- Fundamentals of earning crypto interest
- Jargon you need to know to help you earn interest on cryptocurrency
- How to earn interest on cryptocurrency
- Crypto lending versus staking
- The difference between risk and return
- Staking on exchanges vs. staking on blockchain
- Blockchain staking
- Bets on CEX exchanges
- The best cryptocurrency coins for earning interest
- How to earn higher interest on cryptocurrency
- Invest in stablecoins
- Stick to one platform
- Simple Interest vs. Compound Interest
- Are you eligible to earn crypto interest?
- Questions and answers: Cryptocurrency earnings on interest
Fundamentals of earning crypto interest
Cryptocurrency markets are known for their inherent volatility. While this creates non-trivial risks, it also opens up unique opportunities for yield and profit that the traditional stock market investor might not even dream of.
With the development of the decentralized finance (DeFi) industry, these opportunities for generating significant profits have become wider and more accessible. The real turning point in the game has come with the rise of crypto-currency centralized exchanges (CEX) and decentralized exchanges (DEX) that are looking to provide customers with a variety of financial products.
In this article, we will tell you how to earn interest on cryptocurrencies and, more importantly, how to choose investment opportunities that will optimize your profitability.
Jargon you need to know to help you earn interest on cryptocurrency
Before moving on to the best opportunities to earn interest on cryptocurrencies, let's look at some of the most important terms used in the cryptofinance industry.
Annual Percentage Yield (APY)
The Annualized Percentage Yield (APY) is the annual percentage that is earned on your investment after compounding effects are taken into account.
Market capitalization is a measure of the market value of a cryptocurrency, which is determined by multiplying its current market price by its circulating supply.
Total Cost Locked (TVL)
Total Value Locked (TVL) is the total market value of all cryptocurrencies locked in DeFi platform smart contracts.
A bear market is a significant and usually prolonged decline in the market. Bear markets are characterized by the fact that market participants are dominated by selling rather than buying.
Blockchain is a decentralized digital network that stores transactions in blockchains. Transactional activity in the blockchain is controlled collectively by all participants/users of the network. Most of the operations in the blockchain network - the exchange of funds between users, the confirmation of transactions and business transactions - are associated with the use of cryptocoins.
Proof of Stake
Proof of Stake (PoS) is a consensus mechanism used in some blockchain networks to validate block transactions. In the PoS blockchain, network users lock a certain amount of their crypto assets on the platform for the right to confirm transactions and receive stake rewards.
In a broad sense, crypto staking is the blocking of crypto funds, both on centralized and decentralized platforms, in order to generate income.
Liquidity mining is the process where you deposit your crypto assets into a DEX liquidity pool in order to be rewarded in the form of tokens and fees.
A non-permanent loss occurs when the price of a deposited asset in the liquidity pool has declined since you deposited it.
How to earn interest on cryptocurrency
The main methods by which you can earn interest on cryptocurrency are staking and lending. Staking involves fixing your funds on the blockchain to confirm transactions, in exchange for which you receive a cryptocurrency reward from the platform. In addition, some centralized platforms such as CEXs and liquid staking providers such as Lido also offer staking opportunities.
Staking, however, has moved beyond its original meaning and is now often referred to as a variety of CEX and DEX investment products in which the funds are not specifically used to validate the blockchain.
Lending means depositing funds into credit pools (and sometimes other types of pools) using DeFi lending and borrowing protocols, as well as centralized crypto lending platforms.
Crypto lending versus staking
When considering lending and staking cryptocurrencies, the main concern for investors is the associated security and investment risks.
Staking is often viewed as a safer option than lending. After all, staking is a fundamental process in the blockchain network and therefore is well protected by the overall security model of the blockchain. If a bet fails on the blockchain, then the entire blockchain, along with all of its decentralized applications (DApps), will fail. Due to the importance of staking, it is guaranteed to be secure against all but the most serious hacks.
DeFi lending also happens on DApps sitting on top of the main blockchain, creating an additional layer of vulnerability. In addition, DeFi lending comes with some specific security risks such as flash lending attacks and tug of war.
Thus, staking in general poses a comparatively lesser security risk to your funds compared to lending.
The difference between risk and return
However, the difference in risk/reward ratio between staking and lending may not be as clear-cut. In general, well-known lending platforms such as Aave or Compound Finance offer lower interest rates for large and popular cryptocurrencies compared to standard rates. However, some smaller lending platforms may offer extremely high interest rates, usually for very volatile small cap coins.
As with everything in the world of finance, the higher the offered rate, the greater the risk of the investment. The risks associated with investing in the very new, dark horse cryptocurrencies available on some lending platforms can be extremely high. In addition, when using DeFi lending protocols, you will also face the possibility of intermittent losses due to the volatility of crypto assets. However, protocols usually help mitigate losses by sharing a portion of trading fees with liquidity providers.
Collateral is another important factor when comparing staking and lending. On lending and borrowing platforms, borrowers must first pledge funds to the protocol as collateral for borrowed amounts. Stakes, on the other hand, do not require any collateral.
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Staking on exchanges vs. staking on blockchain
If you decide to stake your crypto funds, your two main options will be CEX exchanges and/or participation in the blockchain platform, which can be done directly by running a validator node or by joining a staking pool.
