Hoping that cryptocurrency – be it bitcoin, ethereum, or any other – appreciates in value is the main way to make money in the world of digital coin investing.
But some claim that it is also possible to earn money off cryptocurrency or make returns in other ways from holding it.
How would a cryptocurrency investor do that, is it too risky and how much faith do you need to put in unregulated and previously unheard of entities offering the opportunity? We take a look.
Is your crypto asset just sitting in a wallet and doing nothing? It could be earning interest or returns elsewhere, but as with anything crypto this is high risk
With the crypto boom back on in recent months, gains have been rapid and prices volatile once again.
Since autumn, bitcoin has broken the $20,000 (£14,589), $30,000 (£21,884), $40,000 (£29,179), $50,000 (£36,474) and $60,000 (£43,769) marks.
In January, JP Morgan claimed bitcoin could rally as high as $100,000 by the end of this year but as any long-term crypto-watcher knows, the price could just as equally sink.
Nonetheless, cryptocurrency is a long-term game for its keenest investors and that means many have coins just sitting in wallets with the intention that they remain there for perhaps years.
But can you reap a return from it in the way you can interest on cash or dividends from shares, or is it just an asset like gold that acts as a store of value and gains only come from a rising price?
Alex Wearn, CEO of decentralized exchange Idex, says: ‘There are a lot of ways to earn interest in cryptocurrency including “bitcoin rewards” credit cards, crypto lending services, and DeFi (decentralized finance) yield farming.
‘Some of these require little to no crypto knowledge (bitcoin credit card rewards), while others require deep technical knowledge (yield farming).
‘In general, the more knowledge required or the riskier the investment asset, the higher the potential yield.’
1. Interest accounts
A number of centralized and decentralized finance (DeFi) platforms are offering some form of interest if you store digital currencies (like bitcoin) and stablecoins (like dai) with them.
A stablecoin is also a digital currency but, unlike cryptocurrencies like bitcoin, its price is pinned to an asset or currency. That currency is usually the US dollar.
DeFi platforms give people the ability to lend or borrow from others, trade cryptocurrencies, earn interest in accounts that mimic traditional savings, and more. They’re not controlled by a bank or regulated.
What is the difference between a centralized and decentralized finance platform?
When a financial platform is described as ‘decentralized’ it means there’s no ownership or control over it.
Clem Chambers, CEO of private investor website ADVFN and Online Blockchain, explains: ‘The internet in the old days was ‘decentralized’ there was no office to raid or shut down there’s nobody controlling it. It’s all running autonomously.
‘If something is decentralized it gets out of politics. It can’t be bribed or bullied. It’s just there. But if something is managed by people or has a central point then it’s centralized.’
Daniel Polotsky, CEO of bitcoin ATM provider CoinFlip, adds: ‘In the case of crypto-savings accounts – your accounts are being hosted by a third-party, like BlockFi, which is a centralized-service despite supporting decentralized cryptocurrencies.’
As with a traditional interest-bearing account from a bank, you can withdraw your crypto assets when you want – albeit potentially with restrictions – along with any interest that you have gained.
On earning crypto returns, Daniel Polotsky, CEO of bitcoin ATM provider CoinFlip, said: ‘The most common [way], for the majority of consumers, is through centralized services such as BlockFi and Celcius, which have “interest accounts” that offer up to almost nine percent interest on stablecoins and about five percent to six percent on major cryptocurrencies.’
He adds: ‘This is as easy as creating an account with these companies and depositing bitcoin or transferring money with a bank account.’
The problem with traditional savings accounts is that they offer interest rates that are heavily correlated with monetary policy – and with interest rates being slashed to stimulate economies, savers have paid the price.
DeFi accounts can offer greater returns because they do not inhabit a world of currencies affected by central bank interest rates.
But in this unregulated world, there’s no consumer protection to fall back on if you invest your digital coins in them and they go bust or you lose your cryptocurrency.
