Crypto passive income, it’s everywhere. You may have seen a lot of crazy yields like those over 500,000% APYs for seemingly no work, other than depositing your crypto. With inflation close to over 7% year over year, a lot of people are looking for better ways to get a return on their money. and a lot of them will turn to crypto without doing much if any research.
The question is, are these methods actually legit?
In this article, we’re going to break down in simple terms, what crypto yield is, the different types of crypto passive income yield, and the risks associated with it. There’s definitely a lot to consider when it comes to yield farming and a lot of this is new, and knowing the risks can really guide your decision-making.
Yield Farming
When it does come to yield farming or getting yield on your crypto, it’s usually done in a few ways. You could provide liquidity for a liquidity pool, which will get into. What that is, you could stake your cryptocurrency or you could lend out your stable coins. First, I think it would be helpful to define what yield is in crypto. Yield basically refers to getting paid an annual percentage yield, for lending or staking your cryptocurrency.
In a traditional bank account, if you leave your money in your savings account, the bank will pay you interest for keeping money in that account. They reward you with interest because they’re actually borrowing money from your savings account, and in turn lending it out to other people. I know that might come as a shocker, but that’s how they make money. They charge those people a higher interest rate on the loan than what they pay you in interest. They’re basically pocketing the difference in interest charges.
The concept is similar in cryptocurrency, although it’s not exactly an apples-to-apples comparison. You can still get a yield by lending out your crypto to generate an interest rate or staking your cryptocurrency to a blockchain. You’re also able to receive rewards and fees as well, which doesn’t happen if you own traditional stocks or have money in your savings account.
Risks Involved
Gaining yield on your crypto does come with risk, and there’s no FDIC insurance. Let’s actually talk about what probably the least risky is first, which is,
Staking
Staking occurs when the cryptocurrency you’re holding uses a proof of stake model. If you’re familiar with crypto or even if you aren’t, basically, a blockchain needs to verify transactions, and the way they do it is with something called a consensus model. In the proof of stake consensus model, basically, people put up their own cryptocurrency.
They basically lock up their crypto to help the network secure transactions. In exchange for helping to secure and verify these transactions, you actually get rewards from the network for doing so. The typical annual percentage yield from staking is around four to ten percent, depending on the network and the cryptocurrency.
Cryptocurrencies like Solana, Polkadot, Ether, and Cardano all allow staking to name a few. With Solana, you can actually earn around 5.99% a year. There’s a great website called stakingrewards which basically gives you the details of every single cryptocurrency and the APY offered. If you play around on this website, you can also get a calculator to show your potential rewards with different cryptocurrencies, which I think is pretty cool.
How To Stake
Now, while true staking requires you to run a validator node computer on a blockchain, there are easier ways of staking your cryptocurrencies. You could do it through an exchange like Binance or Coinbase. Exchanges these days will make it super simple for you to stake your cryptocurrency, provided you have that cryptocurrency in your exchange wallet.
All you really got to do is press one button and then boom, you’re staking your cryptocurrency and earning some money on it. You can also stake your crypto through what’s called a staking pool. That’s basically when a group of coin holders combines together, they merge their resources, they stake together, and they actually get to split up the rewards altogether as well. For you not to take on too much risk, you’ll want to stake only the largest and the most well-known cryptocurrencies out there.
Pros And Cons of Staking
The biggest benefit of staking is that if you do it through an exchange like Coinbase or Binance. It’s really easy to do, you’ll get the returns, and you won’t really need those high-resource computers or validator nodes to do so.
The con is definitely a market risk. If the underlying cryptocurrency price plunges, you might be screwed if your cryptocurrencies are locked up while being staked. By the way, I do buy some of my cryptocurrencies on Coinbase, so if you’d like to support this blog and get $10 worth of free bitcoin in the process just sign up to Coinbase using my affiliate link. Thank you for that.
