How Does Earning Interest on Crypto Work: a Beginner’s Guide

Published: April 19, 2024 | Last Updated: June 2, 2023

Markos Koemtzopoulos

Markos Koemtzopoulos is the founder and main writer of ElementalCrypto. He has been a lecturer at the University of Nicosia on cryptocurrencies and DeFi and has taught two courses on crypto and blockchain technology.

Cryptocurrency markets have developed to such an extent that they are almost offering everything that the fiat markets are offering but in a decentralized manner i.e. without a central intermediary. They generally offer higher interest rates on crypto assets at much less costs compared to traditional financial institutions. 

Accompanied by novel loan products such as flash loans, crypto investors are much more assured of the safety of their investment than fiat investors. Furthermore, their crypto holdings, when put into crypto savings accounts, have the opportunity to easily earn passive income and other passive rewards whose gains are relatively higher than banks’ traditional savings accounts. 

How do you earn interest on your crypto?

How Does Earning Interest on Crypto Work

Do you have digital assets that are lying idle? Well, consider the many interest-earning opportunities available in the crypto markets today. All these opportunities fall into three broad categories:

1. Crypto staking

Crypto staking is the process of holding or locking crypto assets for purposes of future rewards and/or influence. As many blockchain networks shift away from proof-of-work (PoW) towards proof-of-stake (PoS), staking continues to gain relevance and importance.

Not all cryptos can be staked. The following are the popular cryptos for staking:

2. Crypto lending

Lending cryptos is another great way to earn interest. It is similar to traditional lending except for the level of technology and sovereignty involved. Crypto lending enables others to acquire crypto-backed loans while you receive periodic interest payments. 

Crypto lending platforms 

There are many crypto lending platforms from which cryptocurrency owners can earn passive rewards in terms of interest. These platforms are divided into two main categories depending on their protocols – CeFi lending platforms and DeFi lending platforms. 

CeFi lending platforms are managed by a central intermediary which is usually a financial institution of some sort. Unlike banks is that they use a blockchain to automate their processes.

Top 5 CeFi lending platforms

The 5 best CeFi lending platforms are:

  • Crypto.com
  • YouHodler
  • Nexo
  • Celsius Network Update: This company is now bankrupt
  • CoinRabbit

Top 5 DeFi lending platforms

Decentralized lending platforms are blockchains that are not managed by any specific entity. They just exist and if you want you can participate in them. To really get your head around them I recommend you read up on some of them in more detail.

The 5 best DeFi lending platforms are:

You can find out more about how crypto lending works here.

Crypto Saving

This is the safest yet most passive means of earning interest. It is the preferred option for risk-averse investors. You simply deposit funds into a savings account and let it start earning you interest.

Top 5 crypto savings accounts

When it comes to earning interest on savings, the following are the best crypto interest accounts:

  • Nexo
  • Crypto.com exchange
  • Youhodler
  • Ledn
  • Uphold

3. Liquidity Pools

With the advent of blockchains and things that work on their own a thing called decentralized exchanges emerged. For these to work you need to be able to exchange one crypto coin for another. Centralized exchanges collaborate with large companies called market makers who provide liquidity in exchange for a fee. Decentralized exchange crowdsources the liquidity from people like you and me. So if you want you can put your crypto in what is known as a liquidity pool in exchange for rewards. The largest decentralized exchange is Uniswap.

You are going to need to read up on this one if you want to really get to grips with it. I will drop a link at the end of this article.

What type of crypto interest are you after?

There are several types of interest gains in the crypto markets:

Simple interest

This is a type of interest where the principal invested remains the same just as the interest income. Thus, the interest earned is not reinvested. 

Formula:

I = P x R x T  

Where;

I = Interest Generated  

P = Principal  

R = Interest Rates  

T = Time

Compound interest

This is a type of interest where the principal invested grows over time since the interest earned in a given period is converted into principal in the subsequent period thus increasing the principal in that subsequent period. Thus, both the principal amount and the interest amount grow over time. This assures you of higher yields over time compared to the simple interest. 

