Love it or hate it, blockchain and cryptocurrency technology is a great technological development that has made a lot of people rich along the way. Normally, financial independence advocates – like me! – would tell you to steer clear. “Investing” in crypto tokens is really just speculating at this point, i.e. an educated gamble. However, I think that there might be a way to use cryptocurrencies as an investment that sits nicely with financial independence investing principles.
Like everything on my site, this is not financial advice. It’s just an idea for consideration, for entertainment and discussion purposes. There is also a referral link at the bottom for one of the platforms. Do your own research – don’t trust some internet random.
Why financial independence experts don’t promote crypto
One word: volatility.
Even if you believe that cryptocurrencies are the future, it’s hard to say that a particular crypto token will definitely increase in value. You could buy a bitcoin for around £8k in March 2020, which was a big fall from its previous all-time highs. Ethereum tokens were about £200 at the time, too. The price tag of a single crypto token tends to fluctuate by double-digit percantages within a week.
Then there’s the product risk. This is the risk that you buy into a project that fails. Recently, cryptocurrency Ripple was found to have been sold as a security by the US, and has now been removed from several exchanges, which makes it more difficult to buy. Surprisingly, the token still has a reasonable market cap, but for how long? Now, if you read into how the technology works, you can make your own assessments about which cryptocurrency tokens are likely to fall prey to this, but that’s a lot of reading for your average investor.
The point is that buying crypto tokens doesn’t sit well with the traditional, cautious but tried-and-tested path to financial independence of investing in shares, bonds and ETFs through an ISA or pension. However, I’ve recently come across a way to use more stable cryptocurrencies to earn interest and add passive income that I think might be worth considering for a financial independence portfolio.
Stablecoins: a cryptocurrency with less volatility
There is an alternative to volatility: a family of tokens that track the base price of an asset. These are called stablecoins because their price is stabilised (no, really? You surprise me.) against whatever the asset is that they represent.
This is most commonly the US dollar, although there are also some that represent physical gold in a vault somewhere or other currencies like our own GBP £.
I’m not going to go into all of them but here’s a sample of the more common stablecoins that you can commonly find on the crypto exchanges. We’ll get to how to use these to earn more stable (heh) cryptocurrency interest in a second, but you can probably already see that a stablecoin earning interest is slightly more in line with conventional financial independence wisdom.
Tether (USDT)
Tether is a stablecoin that’s worth $1. In theory, each USD Tether (USDT) token is backed up by $1 of assets held by Tether Limited. This means that there should be a dollar sat in the company’s accounts for each USDT that’s available. Should. However, Tether isn’t audited by any outside agencies, so there’s no way to confirm it. As a result, I don’t use it, but I hear that many people do.
Tether now also has a gold-backed version, Tether Gold. There’s a cool tool on the tether website that links a Tether Gold token to the actual allocated 1oz gold bar in their vault. If you trust Tether Limited then this might be an interesting option.
The Tether Gold logo
USD Coin (USDC)
USDC is another $1 stablecoin, again backed by cash in a vault somewhere. Circle Internet Financial Inc. is the company that backs USDC. USDC claims to be the world’s leading digital stablecoin, which is believable from the internet chatter that I read about it. Unlike USDT, USDC is audited by Grant Thornton LLP, who are a pretty big deal in the accountancy world.
In theory, you can move USDC on several blockchain networks but in reality when you buy USDC on Binance or any other exchange you’re probably going to get the version that’s on Ethereum. That’s currently an issue because transfer fees on the current version of Ethereum are pretty big. Despite this obvious weakness, USDC is the main stablecoin that I hold to earn cryptocurrency interest.
True USD (TUSD) / True GBP (TGBP)
The company TrustToken operates the TrueGBP, TrueUSD, TrueAUD… you get the picture. Like Tether and USDC, each token is backed up by cash in an account, but in this case TrustToken use a third party company to hold the cash. TrustToken claim that you can check the blockchain to verify that the account is accurate, but to be honest I don’t understand how I would do that and there’s zero chance of me actually doing it.
The advantage of TrueGBP is that you can sign up to their platform and create the tokens yourself in exchange for cash. That means that you can convert real GBP into TrueGBP, earn interest on the stablecoin in TrueGBP, then convert it back in GBP when you want it.
I haven’t used TGBP yet, but that’s purely because I know that USDC is liquid and audited. If TGBP becomes more widely available on crypto exchanges then I’d see it as a viable option for earning cryptocurrency interest.
Dai
Dai is different in that it’s a stablecoin by value but isn’t backed up by cash. Instead, the Dai protocol owns a portfolio of other crypto assets that it balances by selling or buying to make each Dai worth $1.
