Jul
30
2021
Crypto Diversification: Can You Diversify with Crypto?

Crypto Diversification: Can You Diversify with Crypto?

By | Growing Wealth, invest, Investing | Comments Off on Crypto Diversification: Can You Diversify with Crypto?

In 2021, as bitcoin and cryptocurrencies have become more of an acceptable asset class to many big investors and institutions, many retail investors might find themselves wondering if it’s worth having an allocation to crypto in their own portfolios.

Is investing in cryptocurrency worth it? Should crypto diversification be a part of every investor’s diversification strategy? Here’s a closer look.

What is Diversification?

Diversification involves spreading investments across different asset classes in an attempt to minimize risk and maximize returns. A diversification strategy often involves making investments across different sectors of the economy and within particular sectors.

The factors that make an asset good for portfolio diversification will vary depending on an investor’s existing holdings. One of the main goals is to ensure that if a particular sector or asset class takes a dive, the event won’t decimate the entire portfolio.

Ideally, a well-diversified portfolio will see gains in other areas when certain areas see corrections. In this way, downside risk can be mitigated even amidst the many unpredictable factors that come with investing.

Here are a few examples of assets that can be used to create diversification in a portfolio.

REITs

Real estate investment trusts (REITs) are tradable securities that give investors exposure to real estate. REITs also provide shareholders with a substantial portion of their income in the form of dividends.

Furthermore, there are different types of REITs, and these could provide even more diversification. Some REITs specialize in commercial real estate, like shopping malls. Others hold residential real estate like single-family homes, apartment complexes, and condominiums. There are even REITs for the healthcare industry and data centers.

Recommended: Pros and Cons of Investing in REITs

ETFs

Exchange-traded funds (ETFs) can serve many purposes as part of an asset diversification strategy. There are ETFs for almost anything imaginable.

An ETF typically holds a basket of securities that aims to recreate the market performance of a particular index. Or the ETF could simply be a collection of top stocks in a particular sector, making it easy for investors to gain exposure without having to pick specific stocks. For instance, thematic ETFs focus on niche sectors like electric cars or artificial intelligence.

Recommended: Benefits of Exchange-Traded Funds (ETFs)

Gold

Gold is an asset that investors might diversify with. Other precious metals investments like silver, platinum, and palladium also fall into this category. Gold is what’s known as a “safe haven asset,” meaning people prefer it during times of uncertainty.

Holding gold can serve as a financial shelter during times when other asset classes see increased volatility or subpar returns. During the initial panic of early 2020, for example, gold performed well at a time when stock markets around the world witnessed historic corrections.

Gold is sometimes compared to Bitcoin when it comes to asset classes and diversification. Investors may consider both as a long-term store of value (though Bitcoin’s volatility makes it somewhat unstable in that regard), a hedge against inflation, and a non-correlated or less-correlated asset.

Recommended: Bitcoin vs. Gold

Asset Diversification With Crypto

One of the key reasons some market observers see crypto as a potential choice for asset diversification is because it sometimes isn’t correlated with other asset classes.

Bitcoin was positively correlated with the S&P 500, the benchmark index for U.S. equities in the fall of 2020. However, the correlation between the two dropped in February 2021, as the cryptocurrency market surged ahead. The 90-day correlation between the two dropped to 0.21 from a high of 0.5 in October.

Meanwhile, Bloomberg reported in May 2021 that some of the volatility of Bitcoin was spilling over into the stock market . A study by Singapore-based DBS Group found that S&P 500 futures contracts tended to post bigger swings after Bitcoin swung 10% up or down in the span of an hour.

How to Diversify a Crypto Portfolio

Once someone has learned the crypto basics and made the decision to diversify with crypto, they might then start asking whether or not they should diversify within crypto. In other words, should they invest in different types of cryptocurrency other than bitcoin?

