Learn all about crypto savings accounts - including their risks, benefits, conditions, and yield generation process!
What are crypto savings accounts?
Some of you may have heard about cryptocurrency savings accounts, or are familiar with the concept of staking - but what's the difference?
A crypto savings account is a centralized finance solution that allows you to deposit and hold your crypto assets in a custodial wallet to earn passive income in return. It is important to note that centralized finance systems directly manage your private keys and are controlled by a single entity, while decentralized finance systems use self-custodial wallets and are governed by smart contracts. Today, there are many variants of crypto savings platforms that have evolved to include exchange, swap, borrowing, and lending features - but the core concept of earning passive income through your crypto remains the same.
Staking differs in the respect that it A) requires you to lock-in your assets for a set period of time, B) only uses your assets to support the operations of that asset-specific protocol, and C) can pool your assets with those of other investors to meet staking reward requirements.
Admittedly, this sounds very similar to what crypto savings accounts do - and there may even be some overlap in the reward-generating mechanism. However, there are slight differences:
- Not all crypto savings accounts require you to lock-in. Finblox, for example - has no lock-in periods required.
- Assets in a crypto savings account can be employed in a variety of ways to generate yields, not just be put to work in that protocol. We'll discuss this more in the next section.
How do crypto savings accounts generate their yield?
Because crypto savings platforms are not explicitly required to stake your assets in a protocol, there are many strategies available for yield generation. Nearly all of them involve some form of lending or reinvestment, with the interest rates or profits being split between users and the platform responsible for managing funds.
- Unsecured loans are loans that require no collateral. In layman's terms, collateral is something of value belonging to a borrower that is held by the lender - to ensure that the borrower pays back their loans. Otherwise, the lender is within rights to seize the collateral and protect themselves from loss of capital. Offering unsecured loans is riskier, and therefore commands higher interest rates.
- Secured loans are loans that require collateral to receive, and are less risky for the platform. The borrower puts up a certain amount of one crypto as collateral, in order to borrow another. However, since crypto is a highly volatile asset class - secured loans are often overcollateralized to account for price swings - meaning the borrower has to put up more collateral than the amount they are actually borrowing!
- At this juncture, it is important to note that crypto savings platforms engage in secured and unsecured lending to both individual and institutional investors - and that these loans have very different structures and rates.
- Another popular method of yield generation is through decentralized finance protocols. The platform can offer P2P loans, or opt to participate in a liquidity pool - which helps facilitates trades within a token pair. In return, the LP might pay a certain percentage of trading fees to the platform - or cough up additional LP tokens that can be reinvested.
- Collateral lending (yes, it's exactly what it sounds like) occurs when the platform decides to lend the collateral that a borrower has put up for a secured loan. Theoretically, you can even create chains of secured and collateral loans. While this may sound like a risky practice, it is viable as long as there are sufficient liquidity and funds available to return collateral to their owners.
- Not all of your assets are lent or invested in their original form. They may be swapped for another asset temporarily - most likely one that is easier to lend/in high demand. The result is usually higher risk, higher return.
- Finally, some of your assets may even be invested into traditional financial instruments such as stocks and bonds, for the sake of diversification.
This list of methods for yield-generation is not exhaustive, but should provide a strong understanding for how your funds are used.
What are the risks of crypto savings accounts?
Market risk is the single biggest risk of keeping your assets in a CSA, although ironically - market risk is also the biggest driving factor that pushes individuals towards a CSA. The value of your assets can depreciate while they are held in the account, and if you cannot sell quickly enough - there is a chance that you will lose part of your funds. That being said, the value of your assets can go down even if they are not held in an account. Since a crypto savings account has the added benefit of continual interest, most prefer that their money gets put to work offsetting any potential losses that might happen later.
Insolvency risk refers to the danger that a company (the platform) may go out of business, and be unable to pay its debts. This becomes especially prominent for companies that have borrowed large sums of money and still owe their creditors. If you are far down the chain, you might be out of luck! The biggest creditors are usually paid first.
Counterparty risk describes the risk of something going wrong between the parties involved in a yield-generating process. Say for example that Platform A offered an unsecured loan to User A, and planned on partially paying yields to User B through the interest from that loan. However, User A has a history of terrible repayment issues - which means that Platform A might not receive back the money they lent. This means User B is at risk of not receiving some of their yields if this happens.
