Lending and borrowing cryptocurrencies is becoming an increasingly important sub-sector of the crypto industry, one that may end up shaping how the underlying assets themselves are valued and priced in markets. Since many crypto enthusiasts invest in crypto with a long-term mindset anyway, the idea of letting assets generate a return regardless of the price appreciation of the underlying asset is an appealing one to many.
With the rise of Crypto Savings Accounts that promise high annual percentage yields (APYs), investors now have the potential to boost their earnings for crypto deposits.
What is a Crypto Savings Account
The concept behind Crypto Savings accounts is similar to that of traditional savings accounts. You as a crypto owner can deposit your assets into a crypto savings account, which are then lent out on your behalf by a third party provider, earning you interest for your deposits.
The key difference when it comes to crypto savings accounts is that instead of depositing fiat currency, you will instead keep your funds in the cryptocurrency of your preference. Your funds may also be exposed to the volatility and price fluctuations of the crypto market.
A crypto wallet is not the same as a crypto savings account, with the main difference being that the latter accrues interest whereas a crypto wallet does not. If you just keep your coins in a wallet where you own the private keys or in an exchange wallet, your investment will not earn any interest. To earn money for your crypto, you will need to open an account with a provider and deposit funds into your crypto savings account.
For a comparison between providers, check out our guide to the Best Crypto Savings Accounts 2022.
How Does It Work
Before you open a crypto savings account, it is probably a good idea to fully understand what these products are and how exactly they differ from traditional savings accounts.
In the case of a traditional savings account, when you deposit money, you give permission to the bank to loan out the money to third parties. And in return, you earn interest from the bank.
Similarly, when your money is invested in cryptocurrencies like Bitcoin or Ethereum, the cryptocurrency savings account provider will loan out the crypto to borrowers, and provide you a certain pre-arranged rate of interest on your crypto. The interest rates depend on many factors such as the current market rate.
You can also earn interest on stablecoins, which are fixed to the value of the US dollar if you don’t want to be exposed to cryptocurrency price fluctuations. Because the crypto market is speculative, these accounts should be viewed as investments rather than savings accounts, because that is really what they are at their core.
Crypto Savings VS Traditional Savings
Despite sounding similar, crypto savings accounts have some very distinct differences from traditional savings accounts.
- Interest Yields – Crypto savings accounts offer much higher rates of return than traditional banks, reaching as high as 8% to 12% APY. To put this in perspective, the average savings account yield sits at just 0.06% APY according to recent data by the FDIC.
- FDIC Insurance – Major banks have insurance from the Federal Deposit Insurance Corporation (FDIC). This insurance guarantees that, even if your bank loans out the money you deposit into your account, your funds are protected. You won’t lose money when you put it into a traditional savings account because the FDIC backs your account. Crypto savings accounts do not have FDIC insurance.
- Access to Funds – In a traditional savings account, you are free to withdraw your money at any time with no fees or restrictions. Crypto savings accounts may limit access to your coins for a set period of time after you deposit them into your account. They may also charge you a fee for withdrawing your funds before a select date. However, many platforms do not have minimum lockup periods, allowing you to take out your investment at any time. These platforms are also open 24/7, unlike traditional banks.
Benefits of Crypto Savings Accounts
Crypto savings accounts have several positive impacts both to the individual investor as well as to the overall cryptocurrency economy.
- Passive Income – Crypto savings accounts provide an automated method to grow crypto portfolios over time. For someone already fully invested in bitcoin, they simply need to deposit that bitcoin into a crypto savings account and can immediately earn additional interest paid in bitcoin.
- Greater Liquidity – Crypto savings accounts provide an incentive to convert fiat currency into cryptocurrency. By drawing in more participants to the crypto economy, greater liquidity can be attained leading to eventual price stability for the asset.
- Increased Adoption – Long time holders of crypto are incentivized to move their crypto out of storage and into the markets, facilitating adoption and helping innovate new use cases for crypto.
- Higher Demand – Interest rates are important in financial markets because they fill the gap between people with a surplus of assets and the people who need the assets because they have a use for them. High interest rates being offered can be seen as high demand for the underlying crypto assets.
Risks of Crypto Savings Accounts
While the prospect of earning 8% or more in a savings account seems attractive, investors should know that there are also risks involved. Cryptocurrency in general comes with risk and one should only invest once they are fully aware of the risks associated with these investments.
- Price Volatility – The value of cryptocurrencies are volatile and can easily lose their value. Cryptocurrency is not backed by the government so if something happens to cause it to lose its underlying value, then investors would lose their principal invested amount.
- Lock Up Risk – Some crypto savings accounts are very flexible, allowing investors to withdraw at any time. Others may have lock up periods or additional fees for excessive withdrawal activity. Generally speaking, the more restrictive accounts will offer the higher interest rate while the more flexible accounts tend to offer the lower interest rates. Make sure to do some research before committing to a provider.
