles. For example, a note that provides protection of the principal will attract investors that seek lower risk to their capital. A note that employs leverage will attract investors who seek higher returns.
Lastly, the total return potential of crypto-linked notes will appeal to investors who seek alternatives to the low yields of fixed-income investments.
Investors want to invest in cryptos because historically, they’ve outperformed fixed-income investments. Crypto-linked notes give the opportunity to earn higher returns in comparison to fixed-income investments
Most crypto-linked notes provide a way for investors to protect their capital, and it is common for them to offer full principal protection. It is what makes CLNs appealing to risk-averse investors who want to explore crypto markets with a safety net.
Crypto-linked notes also offer investors the flexibility to choose their preferred underlying crypto asset, index, or the number of crypto assets.
The return of crypto-linked notes is linked to the performance of the underlying digital assets, which may fluctuate depending on market performance. It can adversely affect the value of the debt instrument. While notes are designed to reduce market risk, it is possible to lose a portion of the principal investment amount based on market performance.
Crypto-linked notes are usually issued as unsecured debt obligations of a specific company. It means they are subject to that company’s trustworthiness. Should the issuer fail or default, investors may lose either all or part of their investment.
Liquidity is the ability for an investment to be readily converted to cash without a substantial discount. The secondary market for crypto-linked notes is typically illiquid, as notes are designed to be held until maturity. The bid offers that do exist are often at a discount if companies decide to repurchase notes from investors.
Therefore, selling the note before its maturity date may result in a loss of capital. Investors should be prepared to stay invested until maturity; otherwise, they may incur a substantial loss in the principal investment amount.
As with any complex investment, there are many fees and built-in costs to CLNs. They include commissions paid to the issuing company and securities firm that sell the notes.