How to Earn Interest and Increase Performance with Bitcoin and Crypto
In this guide, we examine the concept of crypto yield and yield farming to show how an investor can reliably earn bitcoins, altcoins, and fiat from their existing assets, without trading, and with a better return on investment than many investments. inherited.
Yield refers to the earnings generated and realized on a security over a period of time. It is expressed as a percentage based on the amount invested and includes accrued interest or dividends received for holding a particular security. In the legacy financial world, returns are typically generated from stocks in the form of dividends or bonds in the form of interest.
While most cryptocurrency investors seek to profit from fluctuations in cryptocurrency prices, there are also a number of ways that an investor can obtain a stable and more modest return. In this guide, we will examine three popular ways to outperform crypto assets and detail the risks associated with this type of investment.
Crypto Loans and Lending
Crypto Margin Lending
Crypto Loans and Lending
Another type of loan that is common in the cryptocurrency space is lending to individuals through a cryptocurrency lending platform. The process is very similar to that of traditional banking. As with a bank, cryptocurrency holders seeking better returns deposit their assets on a platform and the platform then lends those funds, usually in the form of fiat currency, to borrowers.
Typically, people who get a loan post at least 150% of the loan’s value in crypto as collateral. This allows borrowers to obtain a line of credit on their cryptocurrency without having to liquidate their holdings. In exchange for lending fiat money to the borrower, the platform charges an annual percentage fee. Once the borrower has paid off the loan with interest, they receive their cryptocurrency back. The platform that facilitates the loan takes a part of the interest paid by the borrower and pays interest to investors who have deposited their crypto on the platform.
Companies offering variations of this type of service include NEXO, Hodlnaut, and Celsius Network. The type of asset you are lending will influence your return, which will typically be 5-10%. For example, at press time, Hodlnaut pays an annual return of 6.2% for Bitcoin, 6.7% for ETH, and 10.5% for stablecoins. At the same time, NEXO pays 6% for Bitcoin and ETH and 10% for stablecoins.
In terms of what kind of platform they are, Nexo, Hodlnaut and Celcius are all “CeFi”. This means that their interest rates are centrally managed and have remained fairly stable over time. The other types of platform in this space are “DeFi”. With DeFi, the performance for depositors is continuously updated using smart contract protocols in line with real-time market demand for different crypto assets.
DeFi has been one of the hottest topics in cryptocurrencies over the past year, but from the perspective of someone looking for predictable performance, the rates of return on DeFi platforms change from minute to minute and are highly volatile. DeFi’s popular lending platforms and loans include Compound, AAVE, and C.R.E.A.M. At the time of writing, AAVE pays 1.7% for USDC stablecoin and 1.12% for USDT, while Compound pays 1.81% for USDC and 2.08% for USDT. Interestingly, none of the DeFi platform surveys conducted by Brave New Coin were providing a stablecoin performance that came close to that offered by CeFi platforms.
Risks of DeFi Loans & Lending
As in the traditional financial sector, the risk to lenders on DeFi lending platforms is reduced when borrowers have to provide collateral, typically at a minimum of 150% of the loan value. Loans are generally secured by cryptocurrencies, and in most cases the borrower receives USD or some other fiat currency.
Over-collateralizing the loan guarantees that 1) if a borrower defaults on the loan, the lender can liquidate the collateral and recoup their investment, and 2) that if the value of the cryptocurrency begins to fall, the collateral can be liquidated to guarantee its value. it does not fall below the value of the loan. These mechanisms provide more certainty to lenders that their principal will be returned to them.
However, oversecured cryptocurrency loans has a downside. Because the percentage by which the loan is oversecured depends on the value of the cryptocurrency, loans of this nature are not good for borrowers in a bear market because the value of their collateral may fall. This means that the borrower has to add more collateral to the loan or that its collateral is liquidated when the loan-to-value (LTV) falls below a set level.
Another risk to consider is the technical risk related to the smart contract that governs the loan process. There have been instances where a hacker has been able to take collateral off a smart contract, such as the $ 25 million that was stolen from dForce in April 2020. Although DeFi is often referred to as ‘trustless finance’ , the counterparty risk associated with lending through legacy financial institutions has now been changed to smart contracts and technical risk.
Crypto Margin Lending
Another way to improve the performance of Bitcoin and other crypto coins has emerged as a result of cryptocurrency exchanges offering leveraged trading to their clients.
