What is a crypto interest account?
A crypto interest account is a type of financial product that pays you interest for depositing your crypto. These accounts are offered by companies operating in the crypto industry.
It's like a savings account at a traditional bank. The exception being that crypto interest account deposits are often not federally insured (like FDIC insurance in the U.S), and instead of depositing a fiat currency (like USD, EUR, CAD, or JPY), you deposit a cryptocurrency.
What is Staking?
When you stake a crypto asset, you're taking part in the economic security of the underlying blockchain that secures the asset itself. By staking a crypto asset, you're in effect bonding your asset to help the blockchain function.
The incentive for bonding your asset to secure the network is known as a staking reward. You're free to remove your initial staked asset whenever you want, but when you remove it, you stop receiving these staking rewards.
In effect, you earn a yield for staking. Not all cryptocurrencies have staking. Bitcoin, for example, does not have staking. Polkadot and, soon to be Ethereum do.
What's the difference between a crypto interest account and staking?
On the surface, a crypto interest account and staking look like the same thing. Both crypto interest accounts and staking are ways to earn a yield on your crypto. Behind the scenes, however, they operate differently.
A crypto interest account is a type of account offered by a company where you deposit your crypto assets, and the company pays you an interest rate for doing so. Similar to depositing funds into a savings account, companies that offer crypto interest accounts use the funds deposited to make loans to borrowers. The interest rate spread between what a company pays to depositors and what they earn from borrowers is how these companies profit.
Staking is a process where you get rewarded for helping secure a blockchain network. You "deposit" your crypto asset into a staking system, and in return, you receive rewards for doing so. When you withdraw your staked asset, you stop receiving rewards.
Both crypto interest accounts and staking pay the depositor a yield for their deposited assets. Crypto interest accounts pay a yield because of financial design. Staking pays a yield because of crypto-economic design.
Why are savings rates in crypto so high? What's the catch?
Interest rates in crypto are generally much higher than more traditional assets because cryptocurrencies are a volatile asset. They carry more risk to hold. Even dollar-backed stablecoins have volatility risk because they are not, in themselves, legal tender as backed by a national government.
Like a traditional bank, the companies that offer crypto interest accounts take your deposits and lend them out to borrowers. The difference between what a company earns from lending and the interest paid to depositors is how they make money.
These companies that lend out crypto charge high-interest rates to borrowers because of the higher volatility risk in cryptocurrency markets. The higher interest rate charged to borrowers translates to these companies being able to pay high interest rates to depositors into crypto interest accounts.
It should also be noted that since many of these crypto interest accounts are not federally insured (like being FDIC insurance in the United States), the companies that offer crypto interest accounts need to pay higher interest to attract depositors.
What should I look for in a crypto interest account? How would I know my funds are safe?
The majority of crypto interest accounts don't have any federally mandated deposit insurance. This means that if the company offering the crypto interest account becomes insolvent, you could lose your deposit.
However, some of the more reputable crypto interest account providers have private insurance to cover depositor funds if the company gets into financial trouble. Be sure to check with the account provider to see what sort of guarantees they have.
It's also important to note where the company offering the crypto interest account is located. Companies located in the United States and Europe, for example, are far more heavily regulated than in other countries. Also, check to ensure they have the proper money service business licenses and credentials to operate a crypto business in their jurisdiction.
Lastly, companies that offer crypto interest accounts will use their deposits to lend out to borrowers at a higher interest rate. Like a traditional bank, if a borrower cannot repay their loan then the lender takes a loss. If losses pile up too quickly from borrowers who cannot repay their loans, then the lender could become financially insolvent.
To counteract this insolvency risk, many companies that offer crypto interest accounts require borrowers that they lend out to, to over collateralize their loan.
For example, if someone wants to borrow $1000 worth of crypto from one of these companies, the company may require the borrower to place $2000 worth of crypto collateral. If the borrower cannot repay their loan, the company making the loan can use the $2000 collateral to recoup their losses. Depositor funds remain safe and whole.
Your crypto deposits are likely to be safe if they are deposited with a company that requires borrowers to over collateralize their loan. Make a note of this when you're researching which crypto interest accounts to deposit into.
Why should I earn interest on my Crypto?
Quite a number of crypto assets have inflationary mechanisms designed into them. For example, every year, new Bitcoin gets created and released into circulation. Over time, if you hold your Bitcoin, you'll get diluted down in terms of the total percentage of Bitcoins you earn. Earning interest on your Bitcoin allows you to stay ahead of the inflation and accumulate more BTC.
The same can be said for other crypto assets such as Ethereum, Chainlink, and others. By earning yield on your crypto assets, you'll be able to maintain or even grow your percentage ownership of all coins in circulation.
Crypto economics aside, if you're a long term hodler (holder) of a crypto asset, why not use it to earn more crypto on top of what you already own? Compared to traditional markets, the yield rates in crypto are significantly higher.
We always advise you to do your own research when it comes to yield earning products and services in crypto. Always go with reputable companies and services that have the proper regulatory licenses to operate with cryptocurrencies.