The answer can be complicated and dives deep into what cryptocurrencies are and how they work. Bitcoin may be the easiest to understand as it only has one use case at present, and that is to serve as digital gold (a store of value) that can be easily divided and transferred among individuals (a medium of exchange).

Most other cryptocurrencies have myriad potential applications and tout themselves as being decentralized solutions. After learning how a crypto exchange works, investors are likely to be exposed to many different tokens.

Bitcoin vs. Smaller Coins

Bitcoin is the largest crypto by market cap and has the highest hash rate of any proof-of-work coin, making it the most secure network and the most liquid market. It was also the first cryptocurrency created and therefore has the longest track record. These features make Bitcoin the investable asset of choice for many large investors, despite the crypto’s ongoing volatility and extreme price fluctuations.

Smaller and newer crypto assets can see high returns in short periods, but their risk is also higher by several orders of magnitude. Many altcoins have seen their values plummet by 90% or more over time, with some going to 0.

Some courageous investors sometimes choose to speculate on the value of an altcoin’s alleged use case through regular crypto trading. These investors are similar to venture capital or angel investors who take on substantial risk for the hopes of finding a rare jackpot or “unicorn” project. This is an available option, but not one well-suited to the average investor with lower risk-tolerance.

Different Strategies for Crypto Diversification

Here are some ways investors can try to diversify within the crypto market:

1.   Different types of crypto: Stablecoins, altcoins, Bitcoin itself–investors can seek coins and tokens that have different backgrounds and histories.

2.   Different crypto market caps: Larger market-cap crypto tokens and coins include Ethereum and Bitcoin, but there are smaller ones, like Tezos, Aave, Theta, and more, that investors may also want to consider.

3.   Different crypto industry focuses: Some cryptocurrencies focus on payment, others on video or the Internet. Investors can seek out different industry focuses.

The Takeaway

While the cryptocurrency market is volatile and not suitable for every investor, there can be benefits to this market, such as periods of time when it’s less correlated to other asset classes and offers a form of diversification.

Photo credit: iStock/Eoneren

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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Jul
30
2021
5 Strategies for Day Trading Cryptocurrency

5 Strategies for Day Trading Cryptocurrency

By | Growing Wealth, invest, Investing | Comments Off on 5 Strategies for Day Trading Cryptocurrency

The term “day trader” comes from the stock market, where trades generally only happen during regular business hours on weekdays. One notable difference when day-trading cryptocurrency is that crypto markets stay open 24 hours a day, 7 days a week.

For would-be day traders, it helps to know some day-trading basics along with a few things to know before investing in crypto in this manner.

First, What is Day Trading?

Day trading is a short-term trading style involving trades that are bought and sold during the same trading day. This is also sometimes called “intraday trading.” Day traders attempt to use intraday trading strategies to profit from the price moves of a particular asset or financial instrument.

Recommended: What Is Day Trading?

Things to Know About Crypto Day Trading

There are two market conditions that must be present for day trading to be profitable:

•  Liquidity: Traders need to be able to enter or exit trades quickly without moving prices too much. In a market with low liquidity, slippage—when a large position can’t be liquidated at the price a trader desires—could eat into a trader’s profits. With slippage, the position must be sold in increments, with each order having a lower price than the previous one, leading to smaller gains overall by the time the whole position has been sold.

•  Volatility: A lack of volatility means prices aren’t moving, and there’s no chance of buying low and selling high. Because day traders try to buy and sell during the same day, markets have to be going up and down on a short-term basis for this strategy to be viable.

Crypto mining could also play a role in markets at times. If miners are selling most of their coins as they mine them, this could increase downward pressure on prices for a time.

5 Day Trading Crypto Strategies

On a multi-year timespan, simply holding certain cryptocurrencies has been a profitable strategy in some cases, not in others.

So when considering how to invest in crypto, one strategy might be to just buy and hold. This can be especially true during crypto bull markets, when corrections tend to be short-lived. However, it’s also important for investors to remember that Bitcoin and other cryptocurrencies are highly speculative investments. Just because an investment has risen in the past, that doesn’t mean it will continue to do so.

