How Interest is Calculated on Crypto

Discover the different interest rates categories to understand how exactly crypto interest is calculated.

Cryptocurrencies have been both praised and reviled for their value swings. It was easy enough to buy into crypto assets that one felt were going to appreciate in the past. Passive income could then be generated from the asset's appreciation, which a person would then sell on the open market. However, the recent rise of stablecoins has made it a viable income strategy to put them in high-interest accounts. The interest rates on these accounts are significantly better than those offered by traditional financial institutions, and setting up a crypto lending account is a breeze.

Cryptocurrency investment advice of the recent past looked at high-risk, high-reward options for earning income from investments. Crypto assets can now be placed into accounts that offer stable returns on investment. These accounts provide either simple or compounding interest at attractive rates. The introduction of stablecoins linked to fiat currencies has introduced a way of earning interest for crypto speculators that they didn't have access to in the past. But how exactly is this interest calculated? We first need to look at different interest rate categories to understand that.

How Simple Interest Works

Simple interest is interest that is based on the principal amount that was loaned and not the interest on top of it. Conversely, compound interest is interest on the principal amount and the interest on the interest. This is great for borrowers as they only pay interest on the principal. However, it's not great for lenders, who usually prefer to earn compounding interest on the principal amount and its interest.

How Compound Interest Works

Compound interest is calculated on both the principal (the initial deposit) and the interest earned previously. Simple interest usually builds up an account very slowly over time. Traditional bank savings accounts use simple interest, and so do some crypto accounts. However, most cryptocurrency savings accounts offer compound interest at competitive interest rates. The only way to determine whether the institution provides compound or simple interest is to do in-depth research.

The best way to understand this is to look at a simple example. If we deposit 1 BTC into a crypto lending platform with a simple interest rate of 5% at the end of the month, we'll be making 1.05 BTC at the end of a month and 1.6 BTC at the end of the year. That's not a bad rate of return. However, if we deposit the same 1 BTC in an account that generates compound interest at a rate of 5% compounded monthly over a year (12 months), our return would be 1.795 BTC at the end of the year. The more years we put into this calculation, the wider the gap between simple and compound interest.

For this comparison, if we left 1 BTC in both accounts for five years, the simple interest account would only afford us 4 BTC total after five years. However, the compound interest account would offer us 18.679 BTC over the same period. That's a difference of around 15 BTC!

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APR vs. APY for Crypto

How can you tell whether your crypto savings will be simple or compound interest? Most platforms represent the type of account they offer through the terms Annual Percentage Rate (APR) or Annual Percentage Yield (APY). In a nutshell, APY describes a compound interest account, while APR refers to simple interest only.

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Platforms that Pay Compound Interest on Crypto

Naturally, the interest rates on lending platforms vary, but some offer impressive rates on crypto deposits. BlockFi is renowned for its crypto compound interest rates, with depositors accessing rates of 7.5% APY on USDC savings.

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How Compounding Periods Work

As previously mentioned, interest rates are applied to crypto assets based on the compounding periods the financial institution offers. This can significantly help you maximize your interest earned. So, for example, a Hodlnaut interest account calculates interest on the deposit daily and compounds weekly. Many other crypto accounts pay interest multiple times a year, and some even compound daily. These compounding periods can greatly affect a person's investment outcomes.

In traditional finance, compounding usually happens once a year. Interest payments are, similarly, only made once per year. When compounding is done more than once per year, the term used is "intra-year compounding." To calculate the expected return rate, we must look at the annual interest rate and divide it by the period. So, for example, if an account compounds daily, the APY would be divided by 365 to get the periodic interest rate.

Calculating Interest on Crypto Assets

Simple interest calculations are straightforward. In simple interest, there are only three things one should be concerned with:

PlaintextP = Principal, or the initial investment
R = interest rate per year represented as a decimal value
t = the number of years that the investment is to be held

Using these terms, we can calculate simple interest (I) with the following formula:

PlaintextI = P x R x t

So, for example, if we have 1,000 BTC at a rate of 1% per year being held for five years, we would have our simple interest as:

PlaintextI = 1000 x 0.01 % 5
I = 50 BTC

Simple interest is typical of traditional finance. Earning interest on these interest-bearing accounts is a chore, and many times the fees that banks charge for their services far outweigh what a person might make through their savings deposit.

Compounded interest is calculated differently since it relies on compounding periods to get a final value. Thus, our compound interest calculations have a few more terms to use:

PlaintextA = Accrued amount, the principal plus the interest generated
P = Principal
r = annual interest rates represented as a decimal value
n = number of compounding periods
t = time in years represented as a decimal

The formula we use to calculate interest compounded with the principal (the accrued amount, A) is as follows:

PlaintextA = P(1+r/n)^nt

So, for an initial principal of 1000 BTC with interest rates of 5% per annum, compounded monthly over five years, we get:

PlaintextA = 1000(1+(0.05/12))^(12x5)
A = 1000(1.004167)^60
A = 1000(1.28336)
A = 1283.36 BTC

This result means that the compounded interest, C = 283.36 BTC.

As we can clearly see here, the compounding effect can significantly sway the interest earned on an account.

Why are crypto interest rates so high?

Crypto interest rates are mouth-watering, sweet, and attractive. They appeal to our inner urge to always want more.

As a savvy investor, it is good to recognize opportunities to maximize gains. It is also more important to know the why's, the how's, and what if's for every opportunity that comes.

This begs the question again: why are crypto interest rates this high?

Demand and supply, the infancy of the industry, and lower overhead costs all contribute to the high, mouth-watering rates you see with crypto firms.

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How to Maximize Crypto Interest

Maximizing crypto interest relies on finding the right crypto savings to earn compound interest from. How does a digital asset holder choose the right savings account? It would help if you looked at several criteria when determining how to maximize your crypto interest.

  • Interest Rate: Higher interest rates usually mean better returns over time. Look for platforms that offer compound interest (APY) instead of simple interest (APR).

  • Using Leverage: The term "yield farming" has been used to refer to taking out crypto loans to reinvest within a platform. While this does offer the potential for greater earnings, it also has a lot more risk associated with the practice.

Which Crypto Has the Highest APY

Currently, Midas.Investments offers the best return of 14.5% APY on USDC.

Who Pays the Highest Interest on Bitcoin?

Currently, Nexo offers some of the best ROI for savings, with their Bitcoin Savings offering up to 7% APY on BTC deposits.

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What's Your Best Option?

If you're looking to earn interest on crypto, your best option is to find an account that compounds interest often. Most institutions offer accounts for holding stablecoins such as Tether (USDT) or USD Coin (USDC). The rate of return on these investments means that you are likely to see significant returns and even earn interest that could potentially support your lifestyle and livelihood over time. It could also be worth educating yourself on taxes for crypto interest.