The short version
- Just like with a traditional savings account, you can also earn interest on your holdings in your crypto accounts.
- The major strategies for earning crypto passive income include staking, cryptocurrency savings accounts, and yield farming.
- Crypto is volatile any you may have to lock in your assets for a set amount of time before you can sell, however the potential for rewards is high as well.
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About earning interest from cryptocurrency
When you put cash in a savings account at a bank, it pools your money with other savers and lends that capital out for mortgages, business loans, credit cards, and other allowed purposes. While the bank keeps most of the income, it passes on a portion to savers like you, which is how you earn interest from your savings.
With cryptocurrency, you can also earn interest from lending to others, but there’s no bank involved. Depending on how you proceed, you could lend to someone else directly without an intermediary.
Every type of crypto passive income has advantages and disadvantages. There’s a wide range of risk levels and rates of return, which is typically measured in annual percentage yield (APY).
Best methods of earning crypto passive income
While smart contracts and decentralized autonomous organizations (DAOs) offer practically limitless opportunities to earn income from cryptocurrency, these are some of the most common and straightforward methods of making passive income with crypto.
Staking
Different cryptocurrency blockchains use different methods to verify transactions. However, blockchains using proof-of-stake (PoS) generally pay rewards to users who hold a currency balance.
Sometimes those payments are automatic when you hold a minimum balance. With others, the holder may need to use a specific type of wallet or go through a process to stake their currency and earn.
Some currencies that pay staking rewards include Algorand, Cosmos, Ethereum, Tezos, and Cardano. Check your cryptocurrency exchange account or wallet settings to learn more about staking options.
More: Best crypto staking and lending platforms?
Crypto savings accounts
A crypto savings account takes care of investing your cryptocurrency and gives you a share of the rewards. This works much like placing your money in a bank account, except the crypto savings account provider then uses your funds for staking, yield farming, and other cryptocurrency activities.
Some providers have recently paid as much as around 8% APY for deposits of stablecoins, which are always pegged to the dollar (or another government currency). However, note that unlike cash that's held inside a bank account, your crypto assets inside these accounts will not be FDIC-insured. Some top places to save and earn interest include BlockFi and Gemini.
More: To crypto savings accounts for 2023
Yield farming
With yield farming, you pool your funds with other cryptocurrency owners to earn a return. If you’ve read about decentralized finance (DeFi), you already know that yield farming is a core part of how it works. Yield farming can contain several components that lead to varying risk and reward opportunities. You can find yield farming opportunities through online exchanges like PancakeSwap or Uniswap and dedicated DeFi services like Curve or Aave.
Typically, yield farming involves contributing to a liquidity pool. A liquidity pool is a large pool of crypto assets used to facilitate transactions at decentralized exchanges (DEXs) or they may be used for lending or other financial services. You will need to use a cryptocurrency software wallet like MetaMask to directly deposit your crypto in a yield farm, though some exchanges may facilitate this.
Note that yield farming can be extremely risky. You may have to lock your funds in for some time. Currencies can lose value while locked away, and you can’t sell until the contract period has been fulfilled. Also, depending on the yield farm, you may need to own volatile, risky currencies to participate.
More: Centralized and decentralized exchange: which is right for you?
Direct lending
If these lending protocols and yield farms sound too complicated, you can also lend directly to others through some platforms, in a somewhat similar fashion to social lending platforms like Lending Club and Prosper. Loans are facilitated by smart contracts, literally removing the middleman. Smart contract terms facilitate loans between two or more cryptocurrency wallets.
While some of these loans include automatic repayment or holding collateral, they’re far from risk-free. As with any investment, it’s essential to understand where your money is going and how repayment works. If you can’t figure that out or it isn’t made clear, you should look for another platform that better suits your needs.
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Risks & benefits of passive income strategies
In your search for cryptocurrency earning opportunities, you may find yield farms or liquidity pools which pay more than 100% APY. As the saying goes – in finance and anything else in life – if it seems too good to be true, it probably is.
The cryptocurrency world is filled with scammers and big promises that don’t pan out. In either case, you could wind up with unexpected losses. It’s critically important to only work with trusted DEXes and DeFi services. If you let the wrong smart contract access your wallet, you could lose everything with no way to recover lost funds.
Cryptocurrency income & taxes
The IRS will almost certainly want a cut when you earn money from any source, including cryptocurrency investments. If you’re staking, yield farming, lending, or earning any kind of income, you must track and report it with your annual tax return.
The income generated by passive income strategies is likely to be counted as regular income. Any gains on the value of those assets are considered capital gains. And any losses can offset other cryptocurrency or investment losses.
Cryptocurrency taxes can be complex. So it’s a good idea to take advantage of crypto tax software, like Koinly or CoinTracker, to ensure you’ve accounted for every transaction. For example, of you earn daily rewards for half a dozen currencies, that’s over 2,000 transactions per year. It’s very challenging to track your taxes accurately without software when you use any of these income strategies.
More: Tax guide to cryptocurrency investments
Pros & cons
Pros
- Earn a return on investment from cryptocurrency holdings
- Potentially high reward rates
- Participate in the DeFi economy
Cons
- Some passive income strategies are extremely risky
- Intermediate to advanced computer skills are required for some methods
- Funds may need to be locked away for a period of time
Is passive cryptocurrency income right for you?
Investing in cryptocurrency is risky and not for everyone. If you are interested in putting a portion of your assets into digital currencies, however, it might make sense for you to take advantage of the DeFi ecosystem to amplify your earnings. If you’re holding cryptocurrency, it’s worth investigating what your options are when it comes to passive income.
BlockFi Bankruptcy Notice -On November 10, 2022, BlockFi announced that it had to suspend withdrawals from its platform due to the FTX liquidity crisis. As a result, consumers should not be using the BlockFi platform. As of November 28, 2022, BlockFi officially declared bankruptcy.
Further reading:
- Which passive investment ztrategy is right for you?
- How to spot a crypto scam
- How to trade cryptocurrency (in 6 easy steps)
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