Investors in digital assets have a considerable appetite for risk. Bitcoin, after all, has had multiple dips exceeding 50% over the past decade. Most of the cryptocurrency sector is as volatile as small cap stocks or commodities in developing markets. It’s a high-risk, high-reward sector.
However, that doesn’t mean there’s no opportunity to mitigate risks and extract a steady payout. Here are some of the ways investors are using digital assets to generate reliable passive income.
The dawn of a new consensus mechanism has unleashed a new investment class. Proof-of-Stake (PoS) allows investors to generate a yield from their existing assets while securing the network their assets are based on. This means they can lock away their holdings and expect a steady stream of recurring rewards just like they would with a savings account in the fiat economy.
Ethereum’s gradual migration to PoS is likely to make staking a mainstream activity. Staking ETH through pools currently delivers a 5.11% annual yield on average. However, ETH is far from the most lucrative PoS token. Avalanche delivers a 9.38% yield while Solana’s network has more value at stake ($9.6 billion) than any other mainstream PoS network.
As these networks mature, the yields could gradually decline. Meanwhile, early adopters can cash in on steady returns that are far higher than most dividend stocks or high-interest savings accounts.
Another way to generate passive income is by providing liquidity in decentralized exchanges. Without a middleman involved, these exchanges need active participation from the community to ensure traders have the liquidity they need to execute their trades successfully. To incentivise users to lend their assets for liquidity in the market, these exchanges have implemented automated market makers that offer a fixed yield.
This strategy of passive income generation is now called yield farming. The yields vary by exchange and asset, but users can expect to generate returns of up to 26%.
Arbitrage requires some skill and perhaps some specialized tools, but it’s perhaps the least risky way to generate returns from digital assets. Put simply, the strategy involves taking advantage of the price gap or mispricing on different exchanges. So if Ethereum is trading at $4,200 on Coinbase and $4,400 on Kraken, a trader could buy the asset on Coinbase and sell it immediately on Kraken to pocket the difference.
These opportunities are diminishing as the market becomes more efficient. However, savvy traders with the right tools can capture substantial profits right now.
Other ways to generate crypto income
There are other creative ways to generate passive income from digital assets. Some enterprising early adopters have started lending out NFTs to collect rent on these digital assets. This strategy is particularly effective if the NFTs are part of a micro-economy where they have some utility. For instance, lending out playable characters on Axie Infinity is starting to look like a legitimate business model.
Another strategy involves derivatives. Canada-based asset manager Purpose Investments recently launched Bitcoin and Ether Exchange-Traded Funds (ETFs) that use covered call options to provide investors a monthly dividend.
As the digital assets space matures, opportunities to generate passive income are quickly emerging.