In the Beginner's Guide to Choosing a DeFi Platform, I mentioned that stable coins such as DAI and USDC earn considerably more interest than coins like BAT, Bitcoin, and Ethereum. It is possible to chase higher interest rates by converting BTC (and other cryptos) to higher interest-earning stablecoins, but this carries risks of its own. Year over year, BTC is up 38%. Traders who would have converted their bitcoin to a stablecoin for lending purposes would have missed out on this price appreciation, so what are investors to do? In this article, I propose a simple strategy for determining whether to convert a crypto to a higher earning stablecoin or retain the crypto in its original form.

Simple Interest Adds Up

The first thing that I want to point out is that small changes in the interest rate can make a huge difference over the long-term. The following chart was calculated based on Compound Finance's lending rates for 4th November, 2019. Let's suppose that you have $100 worth of three separate cryptocurrencies. Basic Attention Token, DAI stablecoin, and USDC stablecoin. For each coin, you have the same $100, but because each token gives you a different interest rate, $100 worth of Basic Attention Token will earn you $0.13 at the end of the year. $100 worth of Dai will earn $6.30 at the end of the year, and $100 of USDC will earn $4.20 (assumes simple annual interest).

Suppose that we have three cars and we give each car the same 5 liters of fuel. We put the same amount of fuel into each car, but a more fuel-efficient car will take us further for the same fuel cost. It has the same amount of gas, but it is more efficient at transforming the chemical energy of the fuel into motion. This is similar to what we see with cryptocurrency lending. We can purchase $10 worth of BAT, $10 worth of USDC, and $10 worth of DAI, but the DAI and USDC will most efficiently transform that $10 into more interest. It is not just how much we are investing that matters, but also what vehicle we are investing in.

If everything else were equal, we would prefer to choose the cryptocurrency that has the highest lending interest rate. However, we can't always be assured that we will have the cryptocurrency with the highest rate. Maybe I will earn BAT from viewing ads with the Brave browser or receive ETH from completing some tasks online. So then, we have to ask ourselves the question, should I exchange crypto with a lower interest rate for one with a higher interest rate?

Exchanging to Higher Yielding Crypto

We will indeed earn more from lending cryptos with a high-interest rate, but that doesn't tell the whole story. The cryptocurrencies with the highest interest rate are usually stable coins which means that their price is designed not to increase or decrease. If I lend $10 worth of DAI, I might receive 6% in interest. At the end of the year, I would have more DAI (10.6 DAI), but the price of DAI itself should remain stable. The only way for me to profit by holding DAI is to lend it out, and I probably won’t get rich by “buying low and selling high” with DAI or any other stablecoin.

By contrast, non-stablecoins, such as BTC, ETH, BAT, and 1UP can appreciate in value. Exactly one year ago on today's date, Bitcoin was priced at $6,405, and today it is priced at $9,471 (Coinbase). This is a price appreciation of 38% in one year. Even though BTC had a much lower interest rate, it still could make a superb investment because the price can go up so much.

The point that I'm trying to make is that interest rate is not the only thing that matters when deciding to lend cryptocurrency. It is also important to consider whether or not the underlying asset could go up in value. Let's suppose that I sell Bitcoin to purchase DAI so that I can receive a higher interest rate. Earning a 6% interest rate certainly isn't bad, but I can guarantee that I will be very disappointed if BTC experiences another 38% yearly increase and I have no BTC to sell because I already converted it to DAI.

So, let's get back to the original question. Should I convert a cryptocurrency to a different crypto just so I can get a higher interest rate? I have to say that it depends. If I believe that a certain cryptocurrency is “going to the moon”, then it is better to hold that cryptocurrency even if I don't receive much of an interest rate. On the other hand, if I don’t think that a certain crypto will have a large price increase, then it might make sense to convert to a higher-yielding stablecoin for lending. For example, USDC and DAI are both stable coins that are designed to remain as close as possible to $1 in value, but DAI has a higher interest rate than USDC. If I sell USDC to take advantage of DAI’s higher interest rate, I don’t have to worry about missing out when USDC goes up by 15%. Therefore, I would feel comfortable selling USDC and purchasing DAI to get a higher interest rate.

As one more example, let’s suppose that I have received BAT from tips on my YouTube channel. I know that if I were to convert this BAT to DAI, I could receive a 6% interest rate, but I would miss out on BAT going up in price. If I feel that BAT is going to only go up 2% per year, then I would be better off by converting to DAI and lending, but if I felt that BAT was going up by more than 6% in the year, I would be better off by keeping the BAT even with the lower interest rate. Again, this is based on the investor's judgement; one person could think a certain coin has mediocre appreciation potential while another investor could predict huge gains.

Conclusion

I am a fan and supporter of DeFi and crypto lending, but it is always important to keep an open mind and remember that there is more than one way to earn money with crypto. The decision to convert a low-yielding coin to a higher-yielding coin has benefits but also carries risks. As with everything else in investing, everyone has to make their own choices and do their own research, but my personal decision comes down to how I feel about the original coin’s potential. If I believe that the original coin has the potential to appreciate by more than the going interest rate, I will keep the coin. If I feel that the coin will appreciate by less than the interest rate, then I will convert the coin to the higher-yielding stable coin and lend it out.

Image Credits:



Cover: https://pixabay.com/users/geralt-9301/

BTC price: https://www.coinbase.com/price/bitcoin