Earning income on your crypto assets
Updated: Dec 11, 2021
The cryptocurrency space has evolved tremendously over the past few years. In the past, the only way for anyone to be profiting from cryptocurrencies were either via trading of HODL. This is no longer true in the current space. The cryptocurrency space is behaving more and more like the traditional finance space (albeit without government regulations) and the options available for investors are now plenty. There are a few ways where you start earning income on your crypto assets. I will share a few here and provide my opinions on them.
Firstly, crypto-staking. If you are familiar with cryptocurrencies, you will probably have heard of things like "Proof of Work" or "Proof of Stake". I'm not going to go much into details about either of these here as I'm sure there are many articles out there which already explain how these mechanisms work. Generally, Bitcoin uses a "Proof of Work" mechanism while other coins such as Ethereum uses "Proof of Stake" mechanism. As you could have already correctly guessed by now, crypto-staking is more applicable to coins which are using the "Proof of Stake" mechanism. In a "Proof of Stake" mechanism, validators of the networks are needed to "stake" their coins by usually locking it in. The cryptocurrency network will then randomly assign the right to validate the next block based on the coins which are "locked in" or "staked in" here. As a reward to validate the next block, you will then be awarded with more coins (which then serves as the income). Hence, owners of cryptocurrencies with a "Proof of Stake" mechanism might choose to do crypto-staking to earn passive income. Personally, I think this is usually quite a secure way of earning income with your cryptocurrencies with the only downside being a high initial income is required. Seedly has a great article on this and I suggest you reading it if you are interested in crypto-staking.
Secondly, liquidity mining. Now, this is a bit more confusing than the earlier one. Generally, you deposit tokens (usually in the form of pairs) to an Automatic Money Maker (AMM) to contribute to their liquidity pool, and in exchange you are awarded a portion of the transaction fees accumulated from users who lend, borrow, or exchange the coins associated with the pairs you deposited. This portion of transaction fees assigned to you is usually in the form of promised Annual Percentage Yield. While the intrinsic details of how these work could be confusing, the general gist of it is not. It's not too different from how traditional finance works where the banks serve as the middle man in this liquidity pool and assign the respective rates to lenders and borrowers. The only different thing here is smart contracts replace the need for a bank here to serve as the guarantor.
The promised Annual Percentage Yield associated with liquidity mining is usually high but it can also be rather risky due to "impermanent loss". Let me give a quick example to illustrate what "impermanent loss" is. Let's say you deposit 1 ETH and 100 DAI in a liquidity pool. The price of ETH is 100 DAI when you deposit. The entire pool is 10 ETH and 1000 DAI, and your share in the whole liquidity pool is 10% based on what you have contributed. Suddenly, the price of ETH increases to 200 DAI. To ensure the liquidity pool maintains this new ratio of 1:400, ETH needs to be removed from the pool with DAI added to the pool. Hence the pool is now 5 ETH and 2000 DAI. When that happens and you decide to withdraw your funds, you will be entitled to 0.5 ETH and 200 DAI based on your 10% share. While that might be a profit, you are actually worse off as compared to what you will get had you decided to just HODL your 1 ETH and 100 DAI instead. This "worse off" situation as compared to HODL is what we call the "impermanent loss". The reson why it's called impermanent is because it will only materialise if you decide to withdraw your funds (pretty much like what people call paper loss). As a general rule of thumb, the more volatile the cryptocurrency are in terms of prices, the more your impermanent loss is going to be. So I'm personally not in favour of this as I'm quite sure we are still going to see a lot of big movements in cryptocurrencies in the near future, and HODLing still seems like the best option to me.
Lastly, open a savings account with a cryptocurrency lending account. A popular option for this is BlockFi. It generally works the same way as how saving accounts in traditional finance works. You put your money in with a bank and earn interest for putting your money in. The only difference here is you don't put money or fiat currency in here. Instead you put cryptocurrencies like Bitcoin in. As you could have guessed, cryptocurrencies aren't exactly mainstream yet so the interests which these spread businesses provide can be really high (usually more than 5%, depending on the tier you are in). There is usually also no lock-in period so you can withdraw anytime. Hence, if you are a believer that Bitcoin will appreciate in the future, you might want to consider depositing your Bitcoin with these lending accounts to increase your returns.
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Hope this article gives you a quick snapshot on how you could generate passive income with your crypto assets!
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