One of the toughest things I have to do as a cryptocurrency investment trainer, is to prepare my students for price volatility. If you have been monitoring the price of Bitcoin (BTC), here’s what you would have observed.
BTC gained 39.7% between March 2019 and March 2020. However, it is accompanied by months, where we would see a drop of more than 10%. More often than not, the average investor would be so nervous that he’d sell off all his bitcoin and miss the rise in prices.
Of course, such a mentality is not unique to Cryptocurrency investors. Equity investors who are ill-equipped, often do the same – selling when markets bottom and buying in again when prices are soaring.
There is a lesser-known method of getting returns in this space, without having to expose your capital to the price volatility of Bitcoin. Before I reveal the 3 approaches, I would like to remind all readers that anything in the Blockchain and Cryptocurrency space, is still very very new. As such, while there is an opportunity, we have to be aware of the risks involved too. Do not invest money you cannot afford to lose. To limit my exposure, I personally invest around 15% of my portfolio into Bitcoin and other altcoins.
Stable Coins
In the past year, the notion of stable coins has been gaining traction in the cryptocurrency community.
It is simply a cryptocurrency that is pegged to the value of one US dollar. Some of the more common ones are USDT (Tether), USDc, and Dai. Tether and USDc are affiliated to major cryptocurrency exchanges while Dai is a decentralized cryptocurrency stabilized against the value of the US dollar.
USDc and USDt belong to the category of fiat collateralized stablecoins. Each USDc or USDt is backed by one USD held in a bank account. The tokens are mainly powered by Ethereum and are designed to offer transparency, steady valuations and price stability. It also allows dollars to move globally between cryptocurrency wallets, businesses and exchanges with minimal transaction charges.
Dai belongs to the category of Crypto-collateralized stablecoins which doesn’t rely on legacy finance infrastructure and utilize crypto assets as collateral. They are more decentralized and transparent by design, but also more complex.
The general idea of all stablecoins is to create a cryptocurrency “asset” that isn’t prone to price volatility. While more can be discussed and dissected in this area, we shall leave that for a later date and separate article.
Now that we have a cryptocurrency that doesn’t fluctuate much in price, let’s dive into how we can utilize them to grow our wealth.
Investors do need to take note of risks such as lending platform safety, and higher potential of defaults compared to high-grade bonds or bank deposits. That said, there are several advantages to crypto lending such as quick approval times, reduced bureaucracy, higher interest rates, shorter lock-in periods and diversification.
#1 Earn interest by lending on an Exchange
Cryptocurrency exchanges provide traders with the option of using margin trading. As holders of stable coins, we can provide these traders with loans to do their trades. Depending on the demand at various points in time, interest rates for stable coins can go as high as 12% per annum.
All transactions and processes are carried out on the platform, which means borrowers will not be able to withdraw the lender’s funds. Each exchange has auto-liquidation features that protect the lenders from losing their capital, although we should be aware that in extreme liquidation events, there is always a possibility that the auto-liquidation mechanism might not be enough. Exchanges try to mitigate that risk by having insurance funds prepared.
Here is a screenshot of lending on an exchange. The rate is a daily rate, which annualised to around 6%.
We compiled some of the best yields on crypto savings accounts here.
#2 Deposit at Cryptocurrency Credit Companies
There are currently companies that provide loans to their users and allow depositors to participate in the process. There are some similarities to bank deposits, whereby the bank earns interest by lending out funds from depositors and sharing part of the interest.
Cryptocurrency credit companies allow their users to increase spending power by enabling them to monetize their Bitcoin and other cryptocurrency assets, without the need to sell them. Using bitcoin as an example, users deposit their bitcoin, set it as collateral and secure a loan (e.g. in the form of USD or stable coin). The funds can be used via a credit card, or simply withdrawn. When the loan is due, the users would pay back the principal with interest, and take back their Bitcoin.
Alternatively, users can also deposit their cryptocurrency assets and start accruing interest. There is usually a flexible option, or a lock-in period that allows you to have higher interest. Bear in mind that all interest are paid out in the form of the asset that is deposited, for e.g. if you deposit bitcoin, your interest would be paid in the form of bitcoin.
To mitigate the price fluctuations, you can choose to deposit stable coins such as USDt.
#3 Lending Directly Via Decentralized Finance (DEFI)
Both methods 1 and 2 rely on a centralized platform to provide the loans. As the blockchain space develops, there are more and more protocols that are developed in the form of Decentralized Finance. These are pieces of open-source technologies aiming to improve various aspects of the current financial system, via a decentralized layer. This would essentially disintermediate costly middlemen.
Imagine someone going to a website to seek a loan for their homes, and your deposits would naturally act to supply such a loan to these borrows, with you earning the full interest. Of course, this is an oversimplification of the entire mechanise but that is the general idea of what these decentralise finance projects hope to achieve.
The segment has developed well and we have our first wave of Defi protocols, which allow you to provide your stable coins to a liquidity pool that would track real-time interest. You simply assign the amount of capital that you wish to supply, and start earning interest.
These protocols link directly to your cryptocurrency wallet and you do not have to give up your private keys nor send your crypto assets to a centralised platform wallet. Below is the screenshot of one such DEFI protocol.
On average, stable coin returns are currently ranging from 8 – 12% using the methods above. It allows investors to gain significant rewards in a yield-starved macro environment. The world of blockchain and cryptocurrencies remain largely undiscovered. There are other methods that would earn you significant returns, if you utilize the right strategies.
Like this? Read the 5 ways to generate passive income with cryptocurrencies here.