How Crypto Compound Interest Works
Learn exactly how interest on interest works and how it can grow your crypto assets.
Compound interest is not a new term, but it's one that's surprisingly overlooked when it comes to cryptocurrency earnings. Most people take it for granted that they'll earn compound interest on a standard bank account. Yet, because of how cryptocurrencies work, investors haven't looked too closely at a buy-and-hold strategy that takes advantage of compound interest. Compound interest is a method of constantly applying interest to a principal that grows over time. Compounding interest works by compounding the interest over a fixed period, which may vary from account to account.
Compound interest (and its close relative, simple interest), are both ways of growing investment over time. The difference between the two methods is based on how fast the initial investment grows. A typical savings account can have either simple or compound interest attached but doesn't usually offer both. But how do these two types of interest differ?
Simple and Compound Interest
Simple interest takes a deposit as its starting point and calculates the value of the interest as a percentage of the principal over time. The interest rate determines how much value the initial deposit will accrue over time. Typically, simple interest is generated as annual interest or paid over a year. Most standard bank accounts earn interest via this simple method, using the calculation:
Simple Interest = Principal amount x Interest rate x Time
Compound interest is a bit different. Instead of this simple formula, compound interest is interest on interest. The person who has a compound interest account earns money on the account's interest rather than just the capital. The compound interest for a particular investment is calculated using the following formula:
Compound Interest = P*(1+r/n)^nt - P
P = Principal r = Interest rate n = Compounding Frequency (how many times the amount will be compounded over time) t = Time
So how do crypto accounts offering compound interest work? If a person decides to borrow money from the crypto bank, the individuals that have their cash deposited in the bank get a certain amount of interest. Borrowing money allows investors to utilize strategies such as yield farming to make the most out of their crypto deposits.
You can learn more about how crypto interest is calculated.
Yearly, Monthly, or Weekly Compounding Interest
Crypto assets that are part of an investment plan earn compound interest in different periods. Typically, in regular investments, compound interest works over an annual period. However, because of the scale and rapidity of crypto investments, compounding on some digital assets may have their own rates. Typically, cryptocurrency compound interest accounts pay interest annually, monthly, or weekly. Some cryptocurrency holdings require you to reinvest the money yourself, while others automatically return the compounded amount into your account.
Crypto APY vs. APR
APY and APR are both interest rates, and they each describe different things:
Annual Percentage Rate (APR)
APR describes the base rate of return on an account over a year. It doesn't consider compounding and is more commonly used to describe borrowed money, such as personal loans or credit cards.
Annual Percentage Yield (APY)
APY is considered compounding and is commonly used to describe interest rates related to a savings or investment account.
Return on investment (ROI) is typically used to determine how profitable a particular investment is. So, for example, if you'd like to know if you'd earn compound interest at a large enough volume to invest in a particular account, you'd use the ROI calculation. ROI ROI also has a simple calculation attached to it:
ROI = (Net Return on Investment / Cost of Investment) * 100%
Most investment advice for cryptocurrency holdings doesn't consider interest in their calculations.
The Crypto Consideration
When a person buys cryptocurrencies, they don't think about earning interest as part of growing that investment. On the contrary, earning interest is relegated to traditional savings accounts. There was no means of earning compound interest on crypto assets for a long time. However, decentralized finance has made it possible (and lucrative) to invest in compound interest accounts in more recent times.
Instead of compound interest, most investors in the crypto space look at buying and holding to speculate on the crypto asset's value. Because of volatility, this speculation could return a lot of value over a short time for intelligent investors. Yet this volatility doesn't benefit these assets in their goal to be a valuable currency. For that, we need stability. The introduction of stablecoins (USDT, USDC, etc.) has changed these digital assets into a more secure form of investing. It also means that compound interest can be used to increase the value of these accounts.
Both speculation and compound interest work to increase the initial value of the investment. Over time, these investments will earn interest based on the initial investment and the interest already generated, compounding the final result. Savings accounts usually earn far more in interest than investment portfolio accounts.
Places to Invest in Crypto Compound Interest
So, where do you start earning interest on your cryptocurrencies? There are several options available to investors.
One of the most commonly known compounding accounts is the BlockFi interest account. The BlockFi account allows an investor to earn interest monthly, and that amount is automatically added to their principal amount. A BlockFi account enables users to make money on more than just the standard "big hitters" like BTC and ETH. It also allows investors to earn interest on LTC, USDC, USDT, GUSD, and PAXG.
A BlockFi interest account is available worldwide (except sanctioned or watch-listed countries). It also allows for easy withdrawals and doesn't require its new users to jump through hoops to get set up.
The Nexo account covers a large volume of cryptocurrencies and has similar and comparative rates for stablecoins as the previous two options. Users can earn up to 7% compounded daily on BTC, BNB, ETH, XRP, LINK, BCH, LTC, TRX, PAXG, and XLM. The interest is added automatically to the investors' account. Earning interest on stablecoins is also simple, with compound interest for these coins up to 12%.
Nexo is a secure option for many investors and one that they should at least look at.
The interest rates Nexo offers are impressive, and they allow an investor to earn interest rapidly. Crypto investors would be unwise not to seek out the best interest in crypto holdings they can get.
Earn Interest On Crypto
So, why should investors be interested if they can earn interest on their crypto holdings? The first and most compelling reason to choose an account that will earn interest is passive income. With a good enough interest rate and compounding, an investor could simply sit back and earn from their investment. There's no need to worry about annual interest in a savings account.
In these crypto accounts, the interest rate is reflected daily, monthly, or weekly. While some of these accounts may generate more interest than others, it's essential to look at stability. More interest doesn't necessarily translate to better gains if that interest is not compounded.
Overall, earning interest on crypto may be the best option to guarantee a stable lifestyle since its rate of return is far more than typical investments. They are also far better than a bank account for deposits.