Security risk is the chance that your account credentials are compromised or lost, or that your funds are hacked and drained. Fortunately, security risk is far lower in centralized platforms than they are in decentralized platforms - which have no oversight or customer support. If you lose your private keys in DeFi, they are irrecoverable. Custodial wallets are also beefed up with cybersecurity features and may even offer insurance on your assets.
Additional risks come into play if users decide to borrow assets on margin and "stake" them to earn interest, or if platforms engage in unsafe lending practices to questionable parties. One of these is a margin call - which happens if the collateral from a borrower has decreased in value relative to the asset they borrowed, OR if the asset they borrowed increases in value beyond a certain ratio relative to their collateral. At this point, the borrower would be forced to add more collateral to keep that loan or be liquidated to protect against any further potential loss of the loaned asset. A liquidation is an instant selloff of the loaned asset, and any difference between that amount and the collateral must be paid immediately.
Naturally, getting liquidated before you were ready to exit a position is devastating - as you may have not been at a desirable price point to sell yet. Perhaps you were using those loaned assets to generate a yield, but didn't reach the next payout period. Regardless, these are just some of the risks that CSAs present.
What are the conditions and requirements of CSAs?
It can be tricky to navigate which crypto savings platforms are best for you, as their ads are laced with hidden conditions and requirements to not only sign up - but to also receive the best rates possible. Here are the most common ones:
- Minimum account balances. Some savings platforms are intended to serve more affluent and institutional investors, and decided to cut their costs of new account creation and onboarding by limiting smaller customers.
- Requiring lock-in periods to get advertised rates. For example, Binance offers 15 - 120 day staking periods - and the longer you stake your crypto, the more yield they are willing to give. During this time, you cannot withdraw your assets and are subject to greater market risk - which explains the higher yield.
- Many platforms place limits on when you can withdraw (once to a few times per month), or charge withdrawal fees.
- Payout intervals may be different. Some platforms pay yield weekly, while others pay monthly.
- There may be a tiered structure for rates based on deposit sizes. Since paying full interest on a larger deposit size is more difficult to sustain for the platform, they may protect themselves by offering different rates at certain intervals.
- Membership and loyalty levels have become extremely common advertising gimmicks - set an attractive rate, but pair it with an almost unattainable condition like reaching "Platinum" level in order to qualify. Be sure to read the fine print when shopping around for a CSA.
- Occasionally, you may be asked to have a fairly large % of required holdings in that platform's token to receive the highest rates. For example, both Nexo and Celsius require you to have 10% of your portfolio in NEXO/CEL.
- Finally, there is accreditation status. A majority of crypto savings platforms, especially in the United States - do not support onboarding of non-accredited investors. An accredited investor is someone who A) has a yearly income of over 200,000 dollars or B) a proven net worth of at least 1 million.
How are rewards from CSAs paid?
One common misconception for first-time users is that crypto savings accounts pay their yields in fiat money. If you've caught yourself asking, "Why did my balance go down?" or "Why did I not earn positive interest?" - then you should pay close attention to this section.
Crypto savings accounts only pay their yields in...you guessed it, crypto! And since the value of crypto is still tied to market performance before being exchanged for fiat, this can affect the total account balance. In fact, it is very common to see your account balance fluctuate up and down.
While your total account value is not always guaranteed to be higher than when you first deposited, the total number of tokens you hold will always increase over time. If the market is doing well, you'll witness exponential gains in appreciation on top of the extra tokens you are earning.
There are two main ways that crypto yields can be paid:
- In-kind earnings are paid in the exact same asset that you deposited.
- Some platforms may allow you to opt-in to receive your yield in the equivalent value of another token (usually their platform token). This drives up the value of their token as there are more holders - and in exchange, they may offer you increased yields.
Timing is another crucial factor to consider. When will you be able to collect your yields? If you have to wait until the end of the month, many things can happen in between that expose you to market risk.
Why should I open a CSA?
A crypto savings account is one of the most effective ways to passively combat rising inflation rates, and the erosion of currency value. As it stands, banks offer extremely low interest rates in exchange for the ability to borrow the money that you deposit, and lend it out. The average bank interest rate in a savings account is a measly 0.06%, while the average worldwide inflation rate in 2021 was 3.81%.
If you could earn amazing returns for doing nothing but letting your assets sit in an account - why wouldn't you? The alternative would be to actively trade crypto for income, which is not suitable for most beginners and risk-averse investors.
Finblox offers highly competitive yields to individuals who would like to hedge against inflation. Don't let your funds depreciate! Give us a try - you might be surprised at how simple it is to earn passive income.
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This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. Charts, graphs and references to any digital assets are for informational and illustrative purposes only.