What Are Some Different Ways To Generate Passive Income With Crypto?
“Make money while you sleep”; the phrase uttered by many passive income enthusiasts must have managed to catch your attention in one instance or another as it did for millions of people around the globe. In contrast, the general core concept of passive income remains more or less the same. Where investing your time and oftentimes money into something which benefits your customers and leads you to generating profits from something you have now created as time passes by.
In this article, we will be exploring passive income ideas in an industry which we have all heard of by now, and many of us would even be familiar with dealing in that industry itself, cryptocurrency. Hence, this article will be looking at a number of ways you can deploy the objective of earning a passive income out of cryptocurrencies. In doing so, we hope to broaden your knowledge regarding how the crypto sphere operates, which leads them to make even more profits from the traditional “buy and sell” games.
For the article to overview the major relevant points in good detail, it is to be ensured we go through each one by one. Thus, the following is a list of content points that will be heavily discussed in the course of this article.
- Liquidity Pools
- Staking
- Crypto Funds
Given how inseparable cryptocurrency is quickly becoming in so many major aspects of our life, looking into cryptocurrencies to generate you a profit is somewhat like trying to see how you can earn money off of Real Estate. Both industries are now considered vital in the functioning of so many sectors we depend on, and on both can be implemented passive income generation strategies to bring forth a good profit.
Jumping onto the first bullet point, which is regarding investing your cryptocurrencies into liquidity pools:
Liquidity Pools?
The option of investing your cryptocurrency holdings in Liquidity Pools arose with the popularity of Automated Market Makers in the functioning of the many decentralized financial exchanges that are becoming more and more prevalent nowadays. If you are unfamiliar with these terminologies and want to learn more about how generating a passive income from this very method works, fear not, for that is exactly what will be discussed in the following paragraphs.
Looking at decentralized financial exchanges, the most common and normal “centralized” exchanges adopted the use of order books to quote the ask and bid price and, in doing so, determine the market value of a particular security or asset being traded on the market. Here, the many prices traders were willing to buy and sell particular security are recorded, and the trade order where the prices match is executed, making that the new value of the particular asset or security.
Many times, the security would run into a risk of becoming illiquid. Illiquidity in this context refers to the difficulty in converting particular security into cash as there are not a lot of buyers of that particular security in a certain exchange.
In order to avoid this and to keep the market liquid, which is to ensure that traders on the exchange can easily convert their assets to cash and have smooth flowing transactions, exchanges used market makers who were entities who would buy and sell particular quantities of securities at certain prices. Market Makers hence quote both the “firm ask” and “firm bid” prices ensuring a wide range of securities can be bought and sold by them, ensuring the overall market liquidity.
In decentralized exchanges, the entire traditional process of relying on “entities”, which were basically groups of people capable of making mistakes, was abandoned. As the word suggests, decentralized exchanges are based on decentralized financial technology, which uses smart contracts to carry out transactions.
Smart Contracts, in simple terms, refer to codes that self-execute once certain conditions are met. For example, when the buyer is ready to send the money to the seller, the seller will then transfer the security to the buyer’s wallet. This entire process will be carried out by lines of code out there for everyone to see hence, not relying on people to carry out the transaction.
However, a major area of concern which is where passive income can be generated is liquidity pools. Remember the market makers discussed above, which referred to “entities” which were essential to any particular exchange market’s liquidity? Well, the “entities” usually are firms, institutions and market specialists. In decentralized exchanges, market making is carried out by automated market makers, which are, again, pieces of code that allow users to contribute to a “liquidity pool”, which is used to maintain liquidity in the particular exchange.
Usually, users on exchanges using automated marketing platforms such as UniSwap, PancakeSwap and so on can contribute to a liquidity pool using their cryptocurrency assets. Their share of how much liquidity they are providing in the particular exchange is recorded. On the exchange itself, traders who are exchanging securities in bids and ask activities are usually charged a small trading fee for sourcing liquidity from the liquidity pool. This is usually 0.2% to 0.3% of their entire trade size. This amount is then shared among the users contributing to the liquidity pool in proportions of how much liquidity they each brought to the market.