Another way that you can earn a yield on your crypto is through what’s called a
Liquidity Pool
A liquidity pool is pretty tough to understand, but the actual mechanic of how it works can be simplified. Let me use a real-world example, pretend that you got US dollars on you, and you want to convert them to Swiss Francs. You go to your local bank, and you say “hey I’d love to get some Swiss Francs because I’m going to go to Switzerland soon, and here are my US dollars. Can I convert them please?”
If the bank has Swiss Francs, they’ll say something along the lines of “sure, we have some Swiss Francs right now, and based on a conversion rate if you give us a thousand dollars we can give you about 920 Swiss Francs”. If they don’t have Swiss Francs, however, they might say something like “oh man, sorry we actually don’t carry Swiss Francs right now, so we really can’t do this exchange for you. Go look for another bank”
Basically, in that scenario, if they don’t have Swiss Francs on hand, you’re kind of screwed. You’ve got to go find another place to get your Swiss Francs. Now, pretend instead of trying to get Swiss Francs with your dollars, you’re trying to trade one crypto for another.
A liquidity pool in crypto basically solves this problem. It’s a place where both assets that you want are trading, and they’re pulled together with algorithms. It doesn’t matter what time of day it is, it’ll always be available. If it’s like our real-world example, the analogy would be that you could show up with US dollars at any given time, and get Swiss Francs at any given time, at the current price all from the comfort of your own computer.
The Differences
To be fair, this also isn’t exactly an apples-to-apples comparison, here are the differences.
1. A liquidity pool is decentralized. There is no bank.
2. It’s just a smart contract or a bunch of if-then statements, allowing people to swap one token for another.
A lot of decentralized exchanges will use liquidity pools as its backbone technology, including popular sites like Uniswap, Pancake swap, and Sushi swap.
Source of The Money
So, where does the money that’s stored in the liquidity pool come from? Well, that my friends is the fun part. Anyone can be a liquidity provider of a liquidity pool. if you’re a coin holder, you can put your coins into this pool to create a market for other people, traders will then use these coins as liquidity to swap for other coins.
How You Make Money
You need two coins to provide liquidity, and it’s typically in the form of a crypto pair. In exchange for providing liquidity within that pool, you get to earn a portion of the trading fees from the swaps that the traders are making within that pool. Using simple math, let’s say you provide $100 of liquidity, and the liquidity pool is worth $1,000. That means you own 10% of liquidity in that pool. If the trading fees for the day are $200, you get 10% of the fees because you own 10% of the pool, or you get about $20 in fees just for providing liquidity.
For example, if you’re using pancake swap, and you’re trying to swap your BNB tokens for CAKE token, you can see while swapping, that there is a 0.17% fee of the 0.25% total fee paid to LP (liquidity providers) token holders. That’s mechanically how the trader swap fees work to pay you.
Cons
In terms of yield, this sounds pretty great. A lot of liquidity pools will try to lure you with extremely high APYs, but you must know that liquidity provides comes with a lot more risk than just staking your crypto.
The biggest risk with providing liquidity is something called impermanent loss, a better word for impermanent loss is actually opportunity cost. This is because, in a liquidity pool, you must deposit two tokens in equal amounts, if the price movement of one of these tokens moves too much, you could actually incur more of a loss than just by holding the token outright.
By putting up liquidity, you’re betting on the low volatility between the two tokens, and you’re collecting yield from the liquidity that you’re providing within the pool. As a really simple rule, the more volatile the assets are within the pool, the more likely it is that you’re exposed to impermanent loss. If you stick to more stable cryptocurrency pairs, you’ll fare better.
Another good rule of thumb is that you should not invest in a liquidity pool if you wouldn’t just hold the token outright.
Yes, I know that part was a little bit confusing especially if you’re a new cryptocurrency investor, so you might want to read it again.
Crazy APYs
Alright, so, what’s with the crazy APYs that we see everywhere? if you actually look at the coin market caps yield farming rankings and sort it by APY, you’ll see crazy numbers such as over 500,000% APY to 1,000,000% APY per year, and a high risk of impermanent loss. This is pretty commonplace in crypto, we see really high crazy APYs, but a lot of people don’t really know what they’re getting into.
