Evaluating a crypto yield product means answering five questions in sequence: what produces the return, who holds the assets, which venues and rules apply, what happens when conditions turn, and what reaches you after costs. The advertised rate is the output of all five, which is why starting there tells you almost nothing.
Most diligence starts at the rate and works outward, which inverts the logic. A rate is only interpretable once you know the mechanism producing it. This article sets out the sequence, what each stage establishes, and the red flags that should stop the process.
Why the Order Matters More Than the List
Any competent checklist contains roughly the same items. What distinguishes a useful process is sequence, because each stage determines whether the next one matters.
If the mechanism producing the return cannot be explained, the custody arrangement is irrelevant — you are evaluating something you do not understand. If the custody arrangement leaves you an unsecured creditor, the strategy's elegance will not help you in an insolvency. Working in order lets you stop early, which is the point.
Stage 1: What Produces the Return?
Establish: the economic source of the yield, and who pays it.
Every sustainable return has a payer with a motive. In crypto that is usually one of four mechanisms — interest on reserves, lending to borrowers, fees from providing liquidity, or capturing a spread in derivatives markets. Each compensates a different risk and behaves differently under stress, which we set out in where stablecoin yield comes from.
Ask:
- Who pays this, and what are they buying?
- Is it income, or is it token emissions funded by issuance?
- What does the mechanism do in a drawdown?
Stop if: the answer cannot be stated in a sentence, or the payer cannot be identified.
Stage 2: Who Holds the Assets, and What Do You Own?
Establish: your legal position if the operator fails.
This is the stage most often skipped, and the one that determined outcomes in every major crypto failure to date. A platform balance is usually a contractual claim; a fund interest is usually a property interest in segregated assets; self-custody is ownership. The frameworks are in who holds your money and what custody actually means.
Ask:
- Do I own the assets, hold an interest in segregated assets, or hold a claim?
- Does the arrangement create a debtor-creditor relationship?
- Is there segregation, and is it on-chain, on the ledger, or both?
- Are sub-custodians used, and are they disclosed?
Stop if: the documentation does not distinguish between a claim and a property interest, or permits broad use of client assets without saying so plainly.
Stage 3: Which Venues, Under Which Rules?
Establish: where the assets actually sit while working, and whose law applies.
Any derivatives strategy posts collateral at trading venues — that cannot be avoided, as covered in what proof of reserves does and does not show. What varies is which venues, how concentrated the exposure is, and what the governing regime requires. Treatment differs sharply by jurisdiction: compare the US position in where US access stands with the UK's.
Ask:
- Which venues, and what proportion of assets is exposed to the largest one?
- What regime governs each, and what does it require on segregation?
- How quickly can assets be withdrawn, and have withdrawal limits ever been applied?
- What verification is published, and is it an audit or an attestation?
Stop if: the venue list is undisclosed, or exposure is concentrated in a single venue with no explanation.
Stage 4: What Happens When It Goes Wrong?
Establish: the failure modes, and whether they have been planned for.
Hedged strategies do not fail the way directional ones do. They fail operationally — through rate inversion, collateral exhaustion, forced closure or venue disruption. The two cases to understand are negative funding regimes and liquidation cascades.
Ask:
- What happens when the spread inverts, and for how long can that be absorbed?
- How is the position sized relative to collateral buffers?
- What occurred during the most recent market dislocation?
- Can a hedge be closed involuntarily, and what is the plan if it is?
Stop if: the answer to "what goes wrong" is a description of controls rather than of outcomes, or if no historical stress period can be discussed.
Stage 5: What Actually Reaches You?
Establish: the distance between the gross mechanism and your net result.
Only now does the rate become meaningful. Between gross and net sit negative intervals, execution costs, collateral drag and fees, in that order — the chain set out in why an annualised funding rate is not a return and management fee versus performance fee.
Ask:
- Is the quoted figure gross or net, and net of precisely what?
- Is it APR or APY, and over what period?
- Does the period include drawdowns and negative intervals?
- Hurdle type, high-water mark, crystallisation frequency?
- What are the redemption terms, and have they ever been suspended?
Stop if: the methodology behind a quoted figure cannot be produced.
The SEC's own investor bulletin on performance claims makes the general version of this point: understand how a performance figure is calculated and presented before relying on it, and if fees were excluded, ask what they were and how they would have affected the result.
The Red Flags
| Stage | Red flag | Why it matters |
|---|---|---|
| 1. Mechanism | The source of yield cannot be explained simply | Complexity is sometimes necessary; unexplainability never is |
| 2. Custody | Marketing says "your assets are safe" without describing the legal arrangement | Safety is a conclusion, not a structure |
| 3. Venues | Venue exposure undisclosed or concentrated without explanation | The exposure that cannot be hedged away |
| 4. Failure modes | No stress period can be discussed | Every strategy of any age has been through one |
| 5. Net return | Methodology unavailable for a quoted figure | A number without a method is marketing |
| Any stage | Questions treated as obstacles rather than reasonable | The most reliable signal in the entire process |
What Good Disclosure Looks Like
Good disclosure is not the absence of risk. It is the presence of specifics — and it generally shares three characteristics.
It states what the strategy does not do. A provider that explains when its approach underperforms is describing a real strategy. One that implies all conditions are favourable is describing a marketing position.
It survives follow-up questions. The second and third questions in a sequence are more informative than the first, because the first has usually been anticipated.
It distinguishes between what is known and what is estimated. Verification has limits — attestations are point-in-time, liability coverage is partial, historical periods are not predictive. A provider that names those limits is more trustworthy than one presenting the same evidence as conclusive.
That standard applies to this site as much as to any other. The framework above is the one we would expect to be held to, and our own strategy, terms and structure are set out on the strategy page, the fund plans page and our FAQ.
Frequently Asked Questions
Where should due diligence on a crypto yield product start?
With the mechanism producing the return, not the rate. Until you know what generates the yield and who pays it, the rate is uninterpretable and every later question lacks context.
What is the most commonly skipped question?
What you legally own if the operator fails. It is rarely addressed in marketing, it is usually answered in the terms, and it determined outcomes in every significant crypto platform failure to date.
How do you assess a strategy you cannot verify directly?
By examining what is disclosed and how it is framed, rather than attempting to audit results you cannot see. Whether the provider explains failure modes, publishes methodology, names the limits of its own evidence, and answers follow-up questions is observable — and is a reasonable proxy.
What should a provider be able to answer immediately?
Where the yield comes from, who holds the assets and under what arrangement, which venues are used, what happens when the spread inverts, and whether quoted figures are gross or net. These are not unusual requests, and hesitation on any of them is itself information.
Diligence Is a Sequence, Not a Checklist
The value of this process is that it lets you stop early. A product that fails at Stage 1 does not need evaluating at Stage 5, and most of the effort usually spent comparing rates is better spent establishing what the rates represent.
The questions are not adversarial. They are what any provider operating transparently should expect, and the response to being asked them is frequently more informative than the answers themselves.
This article is published for informational purposes and does not constitute investment, legal or tax advice, or an offer to transact. It describes an evaluation framework generally and does not assess any specific product or provider. Capital is at risk.
This article is for information only and is not investment advice. Past performance does not guarantee future results.
