While people’s interest in cryptocurrency has skyrocketed, crypto remains a new and speculative investment. Cryptocurrency has the ability to make some people rich in a short period of time, but it is also an extremely volatile high-risk investment. This is where stablecoins, which are pegged to any perceivable stable asset, have gained traction, allowing people to transact in cryptocurrencies more seamlessly. Stablecoins are designed to offer the best of both worlds: cryptocurrencies and traditional finance. They have various utilities including token lending to generate 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 versus reward and do your 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:
- Fiat-backed stablecoins: These coins use a fiat reserve pool as collateral to create a certain number of coins. Technically, the collateral can be oil or gold, but most stablecoins use dollars as their reserves. Example: Tether (USDT) is backed by the US dollar.
- Crypto-backed stablecoins: These coins use other cryptocurrencies as collateral, but since cryptocurrencies are subject to volatility, crypto-backed stablecoins maintain a larger reserve pool of crypto to issue a lower number of coins. rooms. For example, DAI is backed primarily by USD Coin and ETH, but its price is still pegged to the US Dollar.
- Uncollateralized stablecoins: These coins replace a reserve pool with a mechanism resembling central banks. For example, Basecoin (closed in 2018) aimed to maintain stability by automatically adjusting supply tokens as needed.
Why Earn Interest With Stablecoins
Some investors are flocking to stablecoins due to the high volatility of cryptocurrencies. Stablecoins are designed to maintain a fixed value over time, allowing investors to earn passive interest on the assets they own. For comparison, the best interest rate for traditional savings accounts in America only drops to around 0.7% APY; the average national interest rate of the FDIC (Federal Deposit Insurance Corporation) is ten times lower at 0.06%. Instead, the interest rate you can earn with stablecoins is exponentially higher: 3.5% – 12%. Additionally, many stablecoins in the market have proven capable of holding a value extremely close to that of the assets they are pegged to, so their owners are unlikely to experience major price turbulence.
The Other Side of Earning Interest from Stablecoins
Investing in stablecoins also comes with risk, and there are a few concerns that should be considered. For example, money from crypto lending platforms is continuously lent on a very large scale, so there is the risk that multiple parties may not be able to repay the loaned capital due to an extreme stock market crash. This can be minimized by spreading your capital across a variety of platforms.
Moreover, cyber hackers can occur on your personal accounts or on the lending platforms themselves. In the event of a personal account hack, it will be next to impossible to recover the lost funds, so it is entirely up to the 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, platform-targeting hacks are totally out of your control — they’ve happened before, so they’ll happen again. For platform hacks, spreading crypto on many platforms also helps, but remember to only choose companies with a reliable security system, a good reputation and insurance coverage.
How to Earn Interest with Stablecoins
CeFi platforms
There are 2 types of stablecoin lending platforms: CeFi (centralized finance) and DeFi (decentralized finance). For CeFi lending apps, you will need to follow KYC procedures similar to traditional financial platforms. CeFi platforms hold your private keys and manage your collateral, some even offer insurance coverage and keep assets in secure cold storage.
Let’s take Nexo as an example to visualize the lending process in a CeFi platform:
- Visit the Nexo 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 is highly recommended to 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 transfer funds from your wallet/exchange account or buy them directly on Nexo using your bank account.
- Interest should appear after 24 hours and will be paid daily into your savings portfolio. This allows you to automatically earn compound interest.
- Go to “Account” and then “Total Earned” to view detailed information about your interest payments.
DeFi Platforms
DeFi platforms operate differently from CeFi in that they provide services without intermediaries using cryptocurrencies and smart contracts. They offer no insurance coverage for crypto assets in the event of a hack, but give users their private keys and full control of their funds.
The methods for depositing stablecoins in 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 confirming the connection, the process will be almost instantly without registration.
- Choose the amount of stablecoins you want to deposit. You will see all the relevant information such as reserve size, usage rate, APY deposit, etc., and the withdrawal option is usually available on the same screen.