Formula:

A = P(1 + r/n)^nt 

Where; 

A = final amount  

P = Principal/Initial Deposit  

r = interest rates  

n = number of times compounded over the period  

t = number of periods elapsed since the deposit

While almost all crypto lending platforms offer simple interest, just a few of them offers compound interest.

The top 7 platforms that offer compound interest are:

  • Binance
  • Nexo
  • Crypto.com
  • Hodlnaut
  • PancakeSwap
  • Cake DeFi
  • Matrixport

Making your investment decision

Making an investment decision requires information, planning, and strategy. These three factors determine whether you will be a successful investor or not. 

What you need to consider

Like any other investor, being prudent and practicing due diligence matters. To achieve your financial goals, the following are important factors to consider before making an investment decision:

1. Risk vs return trade-off

The common rule of thumb in finance is high risk, high returns; and low risk, low returns. It follows that no risk means no returns! Investment is about balancing risk against return. 

You have to do a quick self-assessment to determine your position and attitude towards risk. The rule of thumb is: Never risk that which you are afraid to lose. If you are not in a solid financial position, then, cryptocurrency investment is not the right vehicle for you. Better opt for the traditional investment vehicles where you are guaranteed, at least, of getting back your principal investment. 

If you are risk-averse, one way to reduce risk is to invest in stablecoins such as the USD Coin (USDC). This is the most stable coin. Another coin is the Tether coin (USDT). Incorporating these stable coins into your investment portfolio helps to reduce risk exposure but has a relatively lower return. 

2. Portfolio structure

Every astute investor endeavors to have a portfolio. The same is the case with crypto investors. A portfolio is simply a mix of investment baskets that helps to diversify risk. 

The following are the four main crypto investing strategies:

  • Unbalanced crypto Portfolio
  • Balanced crypto Portfolio
  • Profit re-investing
  • Dollar-cost averaging
Unbalanced crypto portfolio

In this strategy, the crypto investor allocates funds on crypto assets depending on projected performance. The highest allocation going to the crypto asset is deemed likely to perform best over a given period. 

For example, if you think Ether will perform twice as well as Bitcoin as the two best-performing crypto assets, then, you will rank the rest based on the performance of ether and allocate on a proportionate basis. This will result in your portfolio looking like this:

  • Ether (50%)
  • Bitcoin (25%)
  • AAVE (15%)
  • USDC (7.5%)
  • ADA (2.5%)

This strategy is ideal for those investors with adequate research information at their fingertips. 

Balanced Portfolio

In the balanced portfolio, the crypto investor allocates an equal amount of funds to the preferred crypto assets. 

For example, if the investor has $10,000 funds to invest, then then the portfolio will look as follows:

  • Ether ($2,000)
  • Bitcoin ($2,000)
  • AAVE ($2,000)
  • USDC ($2,000)
  • ADA ($2,000)

This is an easy investment strategy for those investors who either do not have adequate research information or have no time to make follow-ups on the market performance on a daily basis

Profit Reinvesting

This is a strategy where you decide how much of your profits you will plow back into your investment. Thus, you can choose, in percentage terms, how much of your profit you need to re-invest. As a rule of thumb, this percentage should range between 10% and 50%. Profit re-investing is ideal for long-term investors who have less appetite for cash flows. 

Dollar-Cost Averaging

This is a strategy where you invest a fixed dollar amount (or other fiat currency) into crypto assets at a predetermined interval. For example, $1,500 every month. This injection is regardless of the market performance. This is an ideal strategy for new investors with less experience or those investors who do not have sufficient knowledge or time to carry out deep research to establish the fundamental value of a given crypto asset. 

3. The investment platform

Choosing an investment platform is like choosing a marketplace – in terms of finance, this can be a funds marketplace such as a bank, securities exchange, money exchange, etc. There are reasons why you would choose to buy or sell in a certain marketplace as opposed to another. Some of these reasons include:

  • Accessibility – are you allowed access? Are the KYC and AML terms compliant with your needs? Does the minimum deposit or minimum purchase price affordable? 
  • Security – how secure is the platform? Is it free from hacking, manipulation, and other malfeasance? 
  • Choice – Is it a free market? Does it have products of your choice? Can you be able to freely choose the kind of person you want to buy from or sell to? Does it have sufficient liquidity such that you are not limited in terms of when you want to acquire or dispose of your chosen crypto assets?
  • Minimum requirements – due to high gas costs, many platforms require you to have a minimum deposit for savings and also a basic floor on your initial investment. Go for a platform where you do not have to strain to raise a minimum deposit or initial investment. 