For investors specifically interested in day trading, there are numerous strategies to try. Technical analysis might be among the most popular strategies, as entire communities of traders have sprung up around this school of thought.

One thing’s for sure: having a rule-based trading strategy of some kind is a must for short-term traders. Here are five strategies for day trading cryptocurrency.

1. Technical Analysis

Technical analysis (TA) involves using mathematical indicators and chart patterns to try and predict which way prices will move next. Some technical indicators are simply generated with a computer program like TradingView (RSI, for example), while others must be identified by humans looking at charts (the cup-and-handle pattern, for example).

One popular technical indicator is the relative strength index (RSI). This appears as a single line beneath a chart with a value between 0 and 100. The closer the RSI gets to 100, the more overbought conditions are thought to be, meaning prices could fall. The closer the RSI gets to 0, the more oversold conditions are thought to be, meaning prices could rise. This is one example of how someone day-trading cryptocurrency might use TA.

2. News and Sentiment Analysis

While it’s less popular among short-term traders, looking at headlines and overall market sentiment can also be used in crypto day-trading. Sometimes, big news items can move crypto markets quickly.

For example, on the day this article was written in mid-April 2021, the nation of Turkey announced that it would ban Bitcoin and other cryptocurrencies as payment options within its borders. This sparked a global crypto market selloff, with Bitcoin falling about 3.2% initially and more than 10% later.

Additionally, there are websites that attempt to track the sentiment of the most popular cryptocurrencies by analyzing Twitter chatter. More positive tweets about a crypto equals more bullish sentiment, while more negative tweets equals more bearish sentiment—or so the theory goes.

3. Range Trading

Range trading assumes that prices tend to move within a certain range. Using this strategy involves looking at candlestick charts and support and resistance levels.

Traders might buy when prices reach a support level and sell when prices reach a resistance level. Or they might go short when prices hit resistance and close out the short when prices fall to support.

Pivot points are an example of range-bound trading. Calculating pivot points gives investors an idea as to what price levels are likely to see reversals in momentum.

4. Scalping

This strategy involves trying to profit from very small price moves over short periods. Often these are market inefficiencies like gaps in the bid-ask spread or gaps in liquidity.

Because they are aiming to take advantage of tiny price movements, “scalpers” often trade using leverage like margin or futures contracts to amplify their gains. This also amplifies potential losses, however, so managing risk is especially important with this strategy.

Scalpers might utilize strategies like volume heatmaps, order book analysis, or a range of technical indicators to determine entry and exit positions for their trades.

Due to the fast-paced and high-risk nature of scalping, it’s better suited for experienced traders.

Recommended: What Is Scalp Trading and How Does It Work?

5. Bot Trading

Bot trading, or high-frequency trading (HFT), involves the use of algorithms and trading bots that can be programmed to execute a large number of trades very quickly. Using this method requires knowledge of advanced trading strategies and programming.

While crypto trading bots conduct the trading itself, high-frequency traders don’t simply sit back and let a computer program do all of the work. Trading bots involve coming up with a specific strategy, developing the appropriate program to execute that strategy, and then constant monitoring, backtesting, and updating of the algorithms to keep up with changing market conditions.

There are some pre-made trading bots available for purchase from certain dealers. One thing to keep in mind when considering such a bot is this: if the bot is profitable and easy to use, why isn’t everyone using it, and why are its creators selling it rather than using it themselves?

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Which Cryptocurrency is Best for Day Trading?

It depends on what’s currently happening in the crypto markets. As mentioned, liquidity and volatility are key for any day trading strategy, so any cryptocurrency with sufficient liquidity that is showing high volatility could be a good option.

It’s difficult to pinpoint specific examples—as any coin mentioned could be irrelevant by the time you read this article. Such is the volatile nature of cryptocurrency.