Hence, many users are able to earn a passive income by investing their cryptocurrency holdings in such liquidity providers. These liquidity providers areas you have read, market-making substitutes for decentralized financial exchanges. As many decentralized exchanges rise in popularity, so will the options in all kinds of liquidity providers which are available in the market.
Yields are heavily dependent on your overall contribution to the liquidity pool, and how much trading volume your liquidity pool caters to. It is to be noted, however, that if dealing with volatile cryptocurrencies, there is a chance users can face impermanent losses, which is a temporary loss of funds due to dealing with volatile cryptocurrencies. This results due to providing liquidity to high volatility trading pairs.
Let’s now look into another major method that users use to invest their cryptocurrency holdings and hence, earn passive income out of.
Staking
Staking is one of the methods which are used in blockchains as a consensus mechanism. Consensus mechanisms are how blockchain networks validate transactions and hence decide what the current state of the blockchain looks like. There is a consensus mechanism we are all familiar with, which is the Proof Of Work model.
Used in cryptocurrencies such as Bitcoin, the proof of work model allows new coins to be minted by asking users to maintain the cryptocurrency blockchain and rewarding them with the new coins themselves.
However, there are a few points to be noted in the Proof of Work model in order to contrast it with Proof of Stake and hence produce a better understanding of what Staking is. Proof Of Work involves users acting as nodes on the blockchain network.
As most blockchains are decentralized, the processing of transactions needs to be carried out by ordinary users, and in order to encourage users to carry out the processing of transactions, there is an incentive offered if they choose to do so. The incentive is usually newly minted fresh cryptocurrency tokens, either of the same cryptocurrency the users worked for or another.
Although proof of work is an essential mechanism via which many types of cryptocurrencies are maintained, the famous of which is Bitcoin, for example, has been criticized by many. If we look closely, users are rewarded with new coins only if they are able to maintain the blockchain by processing the data necessary. In many cryptocurrencies, due to there being such high competition for newly minted coins, there are a lot of players in the game.
Plus, in order to actually receive pieces of data or “blocks” to process, users need to carry highly-advanced equipped hardware from which they can solve complex mathematical problems. Only if they solve the complex mathematical problems and only if they are the first in the entire blockchain in doing so will they be rewarded a block to process, after which they will get some of the newly minted cryptocurrency tokens.
Due to such high bars of entry that a normal user has to cross, the proof of work model for a lot of cryptocurrencies means that your average user cannot take part in facilitating the minting of new coins as the incentive which is offered will never be able to make its way to the hands of your average user in the form of fresh tokens; mainly because of such high competition and as stated earlier, the requirement of special hardware and good timing.
It has also been criticized for using a very inefficient method of minting new coins. Going back to the requirement of many cryptocurrencies working on the Proof of Work model, we have them requiring the use of special hardware in order to solve complex mathematical problems, which will lead to the user being awarded a block which can be processed in return for some reward.
This means that along with bearing the cost of purchase of the advanced hardware required, the user is also going to have to bear the cost of running it, particularly electricity-wise. As this method will hence cause a lot of electricity to be used for the minting of new coins, it has been called a non-environment-friendly consensus mechanism.
Looking at all the inefficiencies and cons of the Proof Of Work model came the Proof Of Stake model, which is a different consensus mechanism with an underlying simplicity. Instead of having to solve complicated mathematical problems using hardware that takes a lot of expense to acquire and maintain, the proof of stake model allows users to “stake” their cryptocurrencies. By this, it means that users can hold their cryptocurrencies and the more they hold, the more the chances of them being selected to forge the next block.
In proof of stake cryptocurrencies, who gets to forge the next block, which will lead to new coins being minted in the blockchain, is not dependent on who solves mathematical problems first. It is dependent on the size of a particular user’s stake. Users are randomly selected, with the chances of a particular user being chosen highly depending on the size of their cryptocurrency holding, and then awarded the opportunity to forge the new block and, in return, earn some newly minted tokens.
