Cheap Thrills in Crazytown


…a lazy lazy Cryptocurrency investing strategy

‘…Experience the thrill of getting paid to do absolutely nothing.’ ~John Heinzl on dividends

‘I love cheap thrills’ ~ Sia

For most normal stock market investors, the world of Cryptocurrencies still often looks like a sort of Crazytown, full of unpredictable twists and turns, unknowns, and savvy insider FOMO HODL moon type jargon. The wild excitements of the early ‘wild west’ era for cryptocurrencies seems to be slowly easing though as crypto gets embraced by regulators and everyday people. That’s probably a good thing for everyday investors in the long run, even if the correlation with tech stocks is high at the moment. Researchers have pointed out that normal equity portfolios can perform significantly better over time when a small amount of cryptocurrency is added as an asset class. Some of the largest asset managers in the world are getting on the bandwagon too. Fidelity, with $9 Trillion USD in assets under management, is even planning to allow its investors to hold crypto in their retirement funds. We’ve come a long way in just a few years!

Even so, it’s still notoriously difficult to know who to trust, how to stay relatively safe, and what to believe. This article won’t wade into the question of whether it’s a good idea to own cryptocurrencies or not, or how much of them to own if you do. There are plenty of resources and opinions out there already on that topic. Today we’re going to explore a different question- is there something an everyday investor can do to get better returns than just holding crypto over time? I think there is. If you’re interested, pull up a chair. This article is for you.

This article does some rough modelling of a cryptocurrency yield investment strategy. It’s intended for investors who are interested in holding some key cryptos for the long term and would like some of those returns for themselves without an expensive education, constant effort or ulcer medication. For the most part, the strategy uses a ‘set it and forget it’ type of compounding investment approach, using readily available equities that can be bought on normal exchanges and held in a tax sheltered account like a Canadian TFSA or RRSP through the good times and the bad. Readers in other countries can consult their trusted financial advisor for 401k eligibility. It may seem counterintuitive, but the best time to buy is often when an asset or equity falls out of favour. And by golly, these things are out of favour right now.

We’re not in Kansas anymore. Investors are finding themselves smack dab in the middle of a new, scary investment landscape these days. The relatively comfy surroundings of the last few years are well and truly over. We’re looking for safe havens as we navigate a world full of product shortages, disease, supply chain issues, inflation, volatility shocks, less focus on the North American dominated version of globalization, the end of QE, the rise of meme investors and no fee app based investing, an unpredictable Fed… you get the picture. A comprehensive list of the headwinds would make the weather report for a George Clooney fishing expedition seem tame by comparison. So what’s a person to do?

Go with the flow. There’s one good answer. You might have thought that going with the flow meant we’d be talking about momentum investing. For those of you who did think of that, good on you. Momentum trading can be part of this strategy and we’ll talk about it later. The first flow we’ll talk about is handy dandy cash flow though. According to Forbes, Berkshire Hathaway has annualized returns of about 20% a year since 1965. That’s partly because Warren Buffett loves buying businesses with steady amounts of free cash flow. If cash flow is good enough for the GOAT, it’s good enough for me. For this strategy, we’ll use come crypto oriented ETF’s that yield cash flow every month.

ETFs are the products everyday people often buy when they’re looking for a ‘set it and forget it’ strategy. When you want one with lots of convenience you pay a hefty premium for it, just like you do when you buy a candy bar from a gas station at 3 am. In this case, we‘re going to get the convenience of active management, nice cash flows and DRIP eligibility so we never have to get off the couch again. The two ETFs at the heart of this strategy are the Purpose Bitcoin Yield ETF (BTCY.U), the Purpose Ether Yield ETF (ETHY.U). Their MER is 1.41% at the moment- hefty fees! At the time of this writing, they are very new and relatively small ETFs that originate in Canada. They can be bought in CAD versions. For this example, we’re going to use their USD versions though. They have higher posted yields and USD is strong these days. Let’s have a look at what these funds are designed to do and how they can work for you.

The Purpose Bitcoin Yield USD ETF (BTCY.U) and Purpose Ether Yield USD ETF (ETHY.U) funds use a covered call option strategy to earn a variable but regularly paid cash flow- a monthly yield that the fund distributes to you along with capital gains if they come along. That’s the main point. If you’d like to explore the details of how the funds do that, read on. If you’re happy already, maybe save yourself some time and skip to the next section.