That’s… actually a horrible explanation of how Dai works. Sorry, I’m not the best with it. The important point is that Dai is maintained at $1 rather than representative of $1. It does this by using automated smart contracts on the Ethereum network. That means that in theory it’s completely decentralised and there’s no one agency running it. If you don’t trust shady-looking companies and governments, Dai might be of interest to you.
I don’t use Dai because I don’t like investing in something that I don’t fully understand (which is why my Stocks and Shares ISA has a big portion of REITs in it, because I’ve worked in real estate law and know how they work). That said, there’s probably nothing wrong with it, so if you do the research and like what you see then by all means use this as a stablecoin.
Using stablecoins to earn cryptocurrency interest income
Now that you know a little bit about stablecoins, you can see that it should be perfectly logical to earn interest on them in the same way that you’d earn interest in cash.
This is where the fun begins. If you were to put your money in cash savings at the time of writing, you’d be doing well to earn 0.5% interest. That sucks, because the target for inflation in the UK is 2% under the Consumer Prices Index. That means that you’re doing well if your cash savings only decrease in value by 1.5% every year.
Now, what if I told you that you can earn 8-15% gross annual cryptocurrency interest on stablecoins? Wouldn’t you like to know more?
Cryptocurrency interest method 1: DeFi
DeFi is short for “decentralised finance”. You will see a variety of ways this is used on the internet, but for the purposes of earning interest we’re going to look at DeFi lending protocols – you know, where you lend money out and earn interest.
What this basically mean is that you can loan cryptocurrencies using smart contract platforms to earn interest without relying on an intermediary like a bank.
The main lending protocols that I’ve heard about are AAVE and Compound. These basically pay you to throw crypto into a protocol and be borrowed by whomever the protocol lends to. It’s a pretty cool idea and I see it like the peer-to-peer lending form of innovative finance, but for crypto.
Interest rates tend to be around the 9-10% mark for these platforms, so if you like the idea of cutting out the middle man and never trusting governments or companies ever again, you could earn a decent amount of interest using Dai on one of these DeFi platforms. Never has the revolution been so lucrative!
I… don’t use them. As I alluded to with Dai, I won’t put my money into something I don’t really understand. Maybe if my tech skills improve I’ll be more confident but until then I’m keeping away from DeFi for now.
If you’re a bit more adventurous/ really don’t trust banks and institutions, there’s a cool post on Decrypt that explains the whole DeFi thing better than I ever could. It’s a cool use of tech and probably the future of peer-to-peer lending, but I’m not yet ready to cast off the supervision of an actual accountable person. Yet.
Cryptocurrency interest method 2: CeFi
DeFi was “decentralised finance”, so it shouldn’t be a surprise that CeFi is “centralised finance”!
Like banks with money, there are companies and platforms out there that allow you to place your stablecoins with them in exchange for an interest rate. They loan out the stablecoins, you earn cryptocurrency interest – usually paid daily, weekly or monthly, as opposed to an annual payment.
The big three names that I hear a lot about are Celsius, BlockFi and Nexo. All three work on roughly the same model: you give them your stablecoins to lend out, they earn interest, you get a (quite generous) share. For example, Celsius and Nexo usually pay around 10% gross annual interest (compounded daily for Nexo and weekly for Celsius) for stablecoins.
The risk of CeFi is that you have to abide by this bank’s terms, and unlike regular banks you can’t rely on the Financial Services Compensation Scheme to bail you out if they go bust or lose your funds. That said, Celsius claim to be insured and Nexo are at least registered as a European bank, so there is an element of protection even if it’s not as good as your cash account in a UK bank.
If you use CeFi, you should expect to pass the usual “Know Your Customer” and anti-money laundering checks that any financial institution would run on you when you open an account. In m experience, it takes about 24hours to set up a Celsius account, so it’s not for the impatient, however the whole process worked on my smartphone.
Risk, interest and taxes
A juicy return on investment on what is effectively cash sounds great, right? Gimme!
However, you should consider that a) there’s risk involved (as with any investment) and – unlike a cash ISA – this interest is paid gross, which means you need to report it to HMRC at the end of the year.
Risks
The high interest rate should give it away that there’s an element of risk. I’m comfortable taking these risks for the return but you might well not be, and not without good reason! The key risks are:
- Product risk. You might choose a stablecoin that just doesn’t work in the future. Most stablecoins work on Ethereum (although Tether and USDC are spreading to other networks) and there’s a risk that Ethereum eventually gets replaced by a faster blockchain network.
