What Is A Passive Income?
Passive income in crypto would not make sense if you don’t understand the whole idea of passive income in any form of investment.
In finance, passive income is any income that doesn’t require your direct effort. You first make the initial investment, then from then on, you earn off it in perpetuity.
To make it easier for you, think of it in terms of investments such as rental real estate, fixed deposit accounts, or government bonds.
When you buy or build a rental unit, you get to collect an income every month. You do not incur any other expense, or work, to earn that income. You can say the same of holding government paper at a fixed rate, or a fixed deposit where the bank gives you a fixed interest every year.
This is quite different from active income where you have to put in the work for you to earn. For instance, someone who works as a realtor has to work for them to earn. They have to advertise, meet clients, among other things for them to close a sale. There are also no guarantees you can make a profit when pursuing an active income strategy.
The reason passive income is so important to investors is that it takes away the uncertainty in investment. It is also a clear strategy for building wealth over time.
Passive income is so important that even seasoned investors like Warren Buffet advocate for it.
If you are not new to investing, you are probably aware of passive income strategies such as real estate, and government bonds. But how does this apply to cryptocurrencies?
Crypto is a relatively new asset class, and is known for its extreme volatility. Cryptocurrencies are currently trading 30-40% off their most recent highs. Such correction are common, and it’s only natural to wonder how passive income is tenable in such a market.
To understand the concept of crypto passive income, you need to first understand how crypto passive income came about in the first place.
The Evolution Of Crypto And The Rise of Crypto Passive Income
To understand the idea of crypto passive income, one needs to grasp the evolution of cryptocurrencies first.
Bitcoin (BTC), the first successful cryptocurrency, was designed to replace the monopolization of currency by the central banking system. As a matter of fact, the Bitcoin whitepaper was written in 2008, at the height of a financial crisis that was caused by systemic banking flaws.
However, Bitcoin did not quite replace the banking system. That’s because, there is a lot more to legacy banking than just currency issuance.
Nonetheless, shortly after Bitcoin’s launch, came Ethereum, which built on the idea of Bitcoin, but targeted the finance industry even more deeply. Through Ethereum, developers could take pretty much any banking service and decentralize it.
It is Ethereum that birthed decentralized finance (DeFi), a fast-growing area of blockchain-based financial technologies. Through DeFi, concepts like lending that were previously monopolized by banks were opened to everyone.
Not only has this made lending more efficient, DeFi has made it possible to earn a passive income through crypto. Just like in legacy banking where you can earn interest on deposits, DeFi allows this to happen in a decentralized environment.
The best part is that, this is just one of the many ways that one can earn a passive income in crypto. Countless ways have come up to earn passively over the last decade.
Let’s now go through some of the ways you can earn passively in crypto.
How To Earn Passively In Crypto
Staking is one of the most popular ways to earn a passive income in crypto, and for good reason. The APY you can make from staking can be quite high. For instance, with cryptos like Tezos, and Dash, you can make upwards of 6% annually from staking. To earn that, you don’t have to do anything, other than stake your coins.
So what exactly is staking?
Staking is simply the process of using your cryptos to become a network validator, and help ensure that the network runs efficiently.
It is used in Proof-of-stake cryptos, and is quite effective in securing such networks. For context, if someone tries to attack a Proof-of-Work crypto like Bitcoin, they would need to raise 51% of the total hash power used in mining. This is difficult, and for large networks like Bitcoin, almost impossible.
On the other hand, to attack a Proof-of-Stake crypto, one would have to buy 51% of the total cryptos in circulation. This is expensive both in acquisition, and from the price crash that would follow after the attack.
Essentially, the more people stake, the more decentralized, and secure the network becomes. As an investor, the staking rewards are what you get for being part of network of investors helping keep the network safe.
Staking is easy
The best thing about staking is that it is pretty easy to do. You can do it from an exchange. For instance, Binance allows investors to stake their coins directly on the exchange. It’s so easy that Binance staking has become one of the most popular amongst investors. You can also stake cryptos directly from a wallet.
If you do not have the skills to setup a staking node, there are cryptos that allow for delegated staking. One such crypto is Cardano.
In Cardano staking, someone not familiar with node setup can delegate their coins to a staking pool. All they have to do is wait for the staking rewards.
Risks of staking
Despite it being a good way to earn a passive income in crypto, staking carries some risks. Some of the risks you need to be aware of when staking are as below:
Slashing entails the loss of staked cryptos if one does not adhere to the staking rules. The idea is to ensure that all nodes are always behaving correctly for the best interests of the network.
While networks that slash tend to run more efficiently, they are a huge risk to an investor who is not aware of it. Things like unintentional downtime can lead to loss of staked cryptos.
Another risk of staking is price fluctuations during the lockup period. Cryptocurrencies tend to fluctuate quite heavily, and losses of over 50% are not unheard of. In such a case, the staking rewards would be inconsequential relative to the total loss.
