This piece provides an overview of the opportunities to generate investment yield within the cryptocurrency ecosystem.
Reminder: this piece is not investment advice or recommendation. Additionally, it is important to recognize that yield generated is often denominated in a given cryptocurrency. The value of the yield will ultimately be a function of the value of the underlying cryptocurrency.
What is Yield?
Yield is income return on an investment, often expressed as an annual percent rate based on the current market value of an investment. Yield received from an investment does not require the investment holder to sell a position to receive income and is separate from the rise and fall in price of the underlying asset. Examples of yield for traditional assets include dividends received from holding shares of a stock, coupon payments on a bond, or rental income from a real estate property. For instance, buying a share of a company that trades at $100/share with a $4 annual dividend would offer a 4% dividend yield at the time of purchase.
Investments that offer yield can be attractive because they provide income, which can be used to meet expenses without needing to sell an investment position. Additionally, there may be psychological appeal to the certainty of a recurring distribution of value. Finally, in some scenarios, income from investments with yield may receive preferential tax treatment.
Cryptocurrency Yield Opportunities
There are a variety of ways to generate yield within the cryptocurrency ecosystem. Some methods require a substantial holding to meet a minimum threshold amount, while others are accessible to all position sizes. Some arrangements may also involve a meaningful lockup period.
Many cryptocurrencies utilize a proof-of-work mining approach to validate transactions and produce new blocks, but some rely on voting through proof-of-stake. In proof-of-stake systems, users lock up their holdings in a smart contract to gain the ability to validate transactions and produce new blocks. Votes are counted in proportion to the amount of cryptocurrency staked such that those with the most value bound up in the network have the most voting power, thereby aligning incentives. Those who stake their holdings and vote accurately are given a small reward. If a user casts a vote in favor of a transaction that is deemed to be illegitimate, the deposit will be slashed and redistributed to other stakers that have voted properly.
Below are a few projects that currently implement proof-of-stake and grant rewards to those who stake holdings:
Decred: Decred uses a hybrid of proof-of-work and proof-of-stake to validate transactions on the network. To participate, stakeholders lock up Decred in return for a ticket, which allows for a single vote to be cast. Upon voting, each ticket returns a small reward plus the price of the original ticket in Decred (more details about the selection and voting process can be found in the Decred documentation). If a ticket holders misses a vote, the ticket is refunded without a reward. If a user cannot run a voting wallet online 24/7, joining a stakepool (a pool of tickets managed by a group that takes care of voting) offers an alternative to avoid this problem for a small fee. As of August 2018, the annual return in DCR of staking is ~15%.
NEO: Holding any amount of NEO allows a user to claims rewards in GAS, the platform’s internal currency that is used to pay fees to create or alter the NEO blockchain. GAS pays for actions on the NEO blockchain and is distributed to NEO stakers proportionally. As of August 2018, annual yield in GAS is ~2–3%.
Lisk: With Lisk, holders can stake to vote for delegates who are responsible for producing blocks. The delegates receive a reward for this service, then share part of the reward with the voters who elected them. As of August 2018, it is possible to earn an annual yield in Lisk of ~5%.
Many other projects implement proof-of-stake and offer rewards to stakers. Also, Ethereum plans to move to proof-of-stake in the near future.
Running a Masternode
Running a masternode is a combination of staking an allotment of coins while also running software specific to a network. Some networks create the tiered system of nodes and masternodes to enable additional functionality by relying on the increased capability of masternodes. One projects that leverages a masternode system is Dash.
Dash — to run a masternode, a collateral position of 1,000 Dash is required (at August 2018 prices levels of ~$150, this comes out to $150,000). After locking up 1,000+ Dash in collateral, dedicated software must be set up and run (more information about setting up and running a Dash masternode can be found here). The annual return expected is a function of the date and number of masternodes running and can be approximated from this table from the official Dash documentation. As of August 2018, with around 4,000 masternodes running, an annual return of ~6.8% can be expected.
A few other cryptocurrencies other than Dash also run a masternode system, like ZenCash and PIVX, but they are less well established.
Income can be generated by lending out a cryptocurrency holding. This opportunity is more difficult to access for smaller position holders, however, though platforms are emerging that allow holders to lend their positions out. There are more opportunities to lend out large assets, like Bitcoin and Ethereum, but some volume does exist for smaller assets. One project working to make lending and borrowing more accessible is Compound. Lenders can expect to receive ~4–10% annually for lending out their holdings, though these values vary widely and are case-by-case in nature.
It is worth noting that the yield received is often denominated in the relevant cryptocurrency involved, and some of the aforementioned opportunities require a substantial lock-up period for the underlying investment. Therefore, it is important that the cryptocurrency being staked and the yield being received ends up being valuable. However, receiving yield on an investment can help investors smooth out the ups and downs of investing and receive income over the life of an investment. Additionally, yield opportunities can increase returns for long-term investments that would be held in any scenario.
I currently work at Bitwise Asset Management, a specialty asset manager, where I focus on cryptocurrency research and analysis.
If you’d like to chat about cryptocurrencies or anything else technology related, Tweet at me here https://twitter.com/phil_glazer (DMs are open, too). You can also email me at email@example.com.
Note: I do not and will not provide investment advice or recommendation.