- Pledge Risk – When you deposit your assets into a crypto savings account, you no longer control the crypto and are pledging it as collateral. For example, when you deposit at a bank you are staking a claim to a bank’s liability. It is a similar situation with the crypto savings account. If the crypto provider goes under due to a mismanagement of their business or an adverse market event, you will not be able to get your assets back.
- Smart Contract Risk – Decentralized finance (Defi) lenders use automated coding called smart contracts to loan and allocate capital. This coding is viewable by everyone so it is quite transparent. Everyone is incentivized to make sure the coding is solid. However, a previously undiscovered error in a smart contract may open the door for a hacker to find their way in. Though not exempt from the risk, lenders who have been around longer and whose products have stood the test of time are generally less likely to be exposed.
Things to Consider Before Getting Started
Thanks to the rising popularity of crypto savings accounts, there has also been an increase in the number of providers. But how do you know which platform is the best choice for your investment needs? Here are some of the things you should research before selecting a crypto savings account:
- Compound interest
- Crypto market availability
- Security
- Supported coins
- Withdrawal restrictions
- Private key access policy
- Loan-to-value (LTV) rates
Compound Interest
Compound interest is calculated based on both the initial deposit and the accumulated interest. It will make a sum grow at a faster rate than simple interest, which is calculated only on the principal amount. Not all providers offer compound interest so before deciding, it is recommended to inquire whether or not they apply compound interest to their savings accounts.
Crypto Market Availability
It is preferable to choose a savings account that has crypto market access. This will help you buy crypto through the platform and set up your account. Having access to the market also saves a lot of time and documentation.
Security
One of the most important aspects of choosing a crypto savings account is its security measures. Every company has its own security policies to safeguard the assets you save, so it is recommended to look for savings account providers who offer two-factor authentication (2FA).
Apart from 2FA, many companies also provide cold storage as an additional layer of security.
Supported Coins
Thousands of cryptocurrencies are available in today’s market, and there is nothing worse than selecting an account provider that does not support the coins you are holding. Before you deposit your crypto into an account, be sure to verify that the provider supports that crypto.
Withdrawal Restrictions
Some crypto savings accounts have withdrawal limits that cap the amount you can take from your account over a specific period of time. These withdrawal limits can put your money out of reach when you need it most, like during a financial emergency. Not only that, but you may also have to pay fees to withdraw your money. These fees can add up if you are an active crypto trader who makes a lot of transfers in and out of your account, in which case it would be more beneficial to find a provider that offers unlimited free withdrawals.
Private Key Access Policy
Unlike traditional savings accounts that allow you control over your money, not all crypto savings accounts allow you to keep control over the keys to your crypto. Noncustodial wallets like Coinbase leave you in control of the private keys to your crypto. You are the sole owner of your digital assets across transactions on the platform. Custodial accounts like Nexo require you to hand over your private keys, trusting the platform to manage it on your behalf. Thus, it is recommended to always verify the company policy related to crypto key access and understand ownership swapping.
Loan-To-Value (LTV) Rates
Another important point to research is the loan-to-value rates or the LTV rates. The LTV rates represent what the platform is ready to risk. It must be noted that the more robust LTV a platform has, the better it is for you.
Bottom Line: Should You Open A Crypto Savings Account?
While a crypto savings account can produce exceptionally lucrative returns for long-term investors, it is important to remember that the cryptocurrency market is known for its volatility. Crypto savings accounts might accrue interest like a traditional savings account, but they do not have the same financial protections that are awarded to traditional banking institutions.
If you do decide to open a crypto savings account, treat it as an investment account instead of a separate checking account. Keep your emergency funds somewhere safe, and never invest more money than you can afford to lose in cryptocurrency.
FAQ
Crypto savings accounts work in a similar way to traditional bank savings accounts. In a nutshell, you lend money to an institution which lends your assets to borrowers in need of liquidity. Except, crypto savings accounts deal exclusively in cryptocurrencies and stablecoins.
Yes. Every crypto savings account provider has its own security policies to safeguard your assets. It is recommended to look for account providers who offer two-factor authentication (2FA) and/or cold storage.
That depends on the platform you use and the type of cryptocurrency you deposit. As an example, FTX lets account holders earn up to 8% APY on all crypto deposits, while BlockFi offers up to 9.5% APY on stablecoins.
No. Considering the volatility of the crypto market, there are a lot of risks associated with crypto savings accounts. These accounts should be viewed as investments rather than savings accounts.
Sources:
https://www.forbes.com/sites/robertfarrington/2021/05/17/what-are-the-risks-of-crypto-savings-accounts/?sh=61b866591417
https://apyguy.com/best-crypto-savings-accounts/#What_are_Crypto-Based_Savings_Accounts
https://www.coinratecap.com/en/blogDetail/advantages-and-disadvantages-of-crypto-savings-account
https://financeplusinsurance.com/risks-associated-crypto-savings-accounts/
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