This is the fifth entry in our Crypto Starters series. Be sure to check out the rest!
If I were a good marketer, I would have covered this earlier in the series. But I like establishing a base and a frame before actually decorating a house. Call me old fashioned!
Anyway, one of the best parts about cryptocurrencies is the ability to generate yield on those assets. What is yield? If you don't know what yield is, you may want to brush up on your basic economics first! But we'll refer to yield in terms of APY or Annual Percentage Yield, which reflects your gains in an asset if you hold it for one year.
Case in point: let's say you hold $10k of USD in a savings account. A good savings account right now... generates 0.25% APY. That means that at the end of one year, you'll see your $10,000 savings grow to a big, whopping... $10,025.
As we say in the business... those are rookie numbers. If you meet someone who is happy with their 0.25% yield, kindly slap them for me and hand them my business card.
Crypto Yields
Crypto can provide much higher yields than fiat finance. Some of this is through a clearly understandable mechanisms, some cases in crypto though are clearly unsustainable. Let's cover a few cases:
- On the understandable front: banks charge out loans to customers and businesses at much higher rates than they provide back via savings. Credit card debt charges at ~15-20%, and business loans charge at anywhere from 4-10+% depending on the risk of the company. But remember, they are loaning out the money that you deposit and only earn 0.25% on (at best!). Cryptocurrencies disintermediate (read: remove) the bank, thus bringing these two rates closer together. These lending returns are transparent and sustainable.
- Next, we have staking. Many new cryptocurrencies are what is called "Proof of Stake" which can get complicated but basically means that you are able to stake your tokens and generate a return (it is more complicated behind the scenes, but understandable). This basically captures transaction or block rewards and provides a steady return similar to basic lending protocols.
- Next, cryptocurrencies can be provided to liquidity pools to Decentralized Exchanges (or Dexes) that we covered last time. In doing this, they capture a small fee (typically 0.3-0.5%) of the transaction cost which is then spread among the pool. These can yield quite high returns (10% to 50% or more), but the yield is variable and does come with some additional risks. As crypto stabilizes too, you would expect this return to decline as more people can access liquidity pools and the inflows slow. So this return is transparent but likely not sustainable.
- Lastly, you have the dark recesses of the Binance Smart Chain, that offer APYs of at least 100% and up to 300% or more. If this sets off alarm bells, then good. It should. No service should be able to reliably generate 100% APY. I mean, if something did exist, then we could all retire once we hit $200k in savings because that $200k would generate $200k to live on each year! Sounds great, but it definitely won't last. How this can be done is a bit unclear (another warning sign). Certainly much of it is fueled by growth, but it is worth being wary of.
Alright, so that was a lot. But what it boils down to is this: you can get substantially better yield in crypto than you can in traditional finance. Of course, most of these rewards are paid in kind so if you loan Bitcoin then you get rewards in Bitcoin. This does mean that you stay fully exposed to the underlying asset, which can be good or bad depending on your perspective. But this is true of the US Dollar as well - by holding it or putting it into savings accounts, you are exposed to the moves of the USD relative to other currencies or assets.
Some Examples
That all said, let's get practical. I have holdings that fall into all four of the buckets noted above. Let me provide an example of each to help provide some clarity:
- I have a chunk of Bitcoin generating 6.2% APY with Celsius, which makes money by providing low cost loans in USD backed by their cryptocurrency holdings.
- I have Polkadot (DOT) tokens staked on Kraken earning 12% APY, as well as some Tezos (XTZ) that "bake" instead of "stake" at ~5.5% APY, and some Cardano (ADA) staking at around 5% on various platforms.
- I have added a few different tokens (ETH, AAVE, UNI and a few others) to liquidity pools on Uniswap. These have been running for about 2 months and are averaging about 30% APY by capturing a bit of each transaction that people do on Uniswap.
- Lastly, I have several holdings (CAKE, BIFI, LIT, BUNNY) that I've added to liquidity pools on PancakeSwap that generate between 40% and 160% APY currently by pairing them with BNB (the Binance token) to provide liquidity at even higher returns.
What that brings me to overall is a crypto portfolio that returns ~9% APY on its base. Of course, this maintains full exposure to the cryptocurrency assets, so I still gain relative to US Dollars when they go up (or lose when they go down). So what does that 9% mean? Let's examine a few cases:
- Crypto market (and my portfolio) drop 20%. Ugh. But as my APY is 9% my loss relative to the dollar is only 12%.