Crypto Day Trading: Taxes and Regulations

It’s important for traders to educate themselves about the rules and taxes associated with day trading in their area. For example, two important things for day traders to be familiar with are short-term capital gains taxes and the wash sale rule.

Short-term capital gains taxes apply to the sale of any asset that was held for less than a year. This means any earnings are taxed as regular income or at the “marginal rate,” so based on an investor’s tax bracket. The IRS changes these numbers every year in order to adjust for inflation. For the 2021 to 2022 tax rate, the rates ranged from 0% to 37%.

The wash sale rule is also a must-know for day traders. This rule prevents investors from taking a loss on their taxable income when they sell a security then buy the same security within the next 30 days.

There are many more nuances regarding taxes and day trading. Traders should consult with a certified tax professional to understand all the necessary details for their own situation.

What Are the Downsides of Day Trading Crypto?

The majority of people who engage in day trading lose money. An estimated 85% of professional money managers underperform their market benchmarks. Timing the markets can be difficult, and human traders now compete with sophisticated computer bots.

Another issue is trading fees. Every trade involves a small fee, and these fees can quickly add up when making large numbers of trades. Some crypto exchanges, such as Binnace, have their own exchange tokens that provide users a discount when paying trading fees in the form of that token. Even then, day traders still have to subtract fees from their profits.

The Takeaway

Day trading is a strategy that involves buying and selling stocks throughout the course of the trading day to try and turn a profit. With crypto, the trading “day” is even longer, as crypto markets are open 24/7. That said, day trading can be an especially risky pursuit, with no guarantee of profits.

Photo credit: iStock/MF3d

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.
First Trade Amount Bonus Payout
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$50 $99.99 $10
$100 $499.99 $15
$500 $4,999.99 $50
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Jul
30
2021
Blockchain in Finance: What Does it Mean for Fintech?

Blockchain in Finance: What Does it Mean for Fintech?

By | Growing Wealth, invest, Investing | Comments Off on Blockchain in Finance: What Does it Mean for Fintech?

While investors and asset managers have mixed opinions on the future of cryptocurrencies, many agree that blockchain–the technology that enables crypto trading–holds the potential to transform many different industries.

Blockchain technology is the infrastructure that makes trading Bitcoin and thousands of other cryptocurrencies possible. Invented in 2009 by a person or group known as Satoshi Nakamoto, a blockchain is one example of what’s known as distributed ledger technology (DLT).

Distributed ledgers keep records of transactions spread across different servers in multiple locations. Blockchains are special types of distributed ledgers that are immutable (they can’t be changed) and decentralized (they’re outside the control of a single entity).

Understanding Blockchain Basics

Blockchain technology processes transactions into groups referred to as “blocks.” Each new block gets attached to the block that came before it, creating an ever-growing chain of blocks. This is where the term “blockchain” comes from. Altering the data inside any single block would require changing the entire chain, something which requires massive amounts of computing power and is almost impossible in most cases.

However, the data held in blocks can take many forms, not just financial transactions. The ability to create an immutable, transparent, decentralized ledger of data creates many new possibilities. In addition to altcoins, several other industries outside of cryptocurrency are looking at different blockchain applications, including Fintech.

Blockchain Applications in Fintech

There are myriad ways that financial services can make use of blockchain technology. Most of them currently exist in a proof-of-concept or pilot phase, meaning their real-world applications have yet to be consistently utilized or widely adopted.

Payments

Payment systems represent the most tried-and-true use case for blockchain in finance, since that’s essentially how crypto trading works. Sending money across national borders using the traditional financial system takes a long time, and can get costly as each intermediary that facilitates the transaction receives a fee. Blockchain has the potential to make this process faster and more affordable by enabling things like:

•  Fast and secure cross border payments

•  Multiple forms of payment – cryptocurrency, stablecoin cryptocurrency, etc.

•  Reduced fraud risk through digital Know Your Customer (KYC) and Anti-Money Laundering (AML) data

•  Smart contracts, digital agreements between two parties that get stored within the blockchain.