The ETFs hold units of the Bitcoin or Ether funds that Purpose sells, and then they sell derivatives on those units. The derivatives are called covered call options- that means the fund has the assets on hand, so they can always ‘cover’ their obligation to deliver if the Call buyer chooses to buy them. Only a percentage of the overall assets in the pool have calls written at any time. In the meantime, the value of all the cryptocurrency in the fund pool moves with the market. Cryptocurrency assets are far more volatile than most legacy financial market assets, so the premium prices for options are relatively expensive. That’s good for us investors, because that means the covered calls can yield juicy distribution money every month. At the time of this writing on May 9, 2022, ETHY.U has an annualized yield of over 22% as posted on the Purpose Investments website. Yes, that’s right. 22%. Even though that spot yield is sure to change, there’s probably enough yield here to keep the inflation zombies off the porch for investors in most developed countries these days.

These calls are time limited in that they expire after a period of time and the fund sells them on a rolling basis throughout the year. There are two typical outcomes at every option expiry, and the funds stand to make at least some profit money in each case. For example, when a call option expires in the ETHY.U ETF and the price of Ether is lower than the option strike price, the fund keeps the option premiums to pay as its distribution and keeps all its Ether holdings too. The other scenario is that Ether price goes up enough for the the Call options to get exercised. That means the buyer of the Calls decides they want to fulfill the contract because it’s now cheaper to buy the Ether at the agreed upon Call option strike price than it is to buy it on the open market. In that case, the fund earns its option premiums and gets paid USD in cash for the amount of Ether that the Call buyer chooses to exercise. The fund may be making a profit on the Ether, but they also forgo some profit because they have to sell it at the strike price, which is less than the current price. In other words, the upside is capped on that Call option contract. Bear in mind though, that all the rest of the Ether in the fund has also increased in value, so the fund should only forgo profits like this some of the time. The fund then buys Ether back with the cash they earned, sells new call options at an adjusted strike price, makes their cash distribution to investors, and the cycle of life goes on.

There’s a catch. There’s always a catch. In this case, the catch is that the investor has made a tradeoff. In exchange for rain or shine returns, the investor makes some but not all of the upside in Crypto prices in any given period. At the time of this writing, the ETHY.U fund has 100% of its covered Call options in a -12% or more moneyness position. In plain English, that means the fund is winning this round: None of the calls they sold are expected to be redeemed for Ether, so the fund keeps all the option premiums and all of the Ether. Good times, even if Ether prices drop and the prices for call options scale down accordingly. As we said earlier, we’re paying hefty fees to the fund managers to keep an eye on the markets, so on balance we expect them to price their options well over time. Ideally, the investors want the call options to be exercised as rarely as possible for maximal profits. Given that Cryptos tend to have price spikes where huge price changes happen in short periods of time, one has to accept that some options will be exercised some of the time.

In real life, drips usually aren’t good. DRIPs can be great though! The simplest approach to this strategy is to buy the ETFs and activate a DRIP for them in a tax sheltered account. A DRIP directs the the fund to pay the monthly distributions in the form of more fund units, without you having to do a trade to buy them. Canada also has dividend tax credits that may apply to you. Best of all, you do absolutely nothing for your returns. Nothing, that is, except actually invest, activate the DRIP, and stay with it.

Amomentum kicker. While I am very fond of this strategy at the moment, especially for its built in drama and the complete laziness it asks of me, it’s always possible to do things a bit better. Remember how we said that the upside to this ETF is capped? Well, what if we pair this ETF with one where the upside is never capped, and it’s designed to make the most of market conditions? This is where momentum trading comes back into the picture. On paper, the CI Galaxy Multi-Crypto ETF (CMCX.U) is designed to do that. This ETF has no cap to the upside- investors can potentially reap every bit of increases in value for the underlying cryptos and maybe even more. It holds only Bitcoin and Ethereum or cash so far, on an actively managed basis. It seeks to time the Crypto market to some extent by buying and selling Crypto for cash now and then. The managers assess market conditions for the Bitcoin and Ether pools separately, then buy or sell the Crypto assets as they see fit. The goal is to preserve capital by staying in cash when prices drop, and increase returns by holding Crypto when prices are going up. A classic momentum strategy. Presumably they have smart people using various tools to achieve this. At the end of the day, it’s something of an art form though, so it’s usually far better to pay someone competent to do it than it is to try and do it yourself. If the managers choose well enough over time, the returns should be better than a person could get by just holding the assets and letting time pass.

