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Earning interest on Crypto has never been easier and the apparent yield you can rake in never higher. According to valuepenguin, the average interest rate that a savings account yields is about 0.06%. At some of the more popular Decentralized Finance (DeFi) institutions, you can earn over 8% on your cryptocurrency holdings.
But how does it work? Is earning interest on your cryptocurrency dangerous? Is it even legal? In this article, I’ll cover all these questions and more.
Crypto can be difficult to understand. Earning interest on your crypto can be even more confusing. Make sure you are armed with the facts before you put your hard earned crypto at risk.
One thing to consider prior to attempting to earn interest on your crypto is the truly obscene volatility that various coins experience. What this means is that the average value of a crypto coin can vary drastically from day to day when compared to the U.S. Dollar.
What does this mean? It means that holding your cryptocurrency is not for those who may need to spend it any time soon. Your investment horizon needs to be long. In fact, you should consider your crypto holdings a speculative asset… not an investment.
That said, if you are looking to hold on to your cryptocurrency holdings for the long haul it makes perfect sense to earn interest on the underlying asset on top of any capital appreciation.
Why Does Crypto Earn So Much?
One thing that smart investors know is that they should never invest in anything they don’t understand. Understanding why crypto can earn so much more than cash in a savings account is a must before diving in.
The prime way to think about how much interest you are earning is by considering a higher rate implies you are assuming more risk. The higher the interest you are receiving the more risk you are taking on.
So, what’s the risk? The risk is you may lose part or all your cryptocurrency holdings. The interest you are earning reflects the additional risk you are taking by lending it to various borrowers.
Cash in a typical savings account is safe. Usually, it’s insured by the FDIC.
If the bank goes bankrupt, you are guaranteed to get a large chunk of it back from the government. The bank does use your deposits to lend money to other institutions… but again, its largely insured by the government… thus the risk is basically nothing and the interest returned reflects that.
Interest is earned on your cryptocurrency the same way.
The institution that you choose to open an account with will find borrowers for your cryptocurrency. If the institution where your account exists has financial problems or the borrower defaults on the loan you may be the one left holding the bag. Thus, you are compensated highly for the risk you have taken on… and the risk you have taken on is high.
One thing to consider is what type of person or institution borrows cryptocurrency? The answer to this question is not always clear but in general it does appear to be people speculating in crypto markets.
I won’t go into detail in this article but suffice it to say that what people do with borrowed cryptocurrencies can be quite risky. These folks will be the people that you are lending too.
The interest you will earn on your crypto savings account will vary. It is known as a floating interest rate and will vary depending on the supply and demand of the specific crypto you have. Thus, the amount you are being compensated for the risk you are taking on changes.
You must keep tabs on if the rate you are receiving is an amount commiserate with the risk you are willing to take.
Where Can I Earn Interest?
There are two main places to earn interest on your crypto. You can open an account on a DeFi Platform or you can also use a DeFi Application on a blockchain such as Ethereum. The first option, using a platform, is much easier and will be the focus of this article.
DeFi Platforms include BlockFi, Linus, Gemini and Coinbase and you can generally just open an account, select the type of currency you would like to save and nearly immediately start earning interest. Usually, you can earn interest daily and be paid monthly.
Taxes and Regulation
The IRS and the SEC in the United States have not kept pace with the innovation found in various corners of the crypto world. Rule changes, new regulations in general, and legal action could happen suddenly.
This means that although your tax situation may be one scenario today, it could be something completely different tomorrow… and more than likely it will be more expensive. You must be flexible and cognizant of what is going on in your jurisdiction. The consequences of not paying taxes on time or breaking a trading regulation could be very costly.
Cyber Security Concerns
If you have owned crypto in the past you may be well aware that account security can be quite an issue. The engineering marvel that makes cryptocurrency so powerful, the ability to take crypto offline just like physical cash, means that it can be taken… and taken permanently away from your account.
If the firm you have decided to open an account with gets hacked and your cryptocurrency is lost, there may not actually be any way for that firm to compensate you. It just may not be possible. The chances of recovery are basically 0.
Ensure that whatever platform you choose makes security a priority.
Are their servers physically secure? Do they require Multi-Factor Authentication (like a password AND a code sent to your cell phone)? Have they been hacked in the past?
Asking the question now and choosing a reputable platform with solid credentials could literally mean the difference between having and not having all your crypto. It has happened… it will happen again.
Minimum Holding Times
If you don’t necessarily consider yourself a long-term holder of whatever currency you have selected, then lending it out could be an issue. Some platforms have minimum holding times.
If you think that you may need the currency for other purposes in a short time frame, then check to make sure the holding times work for you.
Additionally, if you think you may want to sell your assets to take advantage of price appreciation then holding it in an interest-bearing account may work against that. The time it takes to transfer your currency out so you can sell it or convert it may result in the asset lowering in value by the time you can undertake the transaction.
Is Earning Interest a Good Idea?
If you don’t currently have any cryptocurrency and you are just looking to earn interest on your dollar-based savings account, then opening an account with a DeFi platform and risking your money is probably not a good idea.
However, if you currently have crypto assets and plan to hold onto them for a long time then earning interest in this way may be for you. There is still added risk, however, but not substantially more than just holding crypto anyway. There could be significant upside to holding the underlying asset while also earning an additional return.
If you are holding your crypto in a taxable account, and you are not sure about holding it long term then tying it up in a savings account is probably a step too far. Lending it out may put you in a position of having to sell later than you were anticipating possibly resulting in a lowering of asset value.
The fact that you can earn interest on crypto is wild to me. A few years ago, this type of thing would have likely just been considered a fantasy. That said, a few years from now the SEC and IRS might make it a short lived reality.
Although I don’t have any crypto currently earning interest anywhere myself (at the time of publishing), I am excited about what the future of what DeFi may bring. The ability to earn interest during these interesting times really is democratizing finance in ways that can be very powerful for investors of all sizes.
I hope you enjoyed this article. If there are any facts missed or new DeFi features that might be interesting to read about, please let me know down in the comments.
Warning and Financial Disclosure
Cryptocurrency is highly volatile.
It is a very risky asset class when compared to other currencies or investments (depending on your point of view). Furthermore, taking your crypto and then lending it out to make a substantial amount of money in interest is even more risky.
The chance of losing everything is high compared to almost every other type of investment out there.
I say all this to warn you to not take any of the information in this article lightly. It was written as an expression of my opinion, and you should consider talking to an Advisor or Accountant who can give you professional advice.
Do your research and don’t base any decisions about your money based on what I have written here.