Interest on Crypto

HODL or lend?

One of the most important principles in the crypto world is the self-storage of coins, also called "hodling". For many, buying coins and keeping them in their wallets for the long term is both a belief and an investment strategy. However, if the coins remain in wallets, their owners benefit purely from a potential increase in value. And no one can really say whether this is guaranteed.

Buying platforms and exchanges have become more secure in recent years. Precisely because hackers have been able to collect large sums of coins at regular intervals providers have expanded their cold-storage shares and compensated customers after hacks. Leaving a certain amount of coins in platform storage is now recommended for beginners and experts alike. It is always important to make a conscious decision about the whereabouts of one's coins - whether that is distributed across different platforms to maximize profits or almost exclusively on one's own devices.

Thus, by lending Bitcoin & Co. from one's own portfolio buyers are able to leverage the unused potential of the acquired coins. Decentralized as well as centralized lending platforms allow hodlers to deposit their coins and receive interest on their lent amount. In return, credit seekers can easily and quickly obtain the capital they need.

The provider market is large. We will explain how earning crypto interest works and what points capital providers should pay attention to as follows.

How do capital lenders get interest on their cryptocurrencies?

Crypto loans are based on the provision of coins. Capital providers deposit coins, either from one or from several cryptocurrencies. Capital borrowers receive the coins for their use and pay them back in stages or as a total sum at the end of the agreed term, each with interest. The interest on the loan goes in part to the lender as savings interest.

The interest rate is either determine in advance and based on a fixed interest rate. Alternatively, a variable interest rate is used, which can be recalculated on a daily basis. Interest payments are essentially possible in the same cryptocurrency, another cryptocurrency as well as in fiat (euro or dollar).

When it comes to the implementation, interested parties can choose between institutional providers and decentralized platforms, also known as DeFi - Decentralized Finance.

In decentralized networks, the processes are automated, depending on the specification in the smart contracts. They are frequently based on Ethereum.

Investors receive interest on their coins either through a kind of "savings account" based on credit pools. Or they are directly involved in one or more loans and receive payments from the interest from these trades.

Centralized platforms

Centralized platforms are characterized by their operation simplicity. Large providers are, for example, Binance, BlockFI or Genesis. But Celsius, CoinLoan and YouHodler are also established on the market. 

The mechanisms of central providers resemble those of a bank. Customers first set up an account into which they deposit their coins. They receive interest payments at regular intervals on this sum, in the form of cryptocurrencies or fiat money. To enable portfolio diversification many platforms offer an interest payment in cryptocurrencies that are not already deposited in the account. As a rule, however, customers also receive interest in this currency on ETH Coins, for example.

The big advantage with Binance & Co. is their predictability. On the deposited sums, capital providers receive a fixed interest rate, usually at regular intervals. In addition, the platforms carry all common, i.e. major, cryptocurrencies. Bitcoin or Ether, which would otherwise remain in wallets, can easily be leveraged there. Variable interest rates are also offered, yet are not common here.

In return, customers give up the right of disposal for their coins. Central platforms store coins themselves or via so-called "custodians". These are providers that specialize in the acceptance and secure storage of coin deposits.

Depending on the model, deposited coins can be removed from the account ahead of time. On platforms that form loan pools with the owners' coins and lend them to borrowers, only "free" coins can be withdrawn in each case. Only when the borrower has repaid the respective loan the pool is dissolved and lenders can withdraw the coins again.

Decentralized platforms

Decentralized platforms transfer the principle of Decentralized Finance to loans. The best known are dYdX, Compound Finance and MakerDAO. Likewise, several forms are possible. 

Unlike on institutional platforms users do not transfer their coins. The cryptos remain in the custody of the owners. To be able to execute the lending regardless capital providers connect their wallets to the platform. As a rule, popular browser wallets such as MetaMask are compatible with the networks. Via smart contracts, the coins receive a kind of "blocking notice" and cannot be used elsewhere. 

Decentralized platforms bring together lenders and borrowers with the help of loan pools. They unite coins from different owners and lend them out.

A characteristic of decentralized providers is the variable interest rate. It is always recalculated according to market conditions.

Well-known decentralized platforms with offers for crypto interest rates are:

Usual interest rates

Centralized operators usually offer higher interest rates on the classic cryptocurrencies like Bitcoin and Ethereum. The range is between 2% and 6%.

Decentralized platforms usually have higher interest rates on stablecoins. On the other hand, returns on classic cryptocurrencies are rather low at 1% on average.

Risks - "not your keys, not your coins"

The provision of capital in the form of cryptocurrencies entails risks. Centralized providers could embezzle the cryptocurrencies. Lenders also need to calculate in credit default risk despite over-collateralization of the loans, i. e. cryptocurrencies might no longer be repaid.

Decentralized smart contracts can have bugs and, in the worst case, can be emptied by hacker attacks so that the deposit is lost.

Whether centralized or decentralized, the platform and custodians should always be trustworthy. Audits, a certain number of customers and the absence of hacker attacks can be indications.

As always with crypto products, prospective customers should only commit as much capital as they are willing to lose. If a protocol is still in beta mode it is advisable to invest only small amounts or not yet.

If a variable interest rate is used, the amount of profit from capital lending is not foreseeable. This reduces planning security, both for withdrawals and tax planning.

Opportunities

There are also great opportunities in lending coins. The most important one is in the mechanism itself. If you only keep cryptocurrencies in your wallet, you earn nothing from them and, in case of doubt, you don't even beat inflation. Money in circulation earns interest and has side effects such as generating jobs.

Loans with coins are often over-collateralized, have low transaction costs, have low platform fees, and earn far higher returns than traditional banking does. For example, lenders receive interest rates as high as 15% on stablecoin lending through decentralized platforms.

Choosing the best platform for interest on crypto loans

Lending coins and earning interest on them requires great trust in the underlying technology. Therefore, care must be taken when choosing a platform.

The most important step is to decide between an institutional provider and a decentralized network. For prospective customers who care about predictability and ease of use, it is better to turn to providers like Coinloan. For those seeking the most direct business relationships possible and low fees decentralized platforms are better served.

In both cases, it is also important to consider key points regarding reliability. Who operates the platform? How reliable and secure is the provider? Has the platform been audited or do other mechanisms exist to verify security? How transparently does the provider communicate on this?

Only platforms that support cryptocurrencies from the investor's own portfolio should be considered. Common ones are Bitcoin, Ether, Dai and USDC. Currencies with high market capitalization are also routinely listed. Coins that have only a liminal community can rarely if ever be used for interest income on loans.

One of the most important metrics is APR (Annual Percentage Rate), which is the interest rate. For lenders, it is also known as APY (Annual Percentage Yield). It represents the interest payments that lenders receive for their coins. This interest rate is either fixed or floating, meaning it adjusts to market conditions. It should always be considered in conjunction with the fees incurred. If a provider offers high interest rates, but these are strongly countered by the fee structure, another provider might make more sense.

When it comes to storage users of decentralized mechanisms are on the safer side. The coins remain within their own access at all times. Centralized platforms, on the other hand, hand over coins to custodians in many cases. Therefore, a careful examination of the custodians is advisable.