How to Earn Interest & Boost Yield With Bitcoin and Crypto

Yield refers to the earnings generated and realized on a security over a period of time. It is expressed as a percentage based on the invested amount and includes the interest earned or dividends received from holding a particular security. In the legacy financial world, yields are typically generated from stocks in the form of dividends, or from bonds in the form of interest.

Whilst most cryptocurrency investors seek to profit from fluctuations in crypto prices, there are also several ways that an investor can earn a steady, more modest return. In this guide, we will examine three popular ways to earn a better yield with crypto assets – and detail the risks that are associated with this type of investing.

1. Crypto Loans & Lending

A type of lending that is common in the cryptocurrency space is lending to individuals through a crypto finance lending platform. The process is very similar to traditional banking. Just as with a bank, crypto holders looking for a better yield deposit their assets onto a platform and the platform then loans those funds—usually in the form of fiat currency—to borrowers.

Typically, individuals who take out a loan post at least 150% of the value of the loan in cryptocurrency as collateral. This allows borrowers to get a line of credit on their cryptocurrency without having to liquidate their holdings. In return for lending fiat to the borrower, the platform charges an annual percentage fee. Once the borrower has repaid the loan with interest, they receive their cryptocurrency back. The platform that facilitates the loan takes a cut of the interest paid by the borrower and pays interest to investors who have deposited their crypto with the platform.

Companies offering variations of this type of service include NEXO, YouHodler and Crypto.com  The type of asset you are lending will influence your yield – which will typically be from 5% to 10%. For example, at the time of publishing, Nexo is paying up to 7% annual yield for Bitcoin, and up t0 16% for stablecoins. At the same time, YouHodler is paying 7% for Bitcoin and ETH and 12% for stablecoins. Check here for the latest yield rates for all the major platforms.

In terms of what type of platform they are, Nexo and YouHodler are both ‘CeFi’. This means their interest rates are centrally managed and have remained quite stable over time. The other types of platform in this space are ‘DeFi’. With DeFi, the yield for depositors is updated continuously by smart contract protocols in line with real time market demand for different crypto assets.

DeFi has been one of crypto’s hottest topics for the past year, but from the perspective of somebody looking for a predictable return, the yield rates from DeFi platforms change from minute to minute and are highly volatile. Popular DeFi loans and lending platforms include Compound, AAVE and C.R.E.A.M. At the time of writing, AAVE is paying 7.68% for the USDC stablecoin and 15.11% for USDT, while Compound is paying 6.68% for USDC and 6.93% for USDT. Interestingly, none of the DeFi platforms surveyed by Brave New Coin was providing yield on stablecoins that was anywhere close to that offered by the CeFi platforms.

Risks of DeFi Loans & Lending

As in the traditional finance sector, the risk for lenders on DeFi loan platforms is lowered by borrowers having to provide collateral – typically at a minimum of 150% of the value of the loan. Loans are usually collateralized with cryptocurrency and in most instances, the borrower receives USD or some other fiat currency.

Over collateralizing the loan ensures that 1) if a borrower does not repay the loan, the lender can liquidate the collateral and recover their investment, and 2) that if the value of the cryptocurrency begins to drop, the collateral can be liquidated to ensure its value does not drop below the loan value. These mechanisms provide more certainty to lenders that their capital will be returned.

Over-collateralizing loans with cryptocurrency does have a downside though. Because the percentage that the loan is over-collateralized depends on the value of the cryptocurrency, loans of this nature are not good for borrowers in a bear market because the value of their collateral may drop. This means that either the borrower has to add more collateral to the loan, or that their collateral gets liquidated when the loan-to-value (LTV) ratio drops below a set level.

Another risk to consider is the technical risk relating to the smart contract governing the lending process. There have been instances where a hacker has been able to drain the collateral from a smart contract, such as the $25 million USD that was stolen from dForce in April 2020. Though DeFi is often referred to as ‘trustless finance’, the counterparty risk associated with lending through legacy financial institutions has now been shifted to smart contract and technical risk.

On the CeFi side of the equation, the dominant risk is platform collapse. 2022 was a very bad year for platform failures, with Celsius, BlockFi, Coinloan, Vauld and Hodlnaut all failing and forcing account holders to wait years for bankruptcy proceedings to play out before any funds will be returned. While it would be nice to say that crypto lending is safer now than it was it 2022, the reality is that not much has changed.

2. Crypto Margin Lending

Another way to improve the yield from Bitcoin and other crypto coins has emerged as a result of cryptocurrency exchanges offering leveraged trading to their clients.