Barring these risks, staking is a pretty straightforward way to make a passive income in crypto.
Mining is another popular way to earn a passive income in crypto. The process of mining entails using computers to solve complex math problems and bring new cryptos into existence.
Mining is a form of passive income because the only investment you make is to buy the mining equipment. After that, you get to earn passively from every coin that you bring into existence.
The investment you make for you to mine passively varies with cryptos. For most small altcoins, all you need is an investment in a computer equipped with a GPU.
On the other hand, for cryptos like Bitcoin and Ethereum, you need to invest in highly advanced mining machines called ASICs (Application-Specific Integrated Circuit)s. Once you buy these machines, you get to earn by bringing new Bitcoin, Ethereum, Litecoin and other cryptos into existence.
Given how expensive cryptos like Bitcoin, and Ethereum are at the moment, mining can be a reliable source of passive income.
However, like every other investments, both passive and active, there are risks to crypto mining.
Crypto mining risks
One of the risks especially when mining using ASICs is that the machine can become obsolete pretty fast. That’s because the mining difficulty is ever going up. As the mining difficulty goes up, so does the computational power needed to generate new coins. As such, it is very easy to find yourself stuck with a worthless machine before it breaks even.
Cloud mining is another pretty straightforward way to earn a passive income in crypto. When cloud mining, you pay an actual miner for a stake of their mining rewards.
The idea is that since you may not have the money to invest in mining equipment, you pay someone who has the resources to do it for you.
This used to be a popular mining method a while back, but it’s fading out. That’s because the fees charged in most cases do not make sense. They also tend to have lengthy lockup periods, and the opportunity cost can be huge.
These are just some of the drawbacks to cloud mining. It also carries some real risk to the investor. Some of them are:
Risks of cloud mining
One of the biggest risks you face when cloud mining is scams. There are tons of scam cloud-mining companies.
They are so many that they outnumber the legit companies. As such without in-depth due diligence, you are likely to lose all your money to a scam.
The scams usually use a pyramid scheme model. They pay new members with old members’ money and disguise the payment as mining rewards.
If you choose cloud mining as you chosen path to passive income, some of the companies you can try out include Genesis Mining, and HashNest. These two may not be that profitable, but at least you are sure that you won’t lose your money.
Lending is one of the most popular way to make money in cryptocurrency. Crypto lending is quite straightforward. You give someone your cryptocurrency and get it back with interest. However, unlike a bank, this lending happens in a decentralized environment.
There are a number of ways through which, you can make money passively lending crypto. Some of them are:
- P2P lending
This is quite risky, but it works. It entails visiting peer-to-peer crypto sites like BTCPop. You then negotiate terms with a potential borrower, and lend. Since you are fully in control of the lending terms, you can negotiate a pretty high interest.
The risk is that the borrower can disappear, and there is little you can do to follow up on them.
- Lending to margin traders
This is one of the best ways to earn a passive income in crypto. It entails lending your crypto to day traders who are looking to leverage for higher profits.
The best thing about this option is that it is pretty easy to pull off. All you have to do is deposit your cryptos to an exchange like Bitfinex. The next step is to find cryptos with the highest lending rates and click lend. The rates change in real time so it is easy to monitor.
Despite the convenience, this option has its risks to investors. One of its biggest risks is that the exchange can be hacked. If this happens, there may be little you can do to salvage your investment.
- DeFi crypto lending
This is basically lending your crypto in a decentralized environment. Through projects like Compound and Yearn Finance, you have a platform to lend you crypto, and earn passively.
The money lent out through decentralized exchanges usually goes towards creating liquidity. As a lender, the interest you earn is a reward for helping generate liquidity.
Unlike in centralized banking where there is an entity that decides how much you can earn from your deposits, DeFi rates are purely determined by the market. Due to the forces of demand and supply, how much you earn as interest can shoot up significantly at any time.
4. Crypto savings accounts
Besides lending, there are cryptos that allow you to earn interest on savings. They operate like a savings account, albeit in a decentralized environment.
Unlike staking, or crypto lending, you can get your money back at any time you want. A good example of a crypto savings account is the Celsius network. With Celsius, you deposit crypto and start earning interest immediately. Others that offer similar services include Ledn, Nexo, and Hodlnaut.
As with everything else, this passive income option has some risks too. One of them is getting caught up in a pyramid scheme. There are many out there, and if not careful, you can easily get caught up in scheme that pays interest for a while and then disappears.
5. Decentralized gaming
This is an interesting way to earn crypto passive income in crypto, and its gaining traction fast.
The way it works is simple. You buy items in a Dapp game, and then earn through its value appreciation. The more gamers need that item, the higher its value gets.
