A bitcoin savings account gives holders the ability to earn interest on crypto. But how do they work?
Interest from Bitcoin and other cryptocurrencies can be earned in a number of ways. In the current era of zero or even negative interest rates, many investors have ventured outside the traditional financial system in search of a positive yielding returns. A crypto interest account can for some individuals be the solution for rock-bottom yields.
But the crypto investing ecosystem is still young. Bitcoin was created in 2009, making the technology only twelve years old as of 2021. Platforms that offer a type of bitcoin savings account are newer still.
For this reason, investors would do well to first learn crypto basics and conduct their own due diligence when looking to earn interest on crypto. The ways to go about earning that yield range from high-risk and questionable to lower-risk and reasonable. Choosing one method over another could mean the difference between earning a stable yield and losing 100% of the savings offered.
Bitcoin Savings Account vs. Cold Wallet
When it comes to long-term crypto holdings, investors can choose between several options. Two of the best options might be a bitcoin savings account or a cold storage crypto wallet. Each of these come with their pros and cons.
The main benefit of a cold storage wallet would be security. The term “cold storage” refers to funds that have been taken offline where hackers and thieves can’t access them. Bitcoin can be stored in this manner for extended periods of time. Cold storage is thought to be among the safest methods possible to store crypto.
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The main benefit of a bitcoin savings account would be earning a steady return on those savings. While coins in cold storage might be safe, they won’t be earning anything beyond their potential increase in value. Using one of the potential methods to earn interest on crypto ensures that the coin gets put to work generating passive income for an investor rather than sitting idle indefinitely.
Of course, offering up crypto savings in exchange for interest comes with some kind of risk. The risk varies depending on the method, but in situations like these investors have to assume that the organization they entrust their money to will safeguard it completely.
As we’ll see, this may not always be the case.
Four Ways to Earn Interest on Crypto
What kind of crypto interest account is best? It depends on a user’s preference, technical know-how, and risk tolerance.
There isn’t just one kind of official bitcoin savings account. The term loosely refers to any number of ways that holders can earn interest on their bitcoin or other cryptocurrency holdings.
Here are a few of those methods.
1. Crypto Staking
Staking isn’t technically a bitcoin savings account, but it does provide a return for crypto assets in a similar way.
Coins that use a proof-of-stake protocol work differently than those that utilize proof-of-work (like bitcoin). We won’t go into great detail about consensus mechanisms here, but proof-of-stake involves token holders “staking” their coins for a chance at winning the next block reward. Staking can be an involved, technical process, or it can be as easy as keeping coins in the right wallet on an exchange.
Some exchanges have everything set up on the backend so that all a user has to do to earn staking rewards is hold coins in their hot wallet. Typically, staked coins have to be locked up for a period of time, but some exchanges have worked things out to allow users to move their coins at any time while still earning regular rewards. This method obviously requires learning how a crypto exchange works first.
Keep in mind that staking rewards will be denominated in the token of choice, meaning if that token goes down in price, so too will any rewards.
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2. DeFi Protocols
One of the riskier types of cryptocurrency savings accounts might be decentralized finance (DeFi) protocols.
Some DeFi projects automate the borrowing and lending process. This means that smart contracts govern the loans.
Borrowers like this because they can get a loan with no credit approval necessary. Lenders like it because they can get high yields when lending out capital. Searching for yield in this manner is sometimes referred to as “yield farming.”
While the system can be great for everyone when it works, it can also be catastrophic when it fails. There have been several reports of DeFi protocols either having programming bugs in them or being outright frauds from the beginning. In either case, investors can lose everything and have no recourse.
DeFi platforms typically don’t have to follow any cryptocurrency regulations, making them a sort of “wild west” kind of environment for investors.
3. Exchange Wallets
Some exchanges reward users for holding stablecoins in their exchange wallets. Dollar-pegged stablecoins like USDC and DAI might be eligible for these kinds of rewards.
The interest earned is typically as low as 0.2% or as high as 2%. The upside to this kind of arrangement is that it might not require investors to do anything out of the ordinary. Simply buying stablecoins and holding them in the appropriate wallet could do the trick.
The potential downsides are that the interest earned could be very small (although still greater than fiat currency held in a bank) and not all exchanges will offer this feature.
4. Third-Party Savings Apps
A number of centralized cryptocurrency savings accounts have sprung up in recent years. These are organizations that facilitate the borrowing and lending of crypto assets. Users typically earn a high yield, although not as high as DeFi protocols.
An upside of these apps might be that they offer a good balance between risk and reward. They also tend to be user-friendly and have good customer service, making them ideal for beginners.
The drawbacks might be that these kinds of accounts come with the same third-party risk as anything else. Depositing coins requires entrusting your crypto to those who hold it, and there may or may not be an insurance fund for when things go wrong.
The processes of these organizations are not always transparent, either. It can be unclear how exactly they provide depositors with yield or what kind of risk is being taken.
In an era of ultra-low interest rates, some investors have turned to the cryptocurrency market to earn additional yield. While the crypto universe isn’t appropriate for all yield hungry investors, some measures like crypto staking, DeFi and savings apps may provide a solution.
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Photo credit: iStock/Delmaine Donson
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