When a trader uses leverage, they essentially use their assets, crypto or fiat, to take out a loan which enables them to leverage trade with more money than they have. Crypto exchanges offering leverage trading include BitMEX,DERIBIT, Binance and BTSE – with anything from 5x to 100x leverage being offered. Of course, all the normal trading risks are associated with leveraged trading.

For investors looking for a more reliable yield with less downside risk, lending to these leveraged traders is an option offered by several exchanges. Because of the amount of capital required to offer margin lending services, these loans can be offered by individuals through the exchange, rather than by the exchange. Exchanges offering this type of crypto margin lending service include Poloniex, Bitfinex and dYdX. Check here for a full list of exchanges and their leveraged trading offers.

In simple terms, it works like this. If a trader has US$1,000 and wants to trade with 5x leverage, they use their $1,000 as collateral for a $4,000 loan through their exchange which has an interest rate attached. This interest is typically charged daily, although this varies per exchange, and the rate at which the capital is loaned fluctuates according to supply and demand.

Averaged over a year these loans will typically produce a yield anywhere from 7% to 15%. Because margin lending usually occurs over the course of a day, the investor gets daily compounding interest. At a rate of 0.03% per day (the standard rate on BitMEX for example), the annualized rate is 10.95%, but due to daily compounding, the realized annual rate would actually be 11.57%, netting the investor an extra half percent.

Risks of crypto margin lending

In the context of margin trading, defaulting on a loan looks quite different from simply not making repayments. Margin traders borrow capital to trade with, which in turn magnifies both their losses and their gains. However, this loaned capital cannot be withdrawn from the exchange and must be used to trade with.

To lower risk for lenders, exchanges deploy a range of mitigation strategies because margin lenders typically will not have the legal or logistical means of recovering a debt if the borrower defaults on it. The dominant strategy is to force liquidate a trader’s position if it falls too close to the collateral margin. For example, say a margin trader has US$1,000 of collateral and opens a $5,000 (5x leverage) long position on Bitcoin at US$10,000 USD i.e. has bought 0.5 BTC. If the price of Bitcoin were to drop to $8,000 USD, the margin trader would have no equity left, and any further losses would be the burden of the lender.

To avoid this scenario, exchanges implement a minimum percentage equity that a margin position must maintain, and if it drops below this level, the position is liquidated. This is usually higher than the ‘bankruptcy price’ i.e. the level that the trader no longer has any equity, say at $8,250. This mechanism ensures that a trader should never lose more than the collateral they have put down for the position and this lowers the chances of the lender losing any of their investment. Whilst there are unique scenarios where a lender can still take a loss on their loaned capital, this scenario is extremely rare and in most instances, the exchange covers the loss. This is not to say providing margin lending is risk free, though, as this article from Bitfinex explains.

3. Crypto Staking

Investors interested in earning a yield in the cryptocurrency environment can also stake certain cryptocurrencies to generate a return. Simply put, staking is the act of locking up a cryptocurrency to earn a reward, which is usually paid in the same cryptocurrency. Staking involves holding funds in a cryptocurrency wallet to support the security and operations of a blockchain network. Typically, the percentage that an investor earns is denominated in the cryptocurrency being staked, which means that returns in fiat terms can be quite variable.

Staking is like stocks and dividends in the sense that the underlying asset is subject to price movements, and the asset periodically pays a return. Popular coins for staking include Tezos, Decred and Synthetix. Click here for a full list of crypto staking platforms and current rates.

Risks of crypto staking

When considering the risks involved in staking, the same logic can be used that is applied to stocks and dividends. Because the entity staking the cryptocurrency is not lending it to anyone, there is no risk of a counterparty defaulting on a loan. Instead, the main source of risk to the investment stems from the price volatility of the asset being staked and the technical risk associated with holding and staking a cryptocurrency. Put simply, while you will earn Decred by staking it, if the price of Decred goes down you’re potentially worse off – so investors should consider the opportunity cost of crypto staking. In addition to price volatility risks, all the risks related to platform failure and hacking also apply to staking services.

Conclusion

In conclusion, the lending market for cryptocurrency presents many opportunities for investors to earn a yield that is frequently much higher than they would earn lending elsewhere. There is a strong case to be made for lending in the cryptocurrency world when considering the yields that can be earned compared to the risk that an investor takes. However, in spite of cryptocurrency lending services having safeguards baked into them, the risk of platform failure and hacking still remains high and unfortunately, for now, high yields for cryptocurrency also comes with higher risks.