The gist is that these new crypto pairings, are offering you an introductory offer to get more money into the pool and attract new investors. As more money pours into the pool, the APY eventually drops. If you look at the coin market caps yield farming rankings, You’ll see that the top APYs only have a few thousand dollars locked up in value, which is not a good sign. Essentially, there’s no money invested into those pairs, and putting up liquidity in such an unproven pair, is probably one of the riskiest things that you can do.
Pancake Swap
While providing liquidity for an unproven pair is super risky, as I mentioned earlier, one of the easier ways to provide liquidity in a less risky way is through a platform like Pancake swap. For a popular pairing like BNB and BUSD, you could earn around 26% APR. If you actually click into the calculator, you’ll actually earn a lot less than that, only around 8% base APY. But, by providing liquidity for this pair, you’ll also earn the native token for pancake swap, which is cake.
This next part is complicated and pretty funny because you’re going to earn cake tokens on top of your LP rewards, then you can actually get additional yield for staking your cake. To summarize, you’re getting paid a portion of transaction fees bonus cake tokens, and those bonus tokens can be staked separately for even more yield. You can actually see how this all kind of gets pretty ridiculous pretty quickly.
For now, all you really need to know is that if you see a crazy high APY being offered upwards of 100,000% or more, alarm bells should be ringing in your head. You should really do your own research before committing any funds to them. Remember our rule of thumb here is, don’t provide liquidity if you wouldn’t just hold the token outright. That’s the takeaway.
Lending Stablecoins
I did want to share one decent method for yield which is actually lending out your stable coins. You can get around 19% to 20% APY right now, through the anchor protocol with Luna on the Terra ecosystem. Anchor protocol is a money market on the Terra blockchain, where you can lend your UST, which is Terra’s US dollar stable coin.
By lending your UST, you earn roughly 19 – 20% APY on your money. And I think in terms of the risk to reward ratio, this is probably one of the better values out there. UST is a US dollar stable coin backed by Luna tokens. It’s a little bit more experimental than USDC for example, and it’s not backed by us dollars one to one.
Therefore, UST inherently carries more risk than USDC but should still be a safer option compared to providing liquidity to an unknown token out there.
How You Get Paid
How does Anchor pay you close to 20% on your money through Terra or UST stablecoins?
Well, there are a couple of ways. Anchor allows people to deposit collateral in order to borrow against their assets. That collateral can then be staked by the Anchor protocol, and they get around 6 – 7% for staking that collateral.
In addition, Anchor charges a high APR for borrowing funds from the protocol itself but incentivizes borrowers by giving them their native token ANC. That’s essentially how they’re able to offer 19% to 20% APY, and in the event that they can’t get there, they also have a yield treasury fund that they’ll sometimes dip into.
Risks
First, the 20% isn’t always 20%, this fluctuates depending on the borrower’s interest charge and how much they’re willing to dip into the yield treasury. If the protocol can’t achieve a 19 – 20% stable APY, and it can’t do that with its natural methods, it’ll then dip into the yield treasury to ensure depositors get 20%. If the yield treasury ever runs out, that’s going to be a risk to the APY they’re offering.
Secondly, the UST stablecoin could lose its peg to the US dollar. Sometimes it fluctuates between $0.94 and $0.98 like in the past. If it ever completely loses its peg, that’s the worst-case scenario.
The third risk is a hack. If something is hacked on the Terra network, and malicious actors are able to get into those funds, well, then you’re screwed. The current Anchor protocol has over 10 billion dollars in total value locked, and many don’t believe it’ll get hacked or go out of business. It’s well tested by others, but of course, everything paying close to 20% APY will carry its own risks, and that’s definitely a higher risk in crypto, nothing is FDIC insured. It’s kind of like the wild west.
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Summarizing
Yield farming is a good way to earn some money on crypto that you plan on holding. Anyway, I hope this article was helpful, if you’re still feeling a little bit lost, you can read over this article again or reach out to me on Facebook and Instagram. As all ways, don’t forget to do your own research. Peace and Happy Hustling!
