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Borrowing and lending cryptocurrencies are gradually becoming an important aspect of the crypto financing business. It could shape how some underlying assets are priced and valued in the market.
Although it is still in the developmental stage, the growing number of crypto lending businesses has resulted in a novel measuring metric – interest rates. This metric could attract new investors and encourage the flow of cryptocurrency capital from the storage to the markets.
From our knowledge of traditional banking, we know that the interest rate reveals the state of the economy. It also forms the determining factor for almost every model of asset valuation. Whether you are calculating the future or present market value or your expected return, the percent on interest would determine the borrowing and lending of assets.
In this article, we will discuss some concepts in crypto investment and how investors can earn interest on crypto without trading.
When businesses or individuals apply to get a loan, they usually agree to pay back the principal with a certain percentage of the amount they borrowed. This percentage is the rate of interest.
Simply put, interest refers to the amount you get for lending money. It usually accrues on a monthly or daily basis. On the other hand, it is a fee that you pay for taking a loan.
A good example is your savings account. When you deposit money, the bank will pay a certain amount to your account as interest. The payment is made on specific periods. But have you wondered why the bank does this?
Now, here’s what happens. When your money sits in the account, you’re lending it to your bank. They will loan the money to different customers. Usually, the period during which you leave the money in the account, yields more money.
The interest rate for cryptocurrencies acts as an incentive to users. This is because when they loan out crypto assets, they earn higher returns than when they just store them in their personal wallets or devices.
You may want to visit https://www.coindesk.com/heres-why-interest-rates-on-cryptocurrencies-could-be-a-game-changer to read more about interest rates.
This is the earning that security generates and realizes over time. It includes the dividends received or interest earned from holding the security. It is calculated as the percentage of the amount invested. In the traditional banking sector, yields are derived from the dividends of stocks bought or interests from bonds.
Cryptocurrency Compound Interest
This refers to a method which investors use to build their assets over time. However, the impact may not be noticeable until after the first or second year. But the longer they leave the coins, the more it generates compound interest.
So, when you invest your assets, it may take about 3 to 5 years to start reaping the benefits. Also, if you continue funding the account, the earnings will increase. For instance, if the rate on interest is 8%, let’s see what the compound interest would amount to at the end of the year.
If a user deposits 1 BTC in their account and leaves it for a month, with the 8 percent interest that accumulates daily, by the next month, the account will earn 1.006688 BTC. While this may not sound like a lot of coins, in the next month, they will earn another interest on the 1.006688 BTC which amounts to 1.013421 BTC.
Furthermore, by the third month, the earning becomes 1.020199 BTC. So, you can see that the interest grows every month. By the 12th month, you would discover that the total earnings on interest are 0.083278 BTC. This figure implies that your interest rate increased from 8% to 8.33%.
When you leave the coins again for another year, your total earning on interest alone will amount to 0.090213 BTC. Also, by year 3 of your investment, the interest will rise to 0.97725 BTC.
You may want to check out this website to know how to calculate compound interest.
In summary, assuming you deposit only a single BTC and leave it in the account, the interest on that coin will accumulate to the tune of 0.271216 BTC over three years. So, when you make bigger deposits, you’ll see that the payment on interest will be higher. And when you continue depositing funds, the earnings will further increase. Patience is the key; the longer your coins remain in your account, the more increase you will get.
How to Boost Your Crypto Yield
While crypto investors are seeking ways to make a profit from the fluctuations in the prices of assets, there are various ways to earn steady returns. We will discuss 2 of them to enable you to have a better crypto yield on your assets. We will also outline the risks involved in each investment method.
1. Crypto Staking
Here, investors can stake a share of their coins to generate returns. Staking simply refers to locking up your coins in order to earn rewards, which are also paid using the type of coins you invested. For instance, if you stake with BTC, your reward will come as BTC, not as any other type of coin.
Staking involves placing your funds on hold in your crypto wallet. This would help to support the operations and security of the blockchain network. Usually, the percentage that you earn will vary because each coin has a value. The value that an investor may gain from earning in BTC will differ from what another may earn from investing in Litecoin.
You may want to check out this beginner’s guide to staking cryptocurrency to get more useful information.
Risks involved in Crypto Staking
Crypto staking is similar to dividends and stocks, the risks are also the same. The investor who is staking does not lend the coin to anyone. Therefore, there’s no provision for the counterparty to default on the payment of the loan.
The main risk in the investment is the volatility of the prices of assets that were staked. There is also a technical risk that stems from holding the assets and staking them. Simply put, if an investor stakes Tezos, they will earn on that coin. But if its price decreases due to market forces, the value of your earning will decrease.
2. Margin Lending
Cryptocurrency exchanges are now offering opportunities for their clients to trade based on leverage. This allows clients to use their fiat, assets, or crypto to take a loan, then they can trade with bigger amounts.
Lending to leveraged traders offers more reliable yields with low downside risks and several exchanges are open to such offers. Due to the fact that the capital needed for offering margin lending is huge, investors will offer the loans through the crypto exchange and not by the exchange.
You can visit https://medium.com/@Genson_G/what-is-crypto-margin-lending-8afab1da846f to get more info on margin lending.
Risks involved in Margin Lending
Defaulting on payment of the loan is a bit different from when a borrower declines in making a repayment. Margin traders usually borrow capital. When they trade, it determines both their profits and losses. However, the loaned capital must be traded; you cannot withdraw it from the crypto exchange.
Now, to reduce the lender’s risk, the exchange uses several strategies since the lender has no logistical or legal method of recovering the loan if the trader defaults. The major strategy involves forcing liquidation on the trader’s position, assuming it falls close to the margin of the collateral borrowed.
For example, if a trader has 1000 USD and wants a 5x leverage, they will use the 1000 USD as collateral to take a loan. The trader buys BTC worth 10000 USD, that is, 0.5BTC. Now, if the value of BTC drops to 8000 USD, the trader will have zero equity. Any further loss will become the lender’s burden to bear.
However, to prevent this from happening, the exchange will present a minimum equity percentage for each margin position. If it goes below that level, the trader’s position will be liquidated.
This strategy ensures that traders do not lose anything more than their collateral. Hence, the lenders will also not lose their investment. There are some unique cases where the lender can lose a part of the loaned capital, but this is very rare. In such situations, the exchange will cover the loss. But this does not mean that there are no risks in margin lending.
The crypto lending market offers investors many opportunities to earn interest in crypto. Although there are risks involved, the lending agencies have strategies to prevent lenders from making losses. However, the yields that a lender can earn is high compared to all the risks involved.