So the Purpose Yield and CI Momentum Crypto funds seek to do a couple of the ‘fancy things’ my Finance Prof used to talk about- an option yield strategy and a momentum trading strategy. Those ‘fancy things’ can complement each other over time. Be aware though- in all of these ETFs, the quality of the choices management makes will have a significant effect on the financial results, unlike a much simpler index tracking ETF. For instance, most of the big price moves that happen in crypto markets have tended to happen in just a few days a year. If management for any of these ETFs fails to anticipate those moves, you earn less. On the other hand, if they both get it right enough of the time, you can make good steady money compared to many other investment opportunities, including a simple buy and hold strategy for cryptocurrencies themselves.

Let’s put it all together now and look at potential returns. The core idea of this strategy is to purchase one or more Purpose Yield funds inside a tax sheltered account, then DRIP back into them for a total auto-pilot outcome with a capped upside, or buy a complementary fund like CMCX.U with their yield so that some of your holdings can make the most of a rising market. While I very much like the CMCX.U fund in principle, it’s really really small and just not trading a lot right now. So for today we’ll just note that the CMCX could be an interesting alternative and model out some possible scenarios using the DRIP method to reinvest our monthly distribution in ETHY.U. None of these scenarios are intended to be predictions, or even very specific, and certainly no one is making any promises about future results, people!

Investors, start your engines!!! With an initial capital of $10,002 USD, we buy ETHY.U and BTCY.U. I like the future prospects of Ether a bit better than Bitcoin, and it performed much better than Bitcoin in 2021, so we’re going to buy a bit more of the ETHY.U and DRIP all of our distribution money into that. For this example, we’re going to buy exactly 1385 units of ETHY.U priced at $4.80 USD, and 650 units of BTCY.U priced at $5.16 USD in our no-fee stock trading account. On our day one, which is May 9, 2022, ETHY.U yields 22.77% according to the Purpose Investments website, and BTCY.U yields 21.81%. Your yield will likely be different. Each initial purchase fixes our initial cost base and give us a starting point for yield in our example. It’s all happening inside our tax sheltered account, and for simplicity’s sake, let’s just say we’re savvy enough to DRIP it, or remember to do the monthly repurchase of units ourselves. Because of these choices, we can basically put all of the distributed funds into buying more ETHY.U every month.

‘Assume’ makes an ASS out of U and ME. Ever heard that one? Assumptions are the Devil’s plaything, and an absolute necessity if we’re going to try and profit into the future. So we’ll make some assumptions in a few scenarios here and do our best to keep them within reason. The only guarantee I can give is that things won’t turn out exactly like any of these scenarios! There are lots of reasons for this- yields are dynamic and call option prices can change very quickly, for example. Investors can and do act irrationally all the time too- anybody who tells you that markets are rational, well let’s just say I’d question their rationality, or maybe ask them why they keep on using the word ‘rational’. To quote a classic film, I do not think the word means what they think it means.

Getting back on topic, we’re going to plot out some scenarios in simple linear terms here, even though the future is very dynamic. The goal here isn’t to predict the future. It’s to plot out what might happen if prices go in a certain direction in the future. Reality is usually mixed- sometimes crypto markets will go up, sometimes they’ll go down, and sometimes they’ll stay the same. If we’re okay with the outcomes under any of those conditions, we can truly be comfortable leaving our investments alone to work for us.

Here are some of the assumptions we’re working with: That crypto will be worth something more at some future date so it’s worthy of a buy and hold strategy; that the fund managers make good choices overall; that the call option earnings yield the same dollar value distributions every month even though that’s highly unlikely; that Bitcoin and Ether change at about the same rate which doesn’t quite happen; that traders in the future will still pay much more for crypto options than they do for options on other equities; that the ETFs stay liquid, fund expenses stay about the same; and so on. While the funds do declare capital gains from time to time, we’re going to leave them out to underestimate the overall results a little and sweeten the deal now and then.

Now that we’ve grounded ourselves a little bit, let’s get to the scenarios.

