Better Than Your Bank: A Primer on the Benefits and Risks of Crypto Earning

The ability to earn rather than buy your cryptocurrency has always been an important aspect of the crypto community. Unfortunately, for many who are new to the blockchain space, the days of being able to mine hundreds of Bitcoin with just your home computer are long gone. However, there are now more inclusive ways to earn cryptocurrency, and while the idea is still new, crypto-earning platforms could soon make central banks start to sweat.

What is Crypto Earning?

While most people are familiar with Bitcoin and Ethereum miners, for the high-tech, slightly mysterious subset of individuals working the blockchain for paydirt, using high-powered computers stuffed with GPUs, that's not the only way to earn your coins.

Investors looking to earn coins or tokens without spending $20,000 on mining equipment can still participate in community initiatives by way of Proof of Stake. POS is an alternate consensus method used by certain blockchains to secure the network and validate transactions.

While the first Proof of Stake coin, PeerCoin, was introduced as early as 2012, the rise of DeFi and Ethereum's announcement that it would be moving to Proof of Stake has revitalized this once controversial consensus method and sent it into the mainstream.

Now, the only thing stopping you from earning hefty returns on your coins is knowing where exactly you should put your money. Your return will depend on the level of risk you're willing to stomach, the lock-up terms you choose for your coins or tokens, and whether you plan to go with a centralized or decentralized earning platform.

Centralized vs. Decentralized platforms

Like all things in cryptocurrency, or even just investing in general, there is always a risk. The world of cryptocurrency is still very much the wild west, mostly lacking regulation and consumer protection, and putting your trust in the wrong hands can often lead to disaster. Investors who previously lost their Bitcoin fortunes to shady platforms like Mt. Gox will be quick to warn you: "Not your keys, not your coins," a popular saying in the crypto community.

This saying stems from the fact that when you are using a centralized platform, you do not control the private keys to your wallets. That means that, unlike your private wallet, which can't be taken from you, funds kept on platforms owned by someone else are always at risk to some degree of being lost to insolvency, have a higher risk of theft, or can even be seized should your country's flavor of cryptocurrency wane in some way. Part of the appeal of Decentralized Finance (DeFi) platforms is that you are in control of your private keys and recovery phrases, allowing you to participate without giving up wallet ownership.

So why would you ever use a centralized platform, then? Well, in its current iteration, DeFi is not as user-friendly as it could be. There are a lot of ways to make a mistake, and many people simply are not interested in or prepared to be a custodian of their own finances.

This is part of the reason why central banking and credit cards have become a consumer staple; they provide protection to the user. With a non-custodial wallet, this protection is gone. You're responsible for your own private keys and recovery phrase, and if you lose those, then you're certainly out of luck, but you won't be alone. It's estimated that between 2.78 million and 3.79 million Bitcoin have been lost in this manner.

While if you use the custodial wallet, support can come to the rescue in most cases if you lose access to your account or if you were to perhaps send your coins to the wrong wallet, which is an easier mistake to make than you might think. Especially with cross-chain confusion now coming into play.

Earning on custodial vs. Non-Custodial Platforms

Custodial Platform Earning

A custodial platform, such as Nexo or Celsius, simply pays out an advertised interest rate on held cryptocurrencies, just like your bank savings account. Earnings typically go up if you are willing to commit to a longer lock-up term, which is great if you are long on an investment.

You will, of course, not earn as much as you would using DeFi, but your risk is mitigated as long as you trust the platform. This is because these platforms are taking on much of the risk of blockchain finance for you. In return, they take a cut of the profits for themselves.

Interest is paid out daily or weekly, typically in the same currency that you are staking, making it a good way to grow your holdings while you wait. It's the simplest way to earn if you are not technologically inclined or are risk-averse.

These platforms make money by doing their own staking or lending, at varying degrees of risk, and typically also provide other services that allow them to profit off of trade or transaction fees from the users of the platform.

What are the Risks of Custodial Earning Platforms?

Custodial platforms are not without risk. Besides the fact that you are typically not in control of your private keys, management of the exchange can also be an issue. While the platform's job is to absorb risk, if they get into trouble, things could go south quickly, and your investments could be at risk if the company becomes insolvent.

Custodial platforms are not immune to bug exploits or the will of overbearing governments. Hackers exploiting smart contract vulnerabilities or damaging new regulations could put your holdings at risk. Celsius is estimated to have lost $50 million in the Badger DAO exploit. This loss was not passed on to the consumer, but should a loss be large enough to put a platform out of business, it could be. Even FDIC-insured exchanges only offer protection to the fiat currencies in your account.

Non-Custodial Platform (DeFi) Earning

While DeFi staking is much more complicated and more risks are involved, the potential for profit is also greater if you are willing to take those risks. There's also a greater variety of ways to earn going the DeFi route when compared to a centralized earning platform.

You can participate in yield farming, which is essentially becoming a liquidity provider to a platform that provides lending services to traders. Or, you could stake your assets and become a validator for transactions, helping to secure the network, similar to what miners do in Proof of Work setups. You can also participate in liquidity mining, a process that rewards you with native tokens or governance rights rather than a standard APY yield like yield farming does.

Each of these methods of earning has its own benefits and dangers, so it's imperative that you thoroughly research each method before deciding on one. There's a very real risk of losing your initial deposit if you aren't careful.

What are the Risks of Non-Custodial Earning Platforms?

In addition to worrying about potential vulnerabilities in the smart contracts you are utilizing and liquidation, higher-yield currencies are often highly volatile, and shady platform providers can quickly throw a wrench in your plan, like when Sushi Swap's developer decided to sell all of his tokens, plummeting the price of the currency by 50%, and leaving investors high and dry.

It's important to realize that pretty much anybody can create a token or even an entire platform for something like yield farming overnight, often anonymously, and in a faraway country, outside the reach of your country's legal jurisdiction.

This is why it's important to make sure to research not just the type of Defi activity you wish to pursue carefully but also to be sure to vet the platform you intend to do it on properly. Spreading your investments across multiple platforms can also help to avoid a total loss of assets.

In short, both custodial and non-custodial platforms have their own unique benefits and dangers. It's important to know what you're getting into before putting your life savings into a risky situation in which there could be no way out if things go badly.