- Shortfall risk. Interest rates on stablecoins vary and there’s a risk that you expect 10% gross per year but only end up with 6% gross if that’s the market rate. Interest rates in crypto relate to the demand for borrowing it, and this could drop in the future.
- Counterparty risk (DeFi). If you use DeFi, there’s a substantial risk that the borrower doesn’t pay you. If that happens, it’s difficult to see how this could be enforced when there’s no intermediary involved.
- Counterparty risk (CeFi). The Norther Rock fiasco showed that banks can still go bust in this day and age. In theory, because customer funds are segregated into a designated account, a CeFi provider’s creditors can’t seize your money if the provider goes bust. However, if they mess this up somehow, you don’t have the £85,000 protection of the Financial Services Compensation Scheme to insure you. Mitigate this risk – don’t go all in on one CeFi provider!
- Currency risk. I use USDC because it’s so liquid, but that means that I’m exposed to losses if £1 grows against the US dollar. If you drip-feed, you can get around this to some extent.
- Transaction fees. It costs money to buy stablecoins, send them to wherever, withdraw them and convert them back into cash. This will eat into your earnings, so it’s best for longer-term savings or for earning passive income once there’s a bigger amount in there. Paying in or withdrawing a fiver at a time isn’t cost-effective.
Cryptocurrency interest and taxes
In the US, cryptocurrency interest gains are taxed as income. Clear-cut and good-to-go.
However, in the UK, this is less obvious. HMRC’s extant guidance doesn’t actually recognise that crypto interest is a thing. The UK government has (at the time of writing) only recently sent out a request for input on stablecoins, so the situation is even less clear cut.
However, it’s pretty safe to assume that cryptocurrency interest is the same as cash interest if you’re using stablecoins. At least, that’s almost certainly what the consultation is going to conclude.
This means that cryptocurrency interest is almost certainly reportable as interest income on a tax return.
Fortunately, all is not lost. The first £1,000 for a basic rate taxpayer (or £500 if you’re a higher rate taxpayer) is tax-exempt anyway. (Of course, if you’re earning over £100k a year, there’s no allowance – but do you care at this point?) That means that for most people this isn’t even going to be a problem until you have around £5,000 in stablecoins that are earning interest. After that allowance, you have to pay normal income tax on savings interest.
I haven’t asked HMRC myself if cryptocurrency interest is likely to count the same as cash interest. This is purely because I don’t have enough in stablecoins to warrant it. I’m betting though that HMRC wouldn’t want to miss a tax grab and I factor in tax on my cryptocurrency interest earnings.
How I use cryptocurrency interest for financial independence
You might remember from my 2021 campaign plan that I use some of my side hustles for exotic investments like crypto.
This turned out surprisingly well. One of my speculative purchases leapt up in value and gave me the seed cash to try out Celsius. I chose USDC because it was so well known and I knew that it was liquid.
I’ve since added a bit of side hustle cash to this and now have a small pot in Celsius that’s been earning a slice of 10.5-12.5% annual interest per week. It seems to work well and I’ve learned a few tricks. For example, even though I can make payments for USDC within the app using faster payments and debit cards, it’s expensive. You get a cheaper rate by buying USDC through an exchange and transferring it across, paying the fee for the transfer.
My plan is to build this pot up over time until it hits around £3,500, by which time I hope to be a higher rate taxpayer. That way, I know it can earn money tax free alongside my ISA and pensions. I see it as a potential replacement for bonds within a portfolio. We’ll see how this performs in the long term.
I chose Celsius over Nexo and BlockFi because there wasn’t a minimum required deposit. Nexo wanted £1,000 and BlockFi paid a lower rate of interest, which at the time was the deciding factor.
Long term, if it performs well then I might consider moving more of the portfolio into stablecoins when I achieve financial independence. This would become my primary income pot, allowing me to keep my pension in equities for as long as possible. That’s a problem for another day…
If you want to try Celsius, do me a favour…
CeFi and stablecoins earning cryptocurrency interest may not be for you. The technology is pretty new and there are risks to it.
However, if you’re going to give Celsius a try anyway, consider using my referral link. When you deposit $200 of crypto in a single transaction, we both get some money or bitcoin (I forget which) from Celsius, at no cost to you.
https://celsiusnetwork.app.link/1395180533
Even better: using a referral link doesn’t prevent you using a sign-up bonus link. If you check the Celsius Website you’ll find a code that you can enter within the app (after you’ve signed up) to get an extra bonus. At the time of writing, the code “NEW40” would get you $40 in Dai if you deposit $200.
You must use an android or iphone to download Celsius. Sorry, I don’t make the rules.