Scenario 1: Ho-Hum. In our first scenario, prices for Bitcoin and Ether stay about the same for a year. If they do, it’s a pretty safe bet that the funds never have their options exercised and generate pretty steady distribution money. In this scenario, the overall return could be about 23%- our $10,002 USD becomes worth about $12,300 USD after fund MER expenses. At the end of the 12 months, we have increased our holdings by about 515 to a total of 1,900 units of ETHY.U and still have our 650 units of BTCY.U. All of it continues to yield every month. Since we’ve assumed that prices overall stayed the same, it wildly outperforms a simple hold of the cryptocurrencies themselves. And you did nothing but buy and set up a DRIP. Nice start.

Scenario 2: Nooooooooooo!!!!!!!!!!!!!! If history is any guide, we shouldn’t expect a future where Crypto prices stay the same for long. In our second scenario, both of these Cryptos go down 30% from their current prices in the next 12 months. The nice part is that the Purpose funds would almost never have to let go the crypto holdings. Why not? Because the options never get exercised by the call buyers. The fund can just sell options against the same crypto assets over and over again. The less nice part is that the overall value of the fund holdings and their monthly distributions probably go down. Why? crypto prices have gone down, and the price that call buyers are willing to pay for the options might go down too. If you’re holding long term, have some confidence and can afford to be patient, that’s no biggie. On the other hand, posted yields look awesome because these ETF’s price like bonds- if the price goes down, yield goes up and vice versa. Oh, the other nice part is that you still get paid something- every single month.

Since prices drop for the entire 12 months, the total return is about -7%. It’s still outperforming a simple hold though, doing about 77% better, because simply holding the Crypto returns -30%. We’re also compounding our holdings and end the period with more ETHY.U than any other strategy- up 540 to about 1925 units. Our BTCY.U holdings remain the same at 650 units. It’s a nice way to hibernate through a bear market, especially given that a 30% decline in Crypto would accompany a similar rout in many equity markets these days. There just wouldn’t be a lot of better options for a passive investor in those circumstances. And our payments keep on going like the battery bunny. I love cheap thrills, even on a rainy day.

Scenario 3: Racing past the GOAT. Scenario three models for a 30% rise in Bitcoin and Ethereum in the next 12 months. We’ve modelled this as if it’s a nice steady increase, but in reality that 30% rise could happen in a few trading days. We don’t know when those days will happen, and our intrepid fund managers don’t always either, so some of the Call options get exercised sometimes. This is how our upside is capped. To simulate that capping effect, we’re going to reduce our overall assumptions about the fund returns and unit prices by about 15% a year and apply 1/12th of that reduction every month. The 15% figure is a little arbitrary. The real overall effect could be 30% or 2%. Once we have years of real performance to look back on, it will probably be possible to build a better model. In the meantime, as long as the fund managers price their call options well a decent amount of the time, we’re likely getting results that are as good or better than a simple hold of the underlying Crypto. On top of that, we’re adding more units of the fund to our holdings every month.

In this scenario, our initial investment returns something like 49% for a total holdings value of around $14,914 USD. It also outperforms a simple holding strategy by about 64% after fund fees. At the end of the 12 months, we have our 650 units of BTCY.U and are up around 415 units to around 1800 units of ETHY.U. Once again, all of the units are paying us our monthly distributions. At these rates, I just might want to spend some more time in Crazytown, how about you?

Scenario 4: I knew it all along!!! In this scenario, the Crypto market turns around and ramps back up. We’re only imagining 30% of the 2021 total returns for the next 12 months for this model, however it’s worth remembering how amazing those returns were. Bitcoin returned about 62% in 2021, and Ether returned about 415%. Pretty okay returns, eh? With returns like that, it’s worth asking why we’re only modelling 30% of that increase. In part, it’s because we’re only looking to see what our results are like if things move in this direction and optimistic investors usually have no problem imagining things turning out even better. It’s also because 2021 was special. A bunch of factors came together, and they don’t seem likely to occur all at the same time again anytime soon. Anyone following markets is familiar with some of those factors: Money was given to the public in the form of Covid related stimulus cheques. Investing apps helped flood the market with new investors. Historic money printing by the US Federal Reserve gave most investors a sense of security to take extraordinary risks. Many people were also extremely limited in what they could spend their money on and accumulated it. Business analysts often call that phenomenon ‘excess savings’, as if your money doesn’t really belong in your pocket. But I digress.

