While people’s interest in cryptocurrency has skyrocketed, crypto is still a new and speculative investment. Cryptocurrency has the ability to enrich some people in a short time, but it’s also a high-risk investment that’s extremely volatile. This is where stablecoins, which are pegged to any perceivable stable asset, have gained traction, letting people transact more seamlessly in cryptocurrencies. Stablecoins are designed to offer the best of both worlds – cryptocurrencies and traditional finance. They have various utilities, among them lending out tokens to generate a high APY.
Read on to learn everything you need to know about stablecoins, including the benefits and risks of earning interest through this seemingly low-risk method, and how to do it. As always, remember to calculate risk vs reward and perform due diligence before investing.
What Are Stablecoins
Stablecoins are cryptocurrencies backed by a reserve asset to maintain a stable market price. There are 3 types of stablecoins:
- Stablecoins Backed by Fiat: These coins use a fiat reserve pool as collateral to create a certain number of coins. Technically, collateral can be oil or gold but most stablecoins employ dollars as their reserves. Example: Tether (USDT) is backed by the US dollar.
- Stablecoins Backed by Crypto: These coins use other cryptocurrencies as collateral, but because cryptocurrencies are subjected to volatility, crypto-collateralized stablecoins keep a larger pool of crypto reserve to issue a lower number of coins. For example, DAI is backed mainly by USD Coin and ETH, but still has its price pegged to the US dollar.
- Non-collateralized Stablecoins: These coins substitute a reserve pool for a mechanism resembling central banks. For example, Basecoin (shut down in 2018) aimed to maintain stability by automatically adjusting the supply tokens based on need basis.
Why Earn Interest From Stablecoins
Some investors flock to stablecoins due to the high volatility of cryptocurrencies. Stablecoins are designed to maintain a fixed value over time, letting investors earn passive interest from the assets they own. To compare, the best interest rate for traditional saving accounts in America only falls around 0.7% APY; the FDIC’s (Federal Deposit Insurance Corporation) national average interest rate is ten times lower at 0.06%. Instead, the interest rate you can earn from stablecoins is exponentially higher: 3.5% – 12%. Also, many stablecoins on the market have proved to be able to maintain a value extremely close to that of the assets they’re pegged to, so it’s unlikely that their owners will experience any major turbulence in price.
The Other Side of Earning Interest From Stablecoins
Investing in stablecoins also comes with a risk, and there are a few concerns that should be taken into account. For example, the money in crypto lending platforms is continuously being loaned out on a very large scale, so there is the risk of multiple parties not being able to pay back the loaned capital due to an extreme market crash. This can be minimized by spreading your capital across a variety of platforms.
Also, cyber hacks can occur to your personal accounts or the lending platforms themselves. In the event of personal account hacks, it’ll be virtually impossible to retrieve the lost funds, so it’s entirely up to users to secure their personal accounts. Some prevention methods include registering on different platforms with different email addresses, setting a separate and strong password for each account, and using two-factor verification. Instead, hacks targeting the platforms are totally out of your control – they’ve happened before, so they’ill happen again. For platform hacks, spreading the crypto across many platforms helps too, but also remember to only choose companies with a reliable security system, good reputation and insurance coverage.
How to Earn Interest From Stablecoins
There are 2 kinds of platforms for lending stablecoins: CeFi (centralized finance) and DeFi (decentralized finance). For CeFi lending apps, you’ll have to complete KYC procedures similar to traditional finance platforms. CeFi platforms hold your private keys and manage your collateral, some even offer insurance cover and keep the assets in secure cold storages.
Let’s take Nexo as an example to view the lending process in a CeFi platform:
- Visit Nexo’s official website, click “Create Account”, and go to “My Profile” to complete the KYC verification. You can choose between basic KYC or advanced KYC (which includes fiat currencies and crypto).
- It’s highly recommended that you navigate to “Security” in the Profile section and enable two-factor authentication by scanning the QR code.
- Go to ‘Account’ to deposit stablecoins. You can transferr funds from your wallet/exchange account or purchase them directly on Nexo using your bank account.
- Interest should be showing after 24 hours and will be paid daily to your savings wallet. This allows you to earn compound interest automatically.
- Go to ‘Account’ then ‘Total Earned’ to view detailed info on your interest payments.
DeFi platforms operate differently from CeFi in that they provide services without intermediaries by using cryptocurrencies and smart contracts. They offer no insurance cover for crypto assets in case of a hack, but give users their private keys and full control of their funds.
The methods for depositing stablecoins into different DeFi lending apps are quite similar:
- You should get a Web3 wallet like Metamask and transfer the stablecoins you want to deposit into that wallet.
- Go to the platform’s website/app and choose ‘Connect Wallet’. After you’ve confirmed the connection, the process will be almost instantly without registration.
- Choose the amount of stablecoins you want to deposit. You’ll see all relevant information such as reserve size, usage rate, deposit APY, etc., and the withdraw option is usually available on the same screen.