Insurance

Blockchain could allow insurers to more efficiently handle claims. IBM reports that it is already using blockchain technology to help clients automate underwriting, settle claims, and reduce fraud.

Asset Management

When it comes to asset management, blockchain financial services can help real estate funds, private equity firms, venture capital firms, and similar institutions. These groups often find themselves to remain compliant with changing regulations and improve risk management. Blockchain security could also offer an additional layer of protection for their assets.

Blockchain improve efficiency in asset management through:

•  Tokenization of securities, leading to greater liquidity and market access

•  Customizable privacy settings for confidential transactions

•  Reduced human errors in shareholder voting

•  Improved governance with greater transparency for investors

•  Automation of other tasks

Regulatory Compliance

Keeping up with the pace of regulatory change can be challenging for some financial institutions. That’s especially true when an organization conducts business across national borders and exposes itself to regulatory frameworks in multiple jurisdictions. Blockchain can help in ways such as:

•  Programming digital assets with specific governance attributes

•  Eliminating human errors that occur in manual processes

•  Improving network governance

Potential Drawbacks of Blockchain in Finance

As you can see, there are a variety of ways that fintech and blockchain could improve many cumbersome tasks that people and organizations deal with today. The main benefits have to do with increases in speed, automation of complex processes, and “trustless” processes, meaning a central entity doesn’t have to be trusted with information or transactions.

There are also a few potential drawbacks, though. They mostly have to do with the impracticality of creating and maintaining an independent, decentralized blockchain.

Maintaining Decentralization

Decentralization democratizes blockchain by making it resistant to central authority and makes things more secure by eliminating any single point of failure. But when a single organization creates its own blockchain for specific purposes, they might be the only ones with an ongoing incentive to maintain it. This could lead to the nodes becoming centralized, somewhat defeating the purpose of having a blockchain in the first place.

Recommended: 51% Attack: A Threat to Decentralized Blockchain

Trust Issues

With the Bitcoin blockchain, users trust the transaction data because Bitcoins are “born” on that blockchain. From the moment Bitcoin is mined into existence, everyone can see where coins go and what wallets they’re in. However, most of the potential use cases for blockchain finance involve assets that were not born on-chain (insurance claims, securities, loans, titles, etc.). For this reason, it’s possible that the data being put onto a blockchain in this manner could contain mistakes or inaccuracies.

Environmental Concerns

The blockchain requires massive computing power, which makes it an inefficient industry from an energy standpoint.

Recommended: How Much Energy Does Mining a Bitcoin Consume?

The Takeaway

Creating a blockchain in finance, while appealing in principle, might be hard to do in practice while still preserving the unique features that make a genuine blockchain desirable. Still, the technology holds significant promise for improving the way that many financial transactions occur.

Photo credit: iStock/Eoneren

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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Jul
15
2021
Compound Finance (COMP), Explained

Compound Finance (COMP) in DeFi, Explained

By | Growing Wealth, invest, Investing | Comments Off on Compound Finance (COMP) in DeFi, Explained

What Is Compound Finance?

Compound Finance is a marketplace used by crypto investors to lend and borrow their digital assets. Compound crypto is a decentralized protocol, or dApp, built on a blockchain.

Users can also vote on the governance structure of the Compound protocol using the COMP token.

Compound is part of a new system of decentralized finance enabled with the invention of blockchain technology. It’s built by the open-source software development company Compound Labs.

Before diving into the details of Compound Finance, let’s explore the topic of decentralized finance. This will help with understanding how Compound fits into the picture.

» Looking for more guides? Check out our crypto glossary.

Compound Crypto and Decentralized Finance (DeFi)

DeFi is an important term in the crypto ecosystem. The philosophy behind DeFi is to decentralize the full suite of financial services available to individuals and businesses. These include insurance, taxes, lending, borrowing, credit, and more. In decentralized finance, there is no need for a centralized body or intermediary such as a bank to hold money, facilitate, or validate transactions. Decentralization can also apply to the way cryptocurrencies are created and governed.

