Cryptocurrency savings accounts are growing in popularity among investors looking to earn yield on their long-term holdings of cryptocurrencies. While these investment vehicles are not without risk, they allow investors to earn above-average yields, appealing to a range of different investors.
In this guide, we’ll explain how a cryptocurrency savings account works and why you might want to consider setting one up.
What is a Cryptocurrency Savings Account?
A cryptocurrency savings account is a savings product that allows you to deposit cryptocurrency assets and earn interest. Similar to a normal savings account, regular interest payments are made, and you can withdraw assets according to the platform rules and the type of cryptocurrency you deposited.
Most blockchain networks provide staking rewards (technically, this is not a yield, since staking rewards are primarily derived from network issuance), thereby paying interest-like fees to native token holders. Several centralized cryptocurrency exchanges (CEXs) take advantage of this by offering interest-bearing accounts. To generate returns, they use a variety of methods besides staking your cryptocurrency.
Alternative strategies include depositing your crypto into CeFi lending pools or providing liquidity to trading pools that support DeFi protocols like decentralized exchanges (DEXs).
Cryptocurrency savings accounts use the returns from these activities to pay regular interest on your cryptocurrency deposits.
How Cryptocurrency Savings Accounts Work
Cryptocurrency savings accounts offer a superior user experience compared to complex blockchain protocols. As such, they provide you with an easy way to enter the cryptocurrency ecosystem and earn interest through a centralized platform, unlike the complex onboarding processes commonly found in DeFi protocols or native staking strategies that let users interact directly with the blockchain itself different.
While most DeFi protocols offer higher returns compared to cryptocurrency savings accounts, many users find them cumbersome as interacting with them is a rather unfamiliar practice. Instead, cryptocurrency savings accounts enable you to interact with DeFi protocols through apps or CeFi platforms, which makes it seem a lot easier.
The benefit of using a cryptocurrency savings account via a DeFi protocol is the convenience offered by the former. The main advantage offered by the companies behind cryptocurrency savings accounts is that they can handle some of the risk of putting your funds into DeFi protocols or public blockchains for staking.
Some of these firms have agreements in place to pay customers first if they become insolvent, while others insure customer deposits and work with reputable custodians.
However, as we see in 2022, there are also companies that will collect user funds while insolvent, posing a major risk for cryptocurrency savings account holders.
As we mentioned in Part 1, cryptocurrency savings accounts will use deposited funds to participate in token staking, provide liquidity for automated market maker protocols, or engage in lending activities. The interest paid to lock up your cryptocurrency savings is paid in cryptocurrency, usually at a variable rate. While the interest earned is variable, you are generally guaranteed a fixed minimum percentage rate of return.
Types of Cryptocurrency Savings Accounts: Where Do the Earnings Come From?
There are two main types of cryptocurrency savings accounts: flexible accounts and fixed-rate accounts.
Flexible Cryptocurrency Savings Account
A flexible (or variable rate) crypto savings account is flexible, allowing you to deposit or withdraw your crypto assets at any time. There is no lock-up period for these accounts. Interest is usually calculated daily or weekly. However, the trade-off with these types of accounts is that the interest rates are usually lower.
Fixed Cryptocurrency Savings Account
A fixed cryptocurrency savings account locks your funds for a period of time. The vesting period for locked-in savings typically ranges from 7 to 120 days. After the lock-up period is over, you can redeem your funds (principal) with interest or reinvest in additional fixed-rate reinvestments.
Are Cryptocurrency Savings Accounts Worth the Risk?
Some cryptocurrency savings accounts allow you to earn up to 8% or more APY on your savings. However, these types of accounts are not without risks.
While the level of risk associated with these accounts does not necessarily make them bad products, it is recommended that you understand all of the risks before setting up a savings account and getting started.
One obvious risk is that cryptocurrency savings accounts typically do not have state-regulated deposit insurance. With traditional savings accounts, customers’ deposits are protected, and if a financial services provider becomes insolvent, regulators step in to ensure some losses are covered on behalf of customers. For example, the Federal Deposit Insurance Corporation (FDIC) protects US customers up to $250,000 in the event of bank failure.
As of now, no such guardrails exist for crypto assets. If a company does not provide you with the private keys to the wallets where your savings are stored, you run the risk of losing your funds if the respective company goes out of business.
As recent events in the crypto world have shown, handing over control of your crypto holdings to a third party is a major problem. Essentially, you are handing over your private key to another party. If the party managing your cryptocurrency savings account lends money to other counterparties and then happens to default on payments, you will lose some or all of your Crypto assets.
Another concern is that price fluctuations can affect the cryptocurrencies you hold in a savings account. If you deposit cryptocurrencies such as Bitcoin (BTC) and Ether (ETH) into your cryptocurrency savings account, the total principal amount, as well as payouts in return, will fluctuate based on market conditions. On the other hand, if balances and interest are paid in USD-denominated stablecoins, then it is easy to monitor interest payments.
Typically, traditional savings accounts allow you to withdraw funds at your discretion. From time to time, some cryptocurrency savings accounts limit your withdrawals, allowing you to withdraw money from your account only at specified intervals. Additionally, some cryptocurrency savings accounts charge you for withdrawals. If cryptocurrency savings account providers run into trouble, they may permanently stop withdrawals.
So what does all this mean for you as an individual investor?
Despite the risks, a cryptocurrency savings account offers you the potential to earn returns on your crypto assets. This is especially true if you lock your cryptocurrency or opt for a native token from a cryptocurrency exchange or cryptocurrency savings account provider.
For example, Nexo increases the interest rate to 4% APY for holders who wish to earn a return on NEXO tokens. Cryptocurrency exchanges like Binance and Crypto.com also offer you higher interest rates if you lock coins in your savings account and denominate them in their tokens.
As promising as it is, you should only really open a cryptocurrency savings account on a platform you’re familiar with, one that’s been around for a while, and has a solid reputation. You should also read through the terms and conditions to see if the provider might insure your deposit. What’s more, only invest what you can afford to lose, as cryptocurrency savings accounts are far from risk-free.
Source of information: Compiled from CRYPTONEWS by 0x Information.Copyright belongs to the author, without permission, may not be reproduced