When a trader uses leverage, he essentially uses his assets, crypto or fiat, to obtain a loan that allows him to take advantage of the trade with more money than he has. Crypto exchanges offering leveraged trading include FTX, BitMEX, DERIBIT, Binance, and BTSE, with leverage ranging from 5x to 100x. Of course, all normal trading risks are associated with leveraged trading.
For investors looking for a more reliable return with less downside risk, lending to these leveraged traders is an option offered by multiple exchanges. Due to the amount of capital required to offer margin loan services, these loans can be offered by individuals through the exchange, rather than through the exchange. Exchanges that offer this type of crypto margin loan service include Poloniex, Bitfinex, and dYdX.
In simple terms, it works like this. If a trader has $ 1,000 and wants to trade with 5x leverage, he uses his $ 1,000 as collateral for a $ 4,000 loan through his exchange that has an interest rate attached. This interest is normally charged on a daily basis, although it varies by exchange, and the rate at which the principal is loaned varies by supply and demand.
On average over a year, these loans will generally yield a return between 7% and 15%. Because margin loans usually occur over the course of one day, the investor earns daily compounded interest. At a rate of 0.03% per day (the standard rate in BitMEX, for example), the annualized rate is 10.95%, but due to daily compounding, the annual rate realized would actually be 11.57%, which would give the investor an additional half percent.
Risks of Crypto Margin Lending
In the context of margin trading, defaulting on a loan looks quite different than simply missing repayments. Margin traders borrow capital to trade, which in turn magnifies both their losses and profits. However, this borrowed capital cannot be withdrawn from the exchange and must be used for trading.
To reduce risk for lenders, exchanges implement a variety of mitigation strategies because margin lenders will generally not have the legal or logistical means to recover a debt if the borrower defaults on it. The dominant strategy is to force liquidation of a trader’s position if it falls too close to margin. For example, let’s say a margin trader has a $ 1,000 guarantee and opens a $ 5,000 long position (5x leverage) in Bitcoin at $ 10,000 USD, that is, he has bought 0.5 BTC. If the price of Bitcoin fell to $ 8,000 USD, the margin trader would have no capital left and any further loss would be the burden of the lender.
To avoid this scenario, exchanges implement a minimum percentage of capital that a margin position must maintain, and if it falls below this level, the position is liquidated. This is usually higher than the “bankruptcy price,” that is, the level at which the trader no longer has capital, say $ 8,250.
This mechanism ensures that a trader never loses more than the collateral he has placed for the position and this reduces the chances that the lender will lose part of his investment. While there are unique scenarios in which a lender can still take a loss on its borrowed capital, this scenario is extremely rare, and in most cases the exchange covers the loss. However, this is not to say that providing margin loans is risk-free, as this Bitfinex article explains.
Investors interested in earning a return in the crypto environment can also stake certain cryptocurrencies to generate a return. Simply put, gambling is the act of locking a cryptocurrency to earn a reward, which is generally paid in the same cryptocurrency. Gambling involves holding funds in a cryptocurrency wallet to support the security and operations of a blockchain network. Typically, the percentage an investor earns is denominated in the cryptocurrency being wagered, which means that returns in fiat terms can be quite variable.
Gambling is like stocks and dividends in the sense that the underlying asset is subject to price movements and the asset periodically pays a return. Popular currencies to bet on include Tezos, Decred, and Synthetix.
Risks of Crypto Staking
When considering the risks involved in betting, the same logic that applies to stocks and dividends can be used. Because the entity that bets the cryptocurrency does not lend it to anyone, there is no risk that a counterparty will default on a loan. Instead, the main source of investment risk comes from the price volatility of the asset being wagered and the technical risk associated with holding and wagering on a cryptocurrency. Simply put, while you will get Decred by betting, if the Decred price goes down, it will potentially be worse, so investors should consider the opportunity cost of the crypto bet.
In short, the cryptocurrency loan market presents many opportunities for investors to earn a return that is often much higher than they would borrow elsewhere. Additionally, cryptocurrency lending services have built-in protections that in all but a few scenarios prevent a lender from losing their capital. There is a strong case in favor of lending in the world of cryptocurrencies when considering the returns that can be obtained compared to the risk that an investor takes.
Disclaimer: The information provided in this article is solely the opinion of the author and not investment advice; It is provided for educational purposes only. By using this, you agree that the information does not constitute any investment or financial instruction. Please do your own research and contact financial advisors before making any investment decisions.