Can you really earn 8%–12% interest per year with cryptocurrency interest accounts?

“Interest accounts” offered by major crypto lending providers like BlockFi, Nexo, and Celsius emerged starting in 2018 and have already attracted billions of dollars in deposits. Their rapid growth is largely because they promise interest rates much higher than traditional bank accounts, generally ranging from 8% to 12% on US dollar deposits. To many, these interest rates seem too good to be true. To explore whether these interest rates are legitimate, we’ll have to cover how banks work, how lending works, and how cryptocurrencies work.

Banks earn money by taking your deposits and loaning them out at the market rate of interest. For example, as of January 9th, 2022, home equity loans have a 6.46% interest rate, and 15-year fixed mortgages have a 2.69% interest rate. After accounting for borrowers not paying them back, administrative costs, and their share of the profit, banks pay interest to their depositors. Right now, because market interest rates are low, brick-and-mortar banks are generally paying under 0.1% and their online competitors with lower administrative costs are paying 0.5%.

Crypto lenders also earn money using the same principles. As of January 9th, 2022, BlockFi charges interest rates of between 4.5% and 9.75% depending on how much collateral the borrower provides.

Collateral is an asset (like a house) that a lender can take from the borrower if the borrower fails to pay back their loan. With crypto lending, borrowers provide cryptocurrency as collateral that can be automatically sold if the price of crypto falls, or if the borrower fails to make payments. Cryptocurrency lending is unusual in that borrowers are willing to provide high amounts of collateral, sometimes 200% more than the amount of the loan, and the collateral can be automatically sold in near real-time if the price of cryptocurrency falls, making it potentially safer than other forms of collateral which are much harder to sell. Of course, in a rapid crash, lenders may not be able to sell their collateral in time to recover the full amount of the loan.

In general, crypto interest rates are higher than bank deposits. Lenders are at a lower risk of losing money due to the high amounts of collateral required for borrowers to provide and the ease of selling collateral to prevent losses. Administrative costs are also significantly lower. In fact, with the emerging area of decentralized finance (DeFi), money is automatically loaned to other people without the need for human involvement. This combination of higher interest rates, safer loans, and lower administrative costs makes it possible for crypto lenders to pay high interest rates to depositors and still earn a profit.

Of course, this doesn’t mean that crypto lending is without its risks. As mentioned above, if the price of crypto crashes, lenders may not be able to sell their collateral in time to fully recover the cost of the loan. However, this is only a risk if you are depositing normal cryptocurrencies into a crypto lending account. Stablecoins are a type of cryptocurrency in which the value of the cryptocurrency is linked to a fixed asset, like the US dollar. We prefer owning USD Coin (USDC), the #2 largest stablecoin, which has the benefit of size without the concerns and associated volatility that surround USDT, the #1 largest stablecoin. Because stablecoins essentially eliminate the risk of collateral loss if crypto crashes in value and allow you to earn a high rate of interest without the inherent risk in converting your money into normal cryptocurrencies and being subject to their market fluctuations, we recommend stablecoin lending for individuals that want to earn money on US dollars (compared to earning extra money on Bitcoins that you own by lending them out).

There are other risks of crypto lending as well, like the providers of stablecoins going under, or cryptocurrency being stolen via hacking. Looking at the numbers, since they emerged in 2018, crypto lending services haven’t caused a single client account to suffer losses, even after considerable shifts in the value of cryptocurrencies (a risk that doesn’t apply to stablecoin lending). Based on these rates, we think a fairly pessimistic projection is that a crypto lending account has a ~6% annual risk of failure. Optimistically, using failure rates for a typical bank, we think a crypto lending account has a 0.5% annual risk of failure. We expect that the true figure for experiencing any type of loss (whether partial or full account loss) with stablecoin lending is in the low single-digit percentage range. This compares favorably to many other investments, like stocks and bonds, which have a much higher likelihood of ending any given year with a negative return (11 out of the last 50 years for US stocks and 5 out of the last 35 years for US bonds).

We think stablecoin lending has a compelling risk-reward tradeoff. We advise viewing stablecoin lending as an investment, and like any investment, we recommend keeping diversification in mind and spreading your money out across other investment types outside of cryptocurrency lending if you decide to earn 8%–12% per year and brave a low (but not negligible) risk of loss every year. We specifically like BlockFi due to their status as a crypto lending market leader, ease of use and deposits/withdrawals, and high interest rates compared to well-known companies that are newer to the crypto lending space like Coinbase and Gemini. It could also be a good idea to spread deposits out across multiple crypto lending platforms for diversification.