Whereas with traditional savings account in the UK you benefit from the Financial Services Compensation Scheme deposit protection up to £85,000 with each individually licensed bank or building society.
To compensate for the lack of protection some DeFi accounts have aligned their offerings to existing regulations issued by banks and governments to appeal to users. Some go so far as to offer private insurance that investors can buy. But not all offer this.
2. Cashback on a crypto credit card
While the cryptocurrency industry is doing much to distance itself from the traditional banking model, it seems it can’t help but mirror it in some ways.
This is why it’s hardly surprising that some in the sector are starting to offer crypto credit cards.
At the time of writing, there appear to be no such providers offering a crypto credit card in the United Kingdom.
However, there are new providers set to launch in the US this year: the BlockFi Bitcoin Rewards Credit Card and the Gemini Credit Card.
And where any other fintech industry leads, the UK often swiftly follows.
BlockFi says on its website: ‘For every transaction that you make on the card, 1.5 percent cashback will accrue and then automatically be converted to bitcoin and placed into your BlockFi account on a regular monthly cycle.’
Gemini, meanwhile, promises to give up to three percent back in bitcoin or another crypto.
David Moss, CEO of Strongblock, says: ‘Most of these cards are just a different take on the “percentage back” promotions of traditional cards, except you get the percentage back in bitcoin. With bitcoin volatility and transaction fees, there is some risk.’
The risk here, of course, would be that you’d need to spend on the card to get the rewards. If you default, you could lose out as with a regular credit card.
3. Decentralised lending and renting
Decentralized lending is the ability to lend money (digital or otherwise) without the need for an official institution, such as a bank or credit provider, to get involved in the process.
It could all be automated through a smart contract. There are various smart contracts on offer online. They are managed through a computer program or transaction protocol, which automatically executes the transaction on behalf of the parties that agree to the deal.
It’s also possible to lend and rent out cryptocurrency through various online centralized platforms, including a London-based one, Nebeus.`
Michael Stroev, chief operating officer and head of product at Nebeus, says: ‘We give our crypto to low-risk and highly secure institutional partners to obtain liquidity. We use another part for re-investment in various portfolios. We need to be profitable on the six percent that we payout.’
Besides not always knowing what exactly happens to the crypto when you rent it out there are other conditions to consider, such as the lock-up period. In Nebeus’ case, there are two programs on offer.
The Juniper program offers 3.5 percent return per annum with a minimum lock-up period of one month, while its Sequoia program makes customers lock their money in for three months.
Stroev says: ‘This is based on the fixed value of the crypto on the day the person deposited the crypto. So if you deposited your bitcoin now the rate would be fixed at €48,309.57 (£41,660.67) ($57,091.70). We pay out the percentage in euros and not out in bitcoin. We’re trying to merge bitcoin and cash.’
4. Yield farming
Yield farming, also known as liquidity mining, effectively involves an investor moving their cryptocurrencies to different ‘pools’ on various DeFi platforms, such as Aave or Compound.
In return for pooling your cryptocurrency, you can earn tokens, interest, or rewards.
It can get very complex.
Platform Strongblock says: ‘The advantage of yield farming is that it offers higher returns. The disadvantage is that it’s harder to use and less predictable.’
Again you’re not protected by regulators if you use these types of platforms. But your money could be protected by smart contracts.
As smart contracts are automated, they will pay out as per the contract’s terms and conditions. There’s no person or company involved that could hold the money back.
Staking involves locking your cryptocurrencies in a smart contract to receive rewards. It can be offered by crypto wallets, blockchain networks, and exchanges.
Staking could be described as like putting your cash away into a savings account and earning interest, but that bit of the analogy is where the similarity ends.
Banks ‘reward’ their customers with interest – albeit a measly amount at the moment – for keeping cash with them, while platforms with which you stake your cryptocurrency reward you for participating in the network ecosystem where your stake helps to build new blocks in the blockchain.