Many DeFi services are built on the Ethereum blockchain. The blockchain allows anyone to build decentralized applications (dApps) with their own unique cryptocurrencies. These applications can utilize smart contracts which allow for complicated transactions, lending, borrowing, and other functionality.

Despite the growth in DeFi and cryptocurrency there are still many financial services left to be decentralized, such as lending and borrowing. Compound is a liquidity pool that allows cryptocurrency owners to lend and borrow their digital assets.

Recommended: A Guide to Decentralized Finance (DeFi)

How Does Compound Finance Work?

Compound is a dApp that gives users the ability to crypto stake their digital assets and lend or borrow certain cryptocurrencies. Supported assets on Compound include:

•  Ether (ETH)

•  Dai (DAI)

•  Ox (ZRX)

•  Tether (USDT)

•  USD Coin (USDC)

•  Wrapped BTC (WBTC)

•  Sai (SAI)

•  Augur (REP)

•  Basic Attention Token (BAT)

Anyone who owns those assets can engage in crypto lending or borrowing using Compound without dealing with traditional financial institutions. Compound has gained significant popularity in recent years, there are more than $12.4 billion in assets on the platform.

cTokens

When a user locks in funds on the lending side of the Compound protocol, they receive cTokens, or digital assets representing the amount that they have deposited. cTokens are an ERC-20 token built using the Ethereum blockchain protocol. There are different cTokens for each crypto on the Compound platform, including cETH, cBAT, and cDAI. Users receive the token associated with the crypto they deposited.

Owners of the tokens can transfer, trade, or use them on other dApps. The tokens will continue to earn interest on the Compound protocol while they are being used throughout the DeFi ecosystem. cToken holders control their public and private keys just as they would with Bitcoin or another cryptocurrency. Ultimately the cToken can only be redeemed for the particular crypto that it represents.

Interest Rates

The Compound protocol automatically calculates and issues interest rates based on the liquidity available for each cryptocurrency offered on the platform. The rates fluctuate based on supply and demand in the market and change constantly. If there is a lot of money held in the Compound wallet, the interest rates are low. This is because there is a lot of money available for borrowers, so lenders don’t earn very much in exchange for adding more to the pool.

However, if the pool of money for a particular cryptocurrency is small, the interest rates are higher. This creates an ongoing incentive for users to lock funds into pools that contain less funds, so that they will earn a higher rate. It also incentivizes borrowers to borrow from large pools and to repay borrowed funds into smaller pools so that they will pay lower interest rates.

The Compound dashboard shows an annual interest rate which is what users get quoted. Every 15 seconds, any cTokens held by a user increase by 1/2102400 of the quoted annual interest rate for that particular moment. That fraction is the number of 15 second blocks there are in a year.

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Compound Finance Transactions

Lending and borrowing transactions occur instantly using the protocol. There are no intermediary requirements or costs involved, it’s only required that borrowers have deposited funds on the lending side. The decentralization and automatically executionable smart contracts make the process easier, faster, and less expensive than going through a traditional financial institution.

Lending

Those who own these cryptocurrencies can lend any amount of them, also referred to as locking, sending, or depositing. This is similar to depositing fiat currency into a savings account that starts earning interest immediately. However, unlike depositing into a bank account, the Compound dApp is decentralized, and the money goes into a large pool along with other investor’s deposits of any particular cryptocurrency. Whichever crypto the lender deposits is the currency in which they’ll receive payments.

Borrowing

The other main feature of the Compound protocol is the ability to borrow against deposited and locked funds. Any user who puts part of the cryptocurrency portfolio into the Compound pool can immediately borrow against those funds without any credit check or additional requirements. The amount a user can borrow depends on how much they deposit, and each cryptocurrency has different rates.

