The prices of leading cryptocurrencies like bitcoin (BTC 3.89%) and Ethereum (ETH 1.85%) routinely move 10% or more peak to trough in a given week. For investors, this level of volatility can be stressful and frustrating. However, if you believe in crypto's long-term thesis, volatility can work in your favor.
Exchanges like Nexo, BlockFi, Gemini, and Coinbase (COIN 2.01%) pay attractive interest rates on bitcoin, Ethereum, stablecoins, and other leading tokens. Like regular banks, these companies make money by lending assets to customers at a higher interest rate than they pay. Let's dive into a few different crypto assets and their interest rates to determine which one may be best for you.
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1. Ethereum: Bold, dynamic, but very risky
Bitcoin tends to garner the spotlight when it comes to cryptocurrency discussions, but the real star over the last year or two has been Ethereum. Despite being down over 50% from its high, Ethereum is still up 190% year to date and over 800% over the past year.
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Ethereum has gained recognition for its versatility. For example, several well-known alternative coins like Chainlink and Polygon are hosted on the Ethereum blockchain. Most non-fungible tokens (NFTs) operate on Ethereum's blockchain as well. An NFT represents digital ownership of an asset, whether it's a piece of art, a title to a car or house, or an NBA Top Shot moment.
In this way, Ethereum's blockchain is similar to a smartphone in that it can host many different applications that serve different purposes. One of the most exciting use cases of Ethereum is for smart contracts. Contract law can be very complicated. A smart contract, hosted on the Ethereum blockchain, enables two willing parties to enter into an agreement that automatically executes based on the outcome of customized conditions. The advantages are immense. As a 2018 Harvard Law School paper puts it, "Human intervention, including through a trusted escrow holder or even the judicial system, is not required once the smart contract has been deployed and is operational, thereby reducing the execution and enforcement costs of the contracting process."
Sergey Nazarov, the founder of Chainlink, used the example of crop insurance to describe the use of a smart contract. To paraphrase, crop insurance can be purchased by a farmer in case of a drought, flood, or another circumstance that prevents crop yield. A smart contract could be written that automatically pays a predetermined amount of insurance based on a fixed set of risk factors. The advantages are that there's no need for payment middlemen, a legal authority, or other entities gumming up the process. In theory, its simplicity would make the contract more transparent, more accessible, and cheaper by cutting out third parties.
Entities like BlockFi pay up to a 4% annual percentage yield (APY), distributed monthly, on Ethereum. Coinbase pays 0% APY on Ethereum, but it does offer 5% APY if a customer chooses to stake their Ethereum tokens. Ethereum is transitioning from proof-of-work to proof-of-stake, which could help the token's governance and shrink its environmental footprint. Staking prevents a user from trading Ethereum until this process is complete.
2. Bitcoin: Established, simple, but still risky
Bitcoin is far less dynamic than Ethereum -- its simplicity is what makes it so attractive. A limited supply and a network that has proved its stability despite numerous hacking attempts have helped bitcoin garner international recognition. Bitcoin is far too volatile to be considered a viable currency, but its use cases as a commodity, particularly as a store of value, are becoming clear.
Contrary to popular belief, bitcoin doesn't have to replace fiat currencies to become successful. Rather, it can be a globally recognized vehicle that provides value in cases of economic instability. Think hyperinflation, government coups, or a lack of safe and secure banks. Bitcoin's benefits aren't as practical in the U.S., because we have the U.S. dollar -- the world's de facto fiat currency. But elsewhere, there's a need to store value in a place that is safe from disruption.
As the largest and best-known cryptocurrency, bitcoin tends to pay lower interest rates than other coins. Coinbase currently does not pay interest on bitcoin, but BlockFi offers an APY of up to 4%, and Gemini pays a little over 2% interest.
3. Stablecoins: A riskier version of a savings account
Unlike bitcoin and Ethereum, stablecoins represent tokenized versions of the U.S. dollar. They are meant to trade at an unwavering $1 per token, meaning they lack the upside that Ethereum and bitcoin have to offer. Two leading stablecoins, USD Coin (USDC 0.01%) and Gemini Dollar (GUSD -0.10%), act as secure methods of payment that provide liquidity and stability to cryptocurrency exchanges. They are backed dollar for dollar by real U.S. cash held in banks. As with a savings account, virtually every crypto exchange offers interest rates on stablecoins. BlockFi pays 7.5% interest on the first $50,000 of both USDC and GUSD. Gemini Earn, a savings platform from Gemini, pays 7.4% interest on GUSD but not USDC. And just a few days ago, Coinbase released a brand new program that pays 4% APY on USDC.
USDC's circulating supply is valued at $25.8 billion, much bigger than Gemini's $268 million. USDC is accepted by more exchanges and benefits from higher liquidity, but Gemini is unique in that it is tied to the Gemini exchange. As a U.S. company, Gemini claims it is regulated by the New York Department of Financial Services. Therefore, "GUSD reserves are eligible for FDIC insurance up to $250,000 per user while custodied with State Street Bank and Trust." The fine print indicates the FDIC insurance only applies to USD reserves, not the tokens themselves, since they are categories under self-custody and hosted on the Ethereum blockchain.
The bottom line
Just like stocks, Ethereum, bitcoin, and stablecoins like USDC and GUSD all have different roles to play in a portfolio. Investors may find it useful to predetermine the percentage of their overall investment portfolio that they want to be tied to crypto and then focus on allocation.
For example, a risk-tolerant investor could allocate a higher percentage of their crypto portfolio to Ethereum, whereas a risk-averse investor may lean toward bitcoin and stablecoins. High interest rates from stablecoins could serve as a unique opportunity for income investors interested in the crypto space to get a sizable return almost as good as the average annual return of the U.S. stock market. No matter the allocation, an investor should probably avoid cryptocurrency (including stablecoins) altogether if they don't think the asset class will grow.