The best part is that you do not have to be a gamer. You just need to find a popular game on Ethereum or other platforms and buy a few collectibles. It’s an easy way to earn without doing anything.
The risk with this is buying something that is worthless in the in-game ecosystem. Such a purchase would mean holding to an item that no one wants to buyback. Therefore, you need to understand the game economics, to know what could be of value, and what can’t.
These are nodes that help secure the network. Unlike the conventional Proof-of-Stake node, a Masternode does not need to do anything. All that is needed is for the investor to have a particular number of coins, then lock them up.
A good example of a Masternodes network is Dash. With DASH, all you need is 1000 coins, and you are a Masternode. From there, you get to earn rewards doing nothing.
Like other passive incomes, it has some risks too, that you need be aware of. The biggest one is price fluctuations. If the price of the crypto dips so much, the losses would outweigh any income you were to make from being a Masternode.
However, since cryptos have overall been going up, there is a good chance of evening out over time.
Another easy way to earn a passive income in crypto is holding on to your coins. Cryptocurrency are always going up (long-term), and simply holding your coins should give you a good return over time.
For context, someone who bought Bitcoin in the early 2010s and never sold has made lots of money passively. Despite crashing multiple times, Bitcoin has gained consistently over time, and recently hit a high of $64k. You can say the same about pretty much any other cryptocurrency.
Besides the long-term value appreciation, HODLing has a number of other benefits that all add up to long-term value growth. Some of them are as below.
Benefits of HODLing
You get more coins through hard forks
When a cryptocurrency forks (hard fork), it splits into two chains. Investors of the original chain usually get an equal amounts of the new chain coins. This means you get to grow your crypto wealth without having to do anything.
A good example of profiting from a hard fork is the Bitcoin hard fork of 2017. This fork gave rise to Bitcoin Cash (BCH). Bitcoin investors got Bitcoin Cash coins that were equal to the amount of Bitcoin that they held.
This means if someone had ten Bitcoins at the time of the hard fork, they got, ten Bitcoin Cash coins. Similarly, after the Bitcoin Cash hard fork that created Bitcoin SV, BCH investors got BSV coins equivalent to their BCH holdings.
Essentially, someone who only started out with Bitcoin and held all through now has a portfolio that includes Bitcoin Cash and Bitcoin SV.
It goes to show how easy it is to earn passively by simply HODLing crypto.
Exchanges and some wallets do regular crypto airdrops. Usually, you only need to have a wallet address with the exchange doing the airdrop, and you will receive free coins.
You don’t have to do anything to benefit from airdrops. In fact, the exchange does not even ask you for your private keys to do the airdrop. You will just check your wallet one day and realize that your crypto holdings have grown.
The only risks that come with airdrops is that scammers use this technique a lot. To avoid falling for scams, ignore any messages asking you to send your private keys to get airdrops.
The rule of thumb is that genuine airdrops do not require you to share your private keys.
What Could Affect Crypto Passive Income Potential?
While you can make a good passive income from crypto, there are a number of factors that could hinder you from getting the most of out. Some of them are as below:
Mining difficulty for most cryptos is ever going up. This means you have to keep reinvesting to get the right equipment for optimum gains.
For instance, new Bitcoin mining machines are ever coming to the market. Each generation of bitcoin machines is more efficient than the last one. In most cases, a new generation of miners makes the last one obsolete.
This means you can easily lose money, if the rig goes obsolete before you make your money back. It can significantly affect your passive income potential.
The good news is that there is always the option to mine altcoins that do not require expensive machines. Some of the Proof-of-Work cryptos that you can mine from your computer are Digibyte and Dogecoin.
The reward from such altcoins may not be huge, but if you HODL the mined coins, you can make good money long term. For context, Dogecoin is up by over 12000% in less than a year. Anyone who has been mining and HODLing it, has made a tidy profit this year.
Most cryptos that have lots of potential for passive income from staking, also have very high minimums.
For instance, to stake Ethereum, you need a minimum of 32 coins. At current prices, that would translate to an initial investment of over $80,000. This amount may be out of reach for a lot of investors.
Similarly to run a Dash Masternode, one needs 1000 DASH. At current prices, this would translate to an initial investment of $168,000. Again this is an amount that may be out of reach for a lot of investors.
Luckily there is a way around the challenge of affordability. One can choose to stake cryptos that do not require a very large initial amount in initial investments. There are many good ones that meet this criteria.
For instance, Cardano has no limit on the number of coins that one can stake. It is a pretty solid project too. By scanning the market, and doing due diligence, you should find many other good projects you can stake, without being required to raise a huge initial sum.
While cryptocurrencies are a relatively new asset class, they are redefining the concept of passive income. They have opened up new ways of earning passively that were hitherto unavailable in traditional finance. The best part is that, as the industry grows, so will the ways to earn without effort. With a little due diligence, crypto passive income can be a pathway to wealth.
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