Curtis Ting, managing director of Europe at cryptocurrency exchange Kraken, adds: ‘Staking is a means of verifying transactions on a blockchain.
‘Token holders deposit, or “stake,” cryptocurrency to confirm transactions. This makes it an innovative alternative to mining, which needs mass computing power.’
Clem Chambers, CEO of private investor website ADVFN and Online Blockchain says there are several versions of staking to consider.
He says: ‘You may, for example, stake your coins with a company like BlockFi, who will pay six percent annual percentage yield (APY) on ethereum.
‘Or you could hold certain tokens on an exchange and automatically receive interest.’
Fees do apply and you may also need to have a certain amount of cryptocurrency in order to engage in staking.
Staking rules, fees, and minimum amounts can vary, so it’s important to read the terms and conditions carefully and compare various platforms before settling on the right one for you.
Are you prepared to gamble your digital coins on staking and yield farming to gain some interest in your investment?
Should you trust platforms offering returns on your cryptocurrency?
If the platform isn’t based in the UK, there’s a chance that they could be unregulated, which means your money isn’t protected by the Financial Conduct Authority (FCA) if things go wrong.
UK operators do have to be licensed but that can mean just having an e-money license (electronic money).
With an e-money license, funds are not protected under the Financial Services Compensation Scheme, which compensates for lost bank and building society savings in the event of failure up to £85,000 and covers investment issues, such as platform collapse, maladministration, and poor financial advice.
Don’t dive in and imagine it’s Eldorado. The opportunity is to skill up and then make money from it
Clem Chambers, CEO of private investor website ADVFN and Online Blockchain
Online platforms and exchanges aren’t classified as a bank or building society, so this protection does not apply to them. Nor will many places you can buy or hold crypto benefit from FSCS investment cover.
Companies with e-money licenses still have to put measures in place to protect people’s money.
For example, German payment processor Wirecard was subject to safeguarding rules within the Electronic Money Regulations 2011 and the Payment Services Regulations 2017.
Customers’ money is typically safeguarded by holding the money separately in accounts with banks or other credit institutions, which means that it should be returned to customers if the company goes bust.
Stroev says: ‘We’re currently applying for an electronic-money license, which is issued by the FCA. We also comply with UK and EU regulations, which means that when people sign up to our platform we do all the usual checks such as identity and KYC compliant checks.’
Such platforms may even voluntarily go further to protect users’ funds. In January, Nebeus launched insured vaults – a vault for cryptocurrency with a $100million (£72million) insurance policy issued through Lloyds of London. Any such insurance should be interrogated fully by customers.
Stroev advises: ‘It’s important to look at the history of the company and the relationships they have. We work with some of the biggest financial institutions and offer insurances and custody services. It’s important for customers to do their research.’
The risk of investing in platforms that offer interest or returns on your cryptocurrency is high. Traps include that you may not understand how the platform works or investing in high-risk strategies because you’re chasing bigger returns.
It is best to consider all crypto transactions as ‘risky… there’s a whole menu of risks from losing your crypto wallet access to hackers to regulators unexpectedly shutting an operation down
Chambers says: ‘It is best to consider all crypto transactions as ‘risky’. For a start, there is no government deposit insurance.
‘The smaller the enterprise offering savings interest, the higher the risk is likely to be. There’s a whole menu of risks from losing your crypto wallet access to hackers to regulators unexpectedly shutting an operation down.’
Chambers adds that the biggest risk is counterparty risk (the probability of a platform or exchange not holding up their part of the deal and returning your money and the interest).
‘Don’t dive in and imagine it’s Eldorado. The opportunity is to skill up, improve your knowledge and then make money from it.
‘There are fabulous returns to be made – you could earn 13 percent yield – but this is frontier tech and you could lose a lot if you just go in without looking.’
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Check out the heatmap finscreener.org/map/map to learn more about the latest top gainers.