Crypto trading platforms have opened up new and exciting ways of investing in decentralized ecosystems. For a long time, people have been able to buy cryptocurrencies and either hold onto them in the hope of value appreciation over time or trade them to make money on fluctuations in price. Over a decade since Bitcoin was revealed to the world, there are far more ways to profit from a cryptocurrency portfolio.
Cryptocurrencies are volatile and highly speculative, making investors cautious when adding or even making changes to their portfolios. There are many risks involved with investing in cryptocurrencies, but traders can make the best of their investments while minimizing risk by using specific strategies and tools.
However, not everyone is a seasoned trader or experienced with the world of cryptocurrencies, and various projects have identified a market of risk-averse investors who want to put their money to work. This post aims to give you a few ideas on building a cryptocurrency portfolio without making any trades.
Note: The strategies presented below are great tools for building your crypto portfolio. You can use them either as part of an established setup or pick the ones that best suit your needs.
Contents
Staking
Staking is becoming one of the most popular ways to earn passive income on crypto portfolios. However, before diving into how staking works, it’s essential to understand the consensus mechanism that runs it all – Proof-of-Stake (PoS).
Unlike Proof-of-Work (PoW), where miners run complex algorithms and compete to validate transactions, Proof-of-Stake requires validators to stake tokens to win a chance at validating a block of transactions for rewards. The system disincentivizes malicious behavior by holding your stake hostage, and stakers with more capital are selected to validate blocks more often since they have more to lose, making them more reliable.
Staking is the process of sending tokens to a staking wallet in return for transaction fees and newly minted coins. Since the staker owns part of the tokens being used for staking, they are entitled to a percentage of all transaction fees generated by the platform. The longer your coins are locked in the wallet and the higher your coin balance relative to total supply, the higher your chances of collecting staking rewards over time.
Digital Asset Exchanges
Several platforms offer coin staking services for a small fee. Some crypto exchanges allow customers to purchase and stake tokens on their own blockchain. Others will stake your tokens for you through their own staking pools. Regardless, exchanges are probably the most straightforward way to stake your tokens.
Staking Pools
Another way of staking is through joining a staking pool. On Ethereum, for instance, you need 32 ETH to become a validator on the network. However, with a staking pool, people from all over the world pool their tokens to stake collectively, splitting the rewards. Pools tend to have servers spread across different continents to make sure they remain online and produce the best performance possible for their investment.
Staking pools also charge a small fee for hosting users’ assets and distributing rewards among members based on their contribution to the pool. Further, some ecosystems even reward stakers with additional governance tokens that can be used to vote on network decisions, including staking reward rates, protocol changes, and more.
Decentralized Finance (DeFi)
Decentralized finance has evolved into an almost unrecognizable state over the last few years. From DeFi lending and borrowing services to AMM-based decentralized exchanges, this subset of the blockchain industry has grown into one of its strongest pillars, cementing its position as a core value proposition for the emerging technology ecosystem.
Yield farming is the most effective way to maximize profits from dormant assets in your cryptocurrency wallet. Also known as liquidity mining, yield farming can seem quite similar to staking since it also requires users to lock up their tokens for rewards. However, yield farming can introduce unexpected complexities not seen in traditional staking.
Automated Market Makers
To learn how this works, it’s crucial to understand how AMM-based decentralized exchanges operate. Unlike traditional order book-based centralized exchanges, AMM-DEXs use a smart contract to balance the ratio of two (or more) tokens in a pool. The value of the pooled token reserves are balanced, and for each token purchase or sale, the other token must be deposited or withdrawn respectively.
Providing liquidity to these pools means depositing an equal value of both tokens. For instance, if Alice wanted to contribute $100 of liquidity to the BTC/USDT pool, she would need to deposit $50 of BTC and $50 of USDT into the pool. The DEX would then start dishing out rewards to Alice and other liquidity providers (LPs) with special LP tokens in exchange for this liquidity.
Yield Farming
The ‘farming’ aspect of yield farming comes from how these LP tokens can provide liquidity to other token pools, generating more LP tokens and more opportunities to generate yield. Notably, yield farming isn’t entirely risk-free. Balancing the ratio of the value of tokens in a pool can lead to significant losses, especially if the value of one token rises a lot more than the other.
For example, if Alice deposited $100 liquidity with the tokens split equally into a BTC/ETH pool, and Bitcoin’s price fell significantly, the amount of contributed liquidity would fall, forcing the platform to liquidate ETH holdings to rebalance the pool. This causes what’s known as ‘impermanent loss,’ which is mitigated as long as markets correct but can still present considerable risk.
Cryptocurrency Index Funds
Like any other index fund, a crypto index fund is an investment product that derives its value from a basket of assets — in this case, digital assets. Like a mutual fund or ETF in the world of traditional finance, crypto index funds allow traders to invest in entire sectors without worrying about the exact tokens to pick.
This allows traders, especially less experienced ones, to diversify their holdings instantly. Since the funds are actively rebalanced to suit market conditions, it’s also a lot less risky than directly investing. Further, since there’s no need to actively manage multiple wallets and holdings, it almost wholly eradicates costs incurred due to transaction fees and the like.
There are actively managed crypto index funds and passively managed crypto index funds. In actively managed funds, a fund manager chooses which cryptocurrencies to include and when to change the ratio of holdings. In a passively managed fund, the cryptocurrency holdings are selected based on various parameters, such as a token’s weighted market capitalization.
Centralized Finance (CeFi)
CeFi or Centralized Finance is a sort of middle ground between traditional finance and DeFi. With CeFi, the platform is usually owned and controlled entirely by a centralized entity or group. While their interest rates on deposits tend to be lower than their DeFi competitors, CeFi platforms offer a level of polish and convenience that has still yet to make its way into the world of decentralized finance. Additionally, these platforms absorb any losses that occur due to market crashes, guaranteeing interest on deposits by managing user-funds internally.
For example, leading Singapore-based derivatives platform, Phemex provides up to 8.5% APY on its fixed and flexible savings options, applicable on USDT deposits worth up to $1.5 million. Additionally, Phemex also has a ‘Learn and Earn‘ program, giving traders the chance to earn rewards in the form of digital assets and trading bonuses. These bonuses are given to traders for completing blockchain-focused educational courses on the platform and can be used while trading Phemex’s perpetual contracts.
The Bottom Line
If you’re looking for a way to diversify your portfolio and hedge against risk, it may be time to try out some of these strategies. We hope this article helps you make an informed decision about how best to manage your investments so that they continue growing while protecting you from market risk. Remember, always do your own research before investing, and never part with more than you can afford to lose.
Disclosure: This is not trading or investment advice. Always do your research before buying any cryptocurrency.