Running a blockchain validator node allows you to earn stake rewards directly. However, technical settings and minimum investment requirements are often significant. For example, to run a validator node on Ethereum, you need to download the entire blockchain, be online all the time to avoid slash penalties, and run all the necessary software.
The financial requirements for validator nodes are also far from trivial. For example, Ethereum validators must stake at least 32 ETH (about $43 as of September 000, 25).
As an alternative to direct staking, you can join a staking pool, which is managed by a staking provider, allowing you to participate with significantly less technical and financial obligations. However, unlike direct blockchain staking, participating in a staking pool makes you dependent on the operator of that pool.
Bets on CEX exchanges
Instead of staking on the blockchain, individually or through a pool, you can consider staking through CEX. For many crypto investors and users, the CEX path is more accessible, less risky, and less technically complex.
This is mainly due to two key factors - the safety of your funds and customer support. The largest CEXs are the largest cryptocurrency trading platforms in the industry. Their security systems and customer support provide key advantages over blockchains and DApps.
Any potential hacking attacks on the blockchain could result in a possible loss of funds. At the same time, you can use a custodial wallet on a major CEX exchange so that your funds are less at risk of being hacked. Naturally, CEX exchanges are not immune from hacker attacks. However, the large ones provide cybersecurity as a critical part of their business model. Thus, custodial wallets on these CEXs are relatively more secure compared to non-custodial blockchain wallets.
Betting on CEX can also help you access investment products with more stable and predictable rates and conditions. For novice investors, this can also be a less difficult way to enter the world of cryptocurrencies.
In addition, CEX staking allows you to use coins that cannot normally be "stakes" through the blockchain platform. Blockchain betting only works with cryptocurrencies based on PoS networks. For example, the world's largest cryptocurrency, Bitcoin (BTC), is not based on a PoS network, so it cannot be fixed on a blockchain.
The best cryptocurrency coins for earning interest
The volatility of the cryptocurrency market means dynamic change when it comes to the best coins to earn interest. Regardless, the best staking interest rates are usually available through CEX staking. Since CEX offers a wide range of coins and products, you can often find great deals there.
CEXs also offer staking on popular stablecoins – such as USDT, USDC, BUSD, and others – that cannot normally be staked on the blockchain. In addition, some of these coins offer excellent rates.
How to earn higher interest on cryptocurrency
Given the volatility of the crypto industry, the key to getting the best crypto interest rates is to keep an eye on the market and find the best deals as they become available.
Invest in stablecoins
One way to combat the volatility inherent in cryptocurrency markets is to invest in stablecoins. The leading stablecoins — USDT, USDC, and BUSD — are readily available for staking on exchanges, though not directly on the blockchain.
Stick to one platform
Some crypto investors, in pursuit of the best possible rates, move their funds either to centralized or decentralized stabilization funds and loans. However, this strategy can backfire, especially for small amounts of investment, due to fees associated with withdrawals and deposits on some platforms.
Thus, in order to get a higher interest rate in the long run, it is better to choose a reliable platform where you will place and store your cryptocurrencies, instead of moving your assets.
Simple Interest vs. Compound Interest
Another important factor in maximizing returns is the type of interest rate applied to the rate or loan product. Some of them pay interest based on APY, while others use the APR calculation method.
The key difference is that APR is a simple interest rate calculation that does not account for complex accrual. On the other hand, APY is based on interest addition. All other things being equal, an APY-based investment will give you a higher total return than an APR product with exactly the same numeric interest rate.
Do interest rates on cryptocurrencies change over time?
Interest rates on crypto investments change over time. These changes can be dramatic and quite significant. This is especially true for DeFi lending investments on platforms like Compound, where algorithmic interest rates can change within a single day. On the other hand, interest rates on rates are comparatively less volatile.
Are you eligible to earn crypto interest?
Before you make your first investment, check if you qualify as these may vary by platform. The first, obvious requirement is the presence of real cryptocurrency funds on hand.
On most centralized platforms, you also need to meet the Know Your Customer (KYC) and residency requirements. The residency requirement is especially relevant for Americans, as some non-US CEXs do not provide services to US residents.
In addition, you should of course do your own research (DYOR) to understand the risks and technicalities associated with cryptocurrency staking and lending.
Questions and answers: Cryptocurrency earnings on interest
1. What is the best way to earn interest on cryptocurrency?
The best way to earn interest on cryptocurrencies largely depends on your risk appetite. Naturally, opportunities for higher returns come with higher risks.
2. How to calculate cryptocurrency interest?
APR and APY are the two main interest calculation methods. While APR is a simple and straightforward method of calculating interest, the formula for APY is more complex. You can use the online APY calculator to calculate APY.
3. Which cryptocurrency pays the most interest?
Apart from high volatility or new coins, the best interest rates are often offered for established stablecoins such as USDT and USDC.
4. Are crypto stake rewards taxable?
It depends entirely on your country of residence. Speaking specifically to US residents, it can be assumed that the United States Internal Revenue Service (IRS) will charge income tax on your betting income, as well as interest income from cryptocurrencies. By all accounts, the Internal Revenue Service aims to tax anything that has the word “crypto” on it.