Should one rely on cryptocurrencies to generate passive income?

Highlights

• Crypto users can generate passive income from lending out their accumulated cryptocurrency.
• If a borrower can’t pay back the loan, the deposit, or the “stake”, must be sold to cover the losses.
• Remember that crypto is a volatile asset, meaning between the time when it’s lent out and the time it’s paid back, the value of that crypto might fluctuate or deflate.

A lot of financial experts talk about the benefits of earning passive income. This is regarded as any income which is generated without the investor doing anything towards it. Whether you’re aware of it or not, if you have an amount stashed away in a savings account, you’re likely already earning passive income in the form of a savings interest rate, although, right at this moment, that percentage is quite low. The Commonwealth bank, for example, offers only around 0.29% per annum as an introductory rate.

On the other hand, property ownership is the most tried and true way of generating passive income. You have to sell the property or use the appreciated value as leverage to borrow more capital to reap the benefits.

Another passive income earner is through investing in shares. It's due to this that an investor receives a share of a company’s earnings or profits. This payout is what’s referred to as a “dividend”.

As cryptocurrency has emerged as an increasingly popular asset class, investors have also found a way to generate passive income through lending on crypto platforms. But what are the risks? And are the rewards worth it? Let’s take a look.

Crypto Lending

Crypto users can generate passive income from lending out their accumulated cryptocurrency. This process – also known as staking – has become increasingly popular in recent times and is an example of decentralised finance where a process like lending money is achieved without the need for an external financial establishment, like a bank.

This is how it works: Investors in a particular digital currency, say Ethereum, lend out part of their crypto to other users of the platform who wish to borrow it. In return, the lender receives interest payments, which are otherwise known as “crypto dividends”.

So, a lender will put a certain amount of crypto into a crypto wallet specifically used for lending. Then, the owner of that wallet (a third party) lends out the crypto to borrowers, who must stake some of their own crypto in case they’re unable to pay back the lender.

Platforms like Bitcoin pay between three and seven percent interest, although the rate is not fixed.

In the event that a borrower can’t pay back the loan, the deposit, or the “stake”, must be sold to cover the losses.

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The Benefits of Crypto Lending

From the perspective of the borrower, crypto lending is great as there’s

• No background checks or

• No personal information is to be exchanged. 

The process is fully automated, meaning that the interest is paid out with minimal effort.

Obviously, the simplicity involved in this process lends itself to risks as there’s no regulation on these platforms, which is why the borrower must stake their cryptocurrency in the event that they lose the borrowed crypto.

The Risks of Crypto Lending

This brings us to the risks involved in crypto lending, which are high considering the non-existence of regulations central to cryptocurrency’s decentralised, peer-to-peer philosophy.

• Borrowing through a crypto platform is not nearly the same as borrowing from a bank. Remember that crypto is a volatile asset, meaning between the time when it’s lent out and the time it’s paid back, the value of that crypto might fluctuate or deflate. Which of these occurs will obviously benefit either the borrower or the lender?

Furthermore,

• There is the question of security. If, as a lender, the lending platform is hacked and the crypto on that platform disappears, there’s little to no recourse for a lender to receive any compensation, particularly if that platform happens to be offshore. In Australia, the only option for a lender is to use an offshore platform, given that none exist yet in Australia. This means if it all goes south, the lender is not protected by any consumer laws.

Is It Worth It?

Financial experts who believe in crypto advise investors to attribute no more than five percent of their portfolio to cryptocurrency. The reason, of course, comes down the highly volatile and largely unregulated nature of crypto markets.

This philosophy should also be able to apply to crypto lending. It is by no means a safe method of generating passive income. Therefore, if you wish to engage this method, do it sparingly and always be mindful that the crypto you have in your wallet can easily be gone in a flash.