Borrowers must deposit more than they intend to borrow to ensure that their funds are collateralized. This means there are funds available to pay off the loan if the user doesn’t pay back the installments and interest. Cryptos also fluctuate in value, so if the collateralized amount decreases in value, the borrower cToken smart contract automatically closes when the value gets close to the borrowed amount. If this occurs, the borrower keeps the cTokens they borrowed but they lose the collateral they deposited.

Just like if they borrowed from a bank or other financial institution, borrowers must pay interest on the amount of funds they borrow. The Compound protocol automatically determines and implements the interest rates, which varies with each cryptocurrency on the platform.

How Does Compound’s Governance Work?

The Compound protocol also has a decentralized governance system in which users can participate, depending on the amount of COMP tokens they hold. COMP tokens are governance tokens, and all lenders and borrowers receive a particular amount of them every 15 seconds when an Ethereum block is mined. The amount users receive is related to the interest rates of each crypto asset and the number of transactions that they partake in using the protocol.

When a user owns 1% or more of the total supply of COMP tokens, they can participate in the governance system by submitting and voting on any proposals to make changes to the Compound blockchain system. Every COMP token counts for one vote.

The Takeaway

The DeFi ecosystem is constantly expanding to include more options for decentralized financial services, including Compound Finance. DeFi is a complicated system of decentralized exchanges that provide an opportunity for some crypto investors to lend or borrow their digital assets.

Photo credit: iStock/ijeab

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount Bonus Payout
Low High
$50 $99.99 $10
$100 $499.99 $15
$500 $4,999.99 $50
$5,000+ $100

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09
2021
What is the Bitcoin Lightning Network? How Does it Work?

What Is the Bitcoin Lightning Network? How Does It Work?

By | Growing Wealth, invest, Investing | Comments Off on What Is the Bitcoin Lightning Network? How Does It Work?

The Lightning Network, or “Lightning” for short, provides a way for Bitcoin users to make small transactions without hefty fees or long confirmation times. While it’s not yet available to the average Bitcoin user, this innovation could one day solve Bitcoin’s biggest problems—high transaction fees and long confirmation times—both of which make smaller everyday payments unfeasible.

On the list of things to know before investing in crypto, Lightning doesn’t even crack the top five. But it may be an interesting topic for those interested in the technical side of blockchain technology, and for those who want to use Bitcoin as a means of payment.

What Is the Lightning Network?

Lightning is a decentralized network that uses smart contract functionality in the Bitcoin blockchain to facilitate instant payments across a network of users. It’s considered an off-chain or layer-2 solution because it involves activity that doesn’t occur directly on the blockchain.

Why Does Bitcoin Need Lightning?

Due to its decentralized nature, which requires consensus across a broad range of different computers, the Bitcoin network can only process about 7 transactions per second on average. Compare this to 24,000 transactions per second on average for a traditional credit card company like Visa.

Transaction fees, while still relatively low for larger transactions, are too high for micropayments. Sending $5 worth of Bitcoin on-chain isn’t often worth it because the fees would be so large. At times of high network congestion, the fees could even exceed the cost of such a small transaction, making it impossible.

It also tends to take several minutes, if not longer, for a Bitcoin transaction to be confirmed by the network.

Imagine buying a cup of coffee with a direct transaction on the Bitcoin blockchain. After payment, the merchant would have to wait at least a few minutes to receive the funds. The basics of Bitcoin don’t make everyday use easy. The debate over the problem of how to make Bitcoin scale has led to a number of Bitcoin forks since 2017.

Lightning provides a creative solution for these problems.

How Does the Bitcoin Lightning Network Work?

First, users must establish their own multi-signature Lightning wallet, and the two parties involved exchange a single key to validate their spending transactions. In this way, the transactions are kept from being broadcast on the main Bitcoin blockchain while also being verifiably accurate and real.