It should also be noted that not only does a particular user’s chances increase with the size of their stake but also does the reward. This is a common feature found in many proof of stake models. However, not all cryptocurrencies under the model will be obliged to abide by this feature.
Hence, as many blockchains usually have incentives kept out in the form of rewards for the maintenance of the entire blockchain network, when a user is chosen to process a block that would lead to its maintenance, the user does so and hence receives the reward. The reward is usually in the form of a token(s) in the same cryptocurrency as the one they have staked or others.
It is to be noted that in order to earn a passive income out of staking cryptocurrencies, you are going to have to look out for cryptocurrencies that use the proof of stake model of consensus. A popular one that does so is Ethereum, although there are many which do the same.
Along with this, there are also a number of requirements that users are required to abide by before they can start generating a passive income. Some of which may be ones such as being required to stake the cryptocurrency for a minimum amount of time before a user can start earning off of it. Also, there may be a minimum amount of cryptocurrency that the user may be required to store in their wallet before they can participate in “staking” as a method of passive income.
Cryptocurrency staking can be carried out on most popular exchanges and is a primarily passive process requiring little oversight or intervention. Rewards can be very well paying as well. However, there are a few things that should be kept in mind for users intending to use this method as a passive income generator.
Despite the fact that the more coins you stake, the higher your chances of receiving more newly minted tokens, do note that the actual value of those tokens can vary as per their market demand. Hence, staking volatile cryptocurrencies must always be done by keeping in mind the fact that you are going to want to convert it to actual cash one day or the other and that its fiat value changes as per markets.
Another method of generating income passively out of cryptocurrency is one that may go a bit old-school but tried and tested indeed.
Joining Crypto Funds
If you have read the article closely, you will realize that although the two major methods of generating a passive income out of cryptocurrencies mentioned are comparatively more passive than trading a cryptocurrency, they may still require more oversight than joining a crypto fund. Crypto funds are truly an exception from the constant overseeing you may have to carry out in the aforementioned methods.
So what are crypto funds? Much like how hedge funds operate, crypto funds are funds operated primarily by financial analysts and experts who invest large sums of money into cryptocurrency-related securities with the intention of getting positive returns. In cryptocurrency funds, the “large sum” is usually sourced from people willing to invest their assets in the pursuit of receiving positive gains.
Crypto funds are especially advantageous as they allow people willing to earn passive income a good exposure to the cryptocurrency market’s volatility. Essentially, getting them familiar with the price movements that take place without having them open their funds to the risk they would otherwise be exposed to if the funds were not being handled by financial experts. This can serve as a good source of education.
Crypto funds usually have a minimum investment amount and usually have fees that can truly vary from rates that are reasonable to some, which can be called almost absurd. Hence, choosing a good one is a task one should take very seriously.
Crypto funds are tweaked every now and then by financial analysts ensuring they are calibrated in such a way that they give the users who have invested in the fund the maximum possible returns.
However, as they say in the trading world, no deal is risk-free. While there may be some risks that are always going to be open, such as the volatility of a particular asset or even entire markets, there are many risks that are avoidable. When it comes to investing in crypto funds, make sure to scrutinize all the paperwork you are supposed to. Do note that you should pay special attention to the notice period for redemptions.
Summary
This article looked at the three major methods via which users earn passive income through cryptocurrencies; liquidity pools, staking and joining crypto funds. Each of those was addressed by offering relevant contrasts, contextual definitions and some major guidelines for what users tend to look out for as potential risks when choosing the particular method for generating passive income.
Tokenhell produces content exposure for over 5,000 crypto companies and you can be one of them too! Contact at info@tokenhell.com if you have any questions. Cryptocurrencies are highly volatile, conduct your own research before making any investment decisions. Some of the posts on this website are guest posts or paid posts that are not written by Tokenhell authors (namely Crypto Cable , Sponsored Articles and Press Release content) and the views expressed in these types of posts do not reflect the views of this website. Tokenhell is not responsible for the content, accuracy, quality, advertising, products or any other content or banners (ad space) posted on the site. Read full terms and conditions / disclaimer.