Passive Strategies: Staking, Holding and Lending
March 23, 2021
In this article, we will cover some of the passive strategies that can be adopted when buying and selling cryptocurrencies. We will explore together what they are, how they work, what are some of the potential pitfalls and why they are so popular.
What is passive management?
Passive portfolio management comes from traditional finance. The idea behind it is that it is very unlikely that investors can consistently outperform the market, as they attempt to do with active strategies, for example.
Passive management suggests, in fact, that it is better to follow the market instead of trying to outperform it. This is to receive rewards.
The main advantages of passive portfolio management are related to lower fees and operating costs, as well as reduced risks.
What is passive management for cryptocurrencies
Even in the cryptocurrency market, you can choose to follow the market instead of trying to catch it, thereby benefiting from the potential growth of the entire industry.
Some passive strategies allow adopters to earn a reward, an incentive in cryptocurrency. The amount of the reward varies depending on the cryptocurrency chosen, the platform on which it is practised and the type of strategy.
Among the most important passive strategies we have:
It is important to note one difference. Benefits associated with passive strategies can be given by:
- Intrinsic properties of the cryptocurrency. This means that the technological features of the cryptocurrency’s project involve a reward for those who use these features and contribute to the project.
- Specific exchanges or platforms that provide specific services on cryptocurrencies, such as lending services.
What is it?
Holding means buying a cryptocurrency with the purpose of storing it for the medium to long term. HODLers are crypto traders who buy and hold their positions regardless of price fluctuations. Whether the market is up, down or neutral, these people remain confident in the long-term value of the cryptocurrency.
Holders proudly call themselves “HODLER”.
The term originated in 2013 in a Bitcoin forum. A user was watching the price of Bitcoin drop abruptly and still decided not to sell, so he wrote a post titled “I am HODLing,” although he meant to write “HOLDing.”
The misspelt term went viral in the Bitcoin community. Eventually, the community turned it into an evocative acronym for Hold On for Dear Life.
HODLER is one of the most famous slang terms in Bitcoin culture, a true mantra, assumed by all those who hold on to their bitcoin investment without surrendering in the face of falling prices.
How does holding work?
To hold a cryptocurrency, all you have to do is buy it on an exchange and keep it in your wallet for the time you need to.
At this point, you might ask yourself: when is the best time to sell? The answer depends on the objective that you’ve set for yourself. This can be defined either in terms of time (e.g. 15 years), or in terms of capital gain (e.g. realise a x5 on the blocked capital) or in terms of purpose (e.g. retirement fund).
Those who are more practical may consider storing their cryptocurrencies in a hardware wallet that, being offline, is more secure for the long term.
Just as with Bitcoin, holding can be done with any other cryptocurrency. To date, the term is mainly associated with Bitcoin because it is the longest-lived currency that many have chosen to support.
The benefits of holding
The “buy and hold” approach helps counteract two destructive tendencies: FOMO (fear of missing out), which can lead to buying high, and FUD (fear, uncertainty and doubt), which can lead to selling low. The latter is occasionally referred to as SODLing.
What is it?
Staking is a financial term unique to cryptocurrency markets. It consists of keeping your cryptocurrencies locked in a specific network to get rewards in return, in the form of the network’s cryptocurrency. Only certain cryptocurrencies, with a particular blockchain, support staking.
Today, staking is a very popular activity. Suffice it to say that $30 billion is locked up in the largest staking networks including those of DOT, ETH, ALGO and ADA.
How does staking work?
We can consider staking as an alternative to mining. The mechanism is different but the purpose is the same. In fact, staking is also a way to validate transactions and create new blocks on the blockchain.
For cryptocurrencies like Bitcoin we have mining, based on Proof-of-Work: miners compete with each other to solve a complex mathematical puzzle, and the first to succeed gets the right to add the next block to the blockchain. By adding a new block, the miner gets a reward, in this case in Bitcoin.
For cryptocurrencies like Solana, on the other hand, we have Proof-of-Stake: participants can lock-up coins (“stakes”) and the protocol will randomly assign one of them the right to validate the next block in order to get transaction fees. Generally, the probability of being chosen is also proportional to the number of coins you have: the more coins you have, the higher the probability of validating the next block.
Dow does staking work?
Staking can be done in 3 ways:
- Becoming a validator node for some networks such as DOT, ETH, ALGO and ADA. This is a rather long and complex activity that will not be explored here.
- Locking your cryptocurrencies on an exchange wallet. You simply need to buy and lock the cryptocurrencies that support staking on your exchange wallet. When choosing which platform to stake on, it is advisable to check the required lock-up period, reward percentage and risk rate.
- Buying and locking an exchange’s proprietary token. Buying and holding the exchange’s cryptocurrency on your wallet often entitles you to a fixed reward rate. This is not to be confused with the reward associated with staking. In this case, in fact, it is a simple incentive given by an exchange, or rather by the company that owns that token.
How to calculate the staking reward
It depends on the cryptocurrency. Each blockchain has its own technical peculiarities and consequently its own coin distribution policy.
Indicatively, the most common conditions that determine the amount of reward are:
- How many coins you have
- How long you’ve been staking them
- How many coins are in staking in the whole network
- The inflation rate of the coin
Which cryptocurrencies allow staking?
To give you a few pointers, these are some of the cryptocurrencies that support staking:
You can find many more by visiting this website: https://www.stakingrewards.com/
What is it?
Lending consists of depositing your cryptocurrencies to be borrowed by other users, in order to get a recurring incentive in cryptos. Cryptocurrency lending should not be considered as traditional lending: borrowers use them in trading strategies to try and make a big profit.
What are lending platforms?
To lend cryptocurrencies to someone else, you can use:
- Centralised platforms, i.e. created by a company that acts as an intermediary between the two users and is the guarantor of the transaction
- Decentralised platforms, i.e. built on a particular blockchain that is able to regulate the relationship between the two users without the need for a third entity to act as guarantor.
While until recently lending was only possible on centralised platforms, with DeFi things have changed.
How does lending work?
Users who want to lend their cryptocurrencies to get a reward can do so by depositing them on:
- An exchange that supports lending,
- A centralised lending platform
- A decentralised lending platform
The largest decentralised lending platforms include:
Regardless of which platform you choose, the cryptocurrencies you deposit are then lent out to other users who are committed to repaying the full amount by adding a fee. This commitment is usually secured by depositing collateral.If banks ask to pledge cars and houses, cryptocurrency protocols want more crypto funds as collateral.
Due to the volatility of digital assets, borrowers will normally have to ‘overcollateralise‘ what they are borrowing, which means they will have to lock up more cryptocurrency than the total value of the funds they are receiving.
The reward can be fixed or variable, depending on the platform or cryptocurrency. In most cases, the reward is credited on a daily basis. This is because cryptocurrency loans are very flexible, allowing the user to withdraw the cryptocurrency they have lent after a very short period of time.
The benefits of lending
What makes these types of loans very convenient is their ability to yield a reward regardless of the general market performance.
Why stake or lend my crypto?
If buying a cryptocurrency and holding it is the first step on the cryptocurrency management ladder, lending and staking can be the second step.
It requires only a little additional effort and can help you optimise the performance of your wallet in a systematic way, with no particular effort other than choosing which platform to do these activities on.