4. The overall performance of the crypto markets

Yes, while some individual crypto exchanges can face unique up-and-down swings, certain market-wide trends do occur. It is important to watch out. There are times when demand supersedes supply and there are those moments when supply supersedes demand. For interest’s sake, don’t go into the market to invest when there is excess liquidity as the interest rate will be low. Go in when there is extreme scarcity and you will be guaranteed a higher interest rate. 

Choosing your crypto assets 

The choice of your crypto assets should align with your investment strategy. You need to invest in crypto assets in such a way that matches your desired crypto assets portfolio. Decide whether you want to go after a balanced or unbalanced portfolio. If you are interested in growing your portfolio, you also need to formulate your profit re-investing strategy.  You can also cap it with dollar-cost averaging.

Choosing your investment platform

Based on your desired crypto assets portfolio and other factors that we have already mentioned, it is time to decide on the appropriate investment platform. 

Factors to consider

1. Reputation

Reputation is based on:

  • Security
  • Consistency
  • Service quality
  • Integrity 

2. Ease of use

Making an investment decision is already complex. You need not be stressed by platform complexity. Go for a platform that is easy to use as it will not only save you time but also reduce the risk of making inadvertent mistakes that could cost your investment. 

3. Digital assets on offer

Are the digital assets that you require to construct your portfolio available? In case you want to expand your portfolio, will these assets still be available in the near future? Are they affordable and competitive compared to other platforms? 

4. Liquidity

You can determine the liquidity of a given platform by the volume of trade being carried out. Crypto markets are extremely volatile and thus you will need to keep on refactoring your investment portfolio. This would mean quickly disposing of some crypto assets and quickly acquiring others. Lack of liquidity will unfortunately bind you to a corrosive crypto asset that burns your portfolio. 

5. Fiat options

Let’s not forget that most of our earnings and incomes are based on fiat currency. Furthermore, we have to convert this fiat money into cryptocurrency to trade. Thus, having a fiat option either for buying or withdrawing funds is important. 

Confirm whether the platform allows you to buy crypto using a credit card, and other fiat payment options. Also, confirm whether you can withdraw your funds in fiat form if that is your need. 

6. Investment terms

Investment terms are a must-consider factor. As is always said ‘the devil is in the details’. Different crypto platforms have different terms of investment. Do not just click away T&C. Have a closer look at the T&C. Before you click on ‘I agree’, read thoroughly and understand each term and condition. 

Fixed terms

  • Fixed cryptocurrency saving account – this is like a fixed deposit account. You cannot increase or decrease the amount of savings in the account. Furthermore, you cannot withdraw before the maturity period without attracting a heavy penalty. The advantage of these types of accounts is that they provide higher interest rates compared to flexible saving accounts. 
  • Fixed interest – interest is constant throughout the period. 
  • Fixed period of time – this means that the investment contract is for a certain predetermined fixed time period, after which the asset will have to be liquidated. 

Flexible terms

  • Flexible cryptocurrency savings accounts – they operate just like traditional bank savings accounts. you can increase and reduce your amount of savings at will. You can also withdraw at will. 
  • Flexible interest – this is an interest rate that is based on the market rate. It varies based on the forces of supply and demand. 
  • Flexible period of time – there is no predetermined time period. Your contract lasts as long as your crypto assets stay unwithdrawn. 

Best investment platforms

Crypto exchanges vary in terms and provision when it comes to investment, especially staking, saving, and lending. Thus, the best trading platform may not necessarily be the best investment platform. When it comes to an investment platform, you need to consider the annual percentage yield (APY) and the annual percentage rate (APR). Both are important. APY is important if you are a lender and APR if you are a borrower. Nonetheless, when it comes to leveraging, you have to wear both hats – because you will have to borrow low to lend high.  

