Do you want to earn returns on your cryptocurrency with little to no risk?
This sounds impossible, but it’s actually possible with something called a carry trade. A carry trade is not something unique to cryptocurrency – it’s actually pretty common in traditional finance. But it’s now available in cryptocurrency thanks to decentralized finance (DeFi).
This article will cover how to do a carry trade with your cryptocurrency. We will also explore if it’s worth it and how much risk there is to doing a carry trade.
What exactly is a carry trade?
In simple terms, a carry trade involves borrowing money at a low interest rate and using it to invest in something that earns more money than the interest rate you pay for the borrowed money.
It’s a simple concept. Here’s an example from standard finance:
John borrows money from the bank at a 4% interest rate and places that money in an investment that earns a 12% interest rate. Now, it’s normally difficult to find investments that pay more than a normal interest rate you would find from a loan.
However, that is not true with cryptocurrency. As many of you probably know, it’s easy enough to find cryptocurrency investments that pay higher than a standard bank interest rate. And that’s how you can make a lot of money with a carry trade.
How to do a carry trade in crypto?
There are many different ways to do a carry trade with cryptocurrency. Even more options emerged with the popularity of DeFi over the past year.
For instance, some investors have taken out fiat currency loans at low rates and used that fiat currency to purchase tokens that can be staked on DeFi platforms like Uniswap or SushiSwap.
Another popular option is to use a platform such as YouHodler. YouHodler allows users to lock-in cryptocurrency and earn interest rates up to 12%.
That’s a huge interest rate. And an interest rate much higher than the interest you will pay on a bank loan.
Anyway, here’s a step-by-step guide for doing a carry trade with cryptocurrency:
- Borrow fiat currency from a bank.
- You can easily find bank loans at 5%. 4% and under is a little more difficult, but certainly possible with a good credit score and a good relationship with your bank.
- Use the fiat currency to purchase cryptocurrency.
- Ether and stablecoins are the most popular options.
- Place the cryptocurrency in a financial tool that earns interest.
- YouHodler is an option that allows you to earn interest on a cryptocurrency deposit. USDT, USDC, PAX, TUSD, DAI, HUSD, and EURS all pay 12% interest on YouHodler.
- Uniswap offers staking via liquidity mining that can earn a decent return, but it is a little more risky depending on the liquidity mining pair.
- Earn profits from the interest.
- You also earn a profit if the underlying asset, cryptocurrency in this case, increases in value compared to the fiat currency.
Is a crypto carry trade really risk free?
Not really, no. A higher return comes with more risk, so it’s a little bit of a misnomer to say that carry trades are 100% risk free.
However, it’s important to note that the return is high for the amount of risk exposure. For instance, a 12% return in something like real estate is generally viewed as risky because it involves low income housing or real estate development. Both of those investments carry huge risk for traditional finance.
Cryptocurrency, on the other hand, is viewed as risky not because of the risk of the return becoming insolvent or failing, but because the risk of the underlying asset decreasing in value.
That’s a fair risk for volatile cryptocurrencies like Bitcoin or Ether. Cryptocurrency is great, but we would be lying if we said it was not volatile.
This is where stablecoins enter the picture. The value of the stablecoin is pegged to the United States Dollar or another fiat, so it’s essentially a 12% return on fiat currency. Of course, a stablecoin is a little more risky than fiat currency due to internal problems with the stable coin (ie. Tether has never been audited).
Again, this risk can be mitigated by pulling a 12% return on a DAI investment on YouHodler. The smart contract that maintains the 1:1 ratio for DAI is public, so you can audit it yourself. That is not 100% risk free, but it’s as close to risk free as you will find on a cryptocurrency carry trade.
Why don’t more people do carry trades in crypto?
You are probably why everyone is not doing a carry trade in crypto if it’s risk free. There are two reasons for this:
The biggest reason, in our opinion, is that most people do not know about these opportunities. They view cryptocurrency as a store of value and do not realize that it is possible to earn interest on cryptocurrency holdings.
This is why you frequently read stories about people refinancing their home to purchase bitcoin or other cryptocurrencies – they don’t know about the safer alternatives!
The other reason is that they do not fully understand the risk profile. As stated earlier, a crypto carry trade with Bitcoin is much riskier because Bitcoin’s price can plummet, which means the value of your underlying asset (and the interest payments) will plummet.
That’s why we suggest investing in stablecoins with your loan for your carry trade.
Other Types of Carry Trades
It’s also possible to perform other types of carry trades with your cryptocurrency. A popular example is to take out a fiat loan with your cryptocurrency as collateral.
You can then use the fiat currency to invest in traditional financial investments while still holding your entire stack of cryptocurrency.
Now, this strategy only works if you have a lot of cryptocurrency to put up as collateral because that will allow you to prevent liquidation in the event of a price drop. We only recommend this strategy for advanced investors that have a good understanding of these loans and the risks involved.
It also helps if you have a plan for investing the fiat currency. Some people use these loans to pay for living expenses, which is not ideal because you risk your cryptocurrency stack and have to pay interest on the loan.
This is still a carry trade in crypto, though. It just goes from cryptocurrency to fiat currency rather than from fiat currency to cryptocurrency.
That covers it for how to perform a carry trade in cryptocurrency. It’s not a difficult concept, but we did do a very brief overview.
You should always do your own due diligence to fully understand the risks involved. Many of these cryptocurrency lending platforms have very specific terms and conditions that allow them to liquidate the collateral if the price falls below a certain point. It’s actually the same concept as a margin call in trading.
Overall, it’s definitely possible to earn decent returns with this strategy. We just can’t emphasize enough how important it is to only do a carry trade if you know what you are doing. It’s just so easy to get burned with these if you make one mistake, and that results in a loss of your collateral and having to repay a loan out of your own pocket.