2021 was also special because lots of people finally had time to learn about Crypto and were looking for alternative ways to earn. It was relatively easy to put vacation or restaurant money into the markets when no one could take a vacation or eat at a restaurant. Things are different in 2022, to say the least. Our spending options are opening up, investors are running in and out of their investments willy-nilly, and inflation is making sure we’re all paying more for less. Our collective ‘excess savings’ are getting eaten up very quickly.

So let’s get back to the main event. We’re modelling for only 30% of the fantastic gains of 2021 in this scenario. We aren’t going to worry too much about why cryptos go up, but there are a few good reasons they could turn around. Sentiment can turn on a dime. Maybe markets finally do get a bit more rational and start to value Bitcoin as the hard money protection against market flaws that it was designed to be in the first place, instead of a speculative tech asset. Maybe large numbers of everyday investors start to buy a little bit of Bitcoin and Ether for their retirement funds, just in case. Maybe more people flock to Crypto to try and save their economic lives as more countries see inflation spiralling out of control like Turkey and Argentina. Lots of things can and will happen.

For whatever reason, Bitcoin and Ether are going up in this scenario. We’ll assume again that our intrepid Purpose managers have more calls exercised through the year and apply a much higher overall grind factor of 27%. This time around, after paying our investment fees to the funds, we’re looking at a return of about 122%, which is about 34% better than simply holding the Cryptos themselves. Notice our outperformance relative to a simple holding strategy goes down as the underlying cryptocurrencies rise in value. It’s a very important detail. At the end of the 12 months, our $10,002 USD grows to about $22,150 USD in a year. Since the unit prices for our ETHY.U reinvestment have gone up over the period, we only have 1680 units in total, an increase of about 295 units or so. Not too bad for a ‘set it and forget it’ strategy, eh?

“No, there is too much, Let me sum up.” ~Inigo Montoya, in ‘The Princess Bride’

There you go. A set it and forget it style DRIP investment strategy for the top two cryptocurrencies, with the potential to give you some pretty amazing returns under some circumstances. By buying BTCY.U and ETHY.U, and reinvesting the yield distributions, you could potentially outperform Warren Buffett’s Berkshire Hathaway while you sleep. In time, I may also model out the effects of reinvesting the distributions into a momentum Cryptocurrency ETF like CMCX.U. The combination of these ETFs could outperform this simple DRIP strategy in market conditions when cryptocurrencies go up in price. This strategy could be a good place to start though. Until next time, thanks for reading, have fun, and stay safe.

Disclaimer: This article is an example of an investment strategy presented to you for educational purposes only. Use the information in this article at your own risk. No one has more incentive to protect your best interests than you do. It’s important for you to be careful with your money and how you handle it. You could lose money with any investment strategy, including this one. Profit or loss ultimately depend on many factors, including the quality and timing of your choices. In addition, there is no way for me/us to tell if this or any investing strategy is suitable for you in your circumstances. This article is not investment advice. It comes with no warrantees of any kind, express or implied. Please do the responsible thing: Do your own research and consult your trusted financial advisor before investing anything, anywhere, anytime!

This article also talks about some very small Canadian ETFs which are labelled high risk and may have low liquidity. At last check, these funds are eligible for DRIPs, Canadian RRSP’s and TFSA type thingys, so it may be possible to tax shelter and/or automate repurchases for them. By the time you read this, I and/or any related entities may be holding these assets and/or using this investment strategy, and then again, maybe not. No one has paid me and/or any related entities to write this. The phrase ‘Do your own research’ is more than just a hashtag- #DYOR, folks! Make that principle a habit and look after yourselves.

Special bonus marshmallows. Have you ever heard of the marshmallow test? In it, researchers studied children who were given a marshmallow and told that they could eat it anytime they wanted. If they could wait a short time without eating it, they would be given a second marshmallow. If they ate the first one before the time was up, they were told they would not be given another one. The experiment was intended to measure self discipline, though I wonder if it also measured how hungry the kids were and whether they liked marshmallows or not. Unsurprisingly, some kids ate the one marshmallow, and some kids held out for twice the reward. If you’ve come all this way with me, and are still reading this, you just might be a two marshmallow kid with some important skills that can serve you well in many circumstances beyond investing. It’s very important to arrange your life so you can afford to be patient. Best of luck with it all.