Key steps to earning interest on cryptos

To start earning interest on your crypto investments, the following are important steps to guide you:

1. Research

The most important thing astute investors do is to equip themselves with adequate knowledge and information. Many investors ignore this important step to their peril. Don’t be one of them. We’ve provided a brief of this knowledge and information in this article – but as a stepping stone. You need to do more. 

What you need to know:

  • The opportunity cost of your return on your investment (ROI)
  • The fundamental risk factors
  • Annual percentage rate (APR)
  • Annual percentage yield (APY) 

2. Open a crypto wallet

While some platforms have their own crypto wallets, it is often ideal to have a crypto wallet that is independent of the platform that you are trading or investing in. This not only increases your degree of independence but also reduces the risk of your crypto assets being locked in against your will or getting lost when the platform becomes insolvent. 

Hot wallets

These are wallets where you hold your cryptos temporarily during the process of trading and transfer. They are quick but riskier. They are often online and sometimes on-platform. A typical example of a hot wallet is MetaMask. 

Cold wallets

Cold wallets are for long-term storage. They are offline and off-site. They provide a greater level of security from hacking. You may need to transfer your crypto assets to a hot wallet for purposes of trading. Two major types of cold wallets are hardware wallets and paper wallets. 

Hardware wallet: These are wallets that exist on a hardware device such as a hard disk, pen disk, etc. A typical example of a hardware wallet is the Tezos Wallet. 

Paper wallet: Paper wallets store crypto data in a printed form. your public and private keys are printed on them. A typical example of a paper wallet is the QR Code. QR codes are ideal because they not only obfuscate the data from prying eyes but are also easy to be captured by phone or optical input devices.

3. Buy crypto assets

Just as in the traditional financial system, to earn interest, you need to have the principal sum. In the crypto world, this principal sum is in cryptos. You will need to buy them in the crypto market, through the cryptocurrency exchange platform. 

4. Choose the right platform to invest your cryptos

The best platform to buy cryptos is not necessarily the best to invest in your cryptos. Thus, it is common to buy cryptos from one platform, store them in your wallet and then invest on another platform. 

5. Invest in your preferred interest-earning product

Based on your chosen investment strategy, you can now invest in your preferred interest-earning products that achieve your desired portfolio. The portfolio should not just be about coins, but also about:

  • The period of investment – short-term, medium-term, long-term
  • The different modes of earning interest – staking, lending, savings
  • The different investment platforms – to diversify platform risks
  • The different terms – fixed and flexibility 
  • The different interest types – simple and compound

6. Start earning interest

As you earn your interest, fine-tune your profit re-investment strategy. Seek the highest interest rates possible in the market.

7. Monitor your investment

Be watchful about the market performance. Subscribe to various cryptocurrency newsletters to stay up to date. Go for subscription frequency that matches your nature of investment and the time available to read them. 

Review your investment portfolio based on market performance trends. 

8. Harvest your rewards

Yes, just like honey, if you fail to harvest on time, markets tend to chew back their investment. Similarly, like fruits and other farm harvests, inordinate delays can degrade the quality of your harvest. Timing is important. 

Summing up

Crypto staking, crypto lending, and crypto saving are the three main means of earning interest on your crypto holdings. Crypto interest rates vary depending on the cryptocurrency platforms on which the crypto services are provided. To earn higher rates of return and higher yields it is important to establish a proper investment strategy. You also need to carry out prudent research to find the best cryptocurrency exchange platform where you can get your preferred crypto assets at the lowest possible price. You also need to research the best places to invest your cryptos to earn the maximum interest rate. The good news is that you can achieve high returns on your cryptos compared to the traditional market. The above content introduces you to the best way to get started on a solid foundation. 

Further reading

What is Uniswap? 9 easy steps for absolute beginners

What is Uniswap exchange?

Markos Koemtzopoulos is the founder and main writer of ElementalCrypto. He has been a lecturer at the University of Nicosia on cryptocurrencies and DeFi and has taught two courses on crypto and blockchain technology.

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