These off-chain (layer 2) transactions occur independently of on-chain (layer 1) transactions and don’t have to be updated on the main blockchain unless the two parties open or close a channel. Many Lightning Network transactions can occur before their record is broadcast to the blockchain. In this way, fees and confirmation times are greatly reduced.

Lightning uses multi-signature scripts and smart contracts to achieve its goals. When two parties initially fund a channel, this is called a “funding transaction.”

In effect, people are creating their own mini lightning networks when they open a Lightning wallet. Sometimes these multi-signature lightning wallets are referred to as “payment channels” or simply “channels.”

Example of How Bitcoin Lightning Network Works

As more and more people connect to Lightning, they don’t always have to create their own multi-signature wallet for each and every person they want to transact with. As the network grows, so do connections between wallets, and so long as there is a wallet with sufficient funds that the transaction can be routed through, then new users may be able to make use of existing wallets.

For example, imagine that James opens a channel with his local hardware store and deposits $50 of Bitcoin. His transactions with the hardware store can now be facilitated using the Lightning Network instantly.

Heather, who has a different channel open with her local smoothie shop, buys hardware from the same store as James. The connection between James, the grocery store, and Heather makes it possible for James to buy smoothies from the smoothie shop using the Lightning balance he has with the hardware store. Heather can also use her smoothie shop balance to facilitate transactions with other businesses within James’ network.

If Heather were to close her channel with the smoothie shop, then James would have to open a new channel with the smoothie shop to make Lightning purchases there, assuming there are no other available channels open. But as the Lightning Network grows, the idea is that in time, many different customers will have channels with many different merchants, and there will eventually be enough channels for everyone.

Lightning Network Developers

Who is developing the lightning network? There are a number of startups working on different implementations of lightning Bitcoin. The three main developers are listed below, each of them using a different programming language. Input is given from other members of the bitcoin community as well.

Lightning Labs

Lightning Labs focuses its efforts on creating a working model of the Lightning Network. The company is currently developing a Lightning Network Daemon written in the Golang programming language.

Blockstream

Blockstream is known for the creation of satellites that serve as backups for the Bitcoin blockchain in the event of anything catastrophic happening to miners or the electrical grid on Earth.

When it comes to Lightning, the company is working on a version written in the C programming language.

ACINQ

The company is developing Lightning using the Scala programming language.

It’s worth noting that while these versions are written in different languages, tests have shown that the three primary implementations could be interoperable, meaning they could all work together.

Pros and Cons of the Lightning Network

Perhaps the most important benefit of the Lightning Network is that it will allow Bitcoin to scale. Users will be able to make instant micropayments using Bitcoin without paying high fees. The famous example is buying a cup of coffee with Bitcoin, which is all but impossible at present due to high network fees and slow confirmation times.

One con includes the fact that as of the time of this writing, Lightning is not quite available for practical use. Because the project is still under development, it hasn’t yet been universally applied to real-world applications.

The average user will have difficulty making transactions using the Lightning network. Unless someone runs their own Lightning Bitcoin node, they won’t be able to receive payments while offline, and may or may not be able to open a channel with another person or merchant (who must also be using Lightning).

Can You Make Money Running a Lightning Node?

Running a Lightning node doesn’t involve anywhere near the kind of rewards that mining bitcoin does. There are several reasons someone might want to run a Lightning node, such as helping the Bitcoin network scale, increased privacy for personal transactions, and bypassing censorship in areas where governments have heavily regulated crypto and crypto exchanges.

Making money is not an incentive for running a Lightning node, however, as it typically doesn’t pay more than a few pennies per month at most. The hardware required to run a node will cost about $200-400 on average.

The simplest of tips for investing in Bitcoin might be to not run a full node unless you have a good reason or want to support the growth of the technology.

The Takeaway

The Lightning Network is a layer-2 solution that provides a way for Bitcoin to scale. It is still in the early experimental development phase, but once it becomes fully developed and widely adopted, it could help make Bitcoin more widely used as a digital medium of exchange.

Photo credit: iStock/MicroStockHub

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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