Ownership of Crypto Keys
There are two types of digital wallets. Cold storage wallets are the most secure because they store your keys offline, but if you lose the specialized hard drive they are on, you lose access to your cryptocurrency. Hot storage wallets are accessible online, and some providers might take ownership of your crypto keys. Most crypto savings account providers require you to give up ownership of your keys so that they can lend them out.
Risks Associated with the Highest APY Crypto Accounts
As with all financial products and with decentralized finance, there are some risks to crypto savings accounts. In some cases, you could even lose money. Here are the primary risks you should be concerned about.
Exchange Rate
The number one issue with anything having to do with cryptocurrencies is sudden fluctuations in the prices. Companies attract investors by offering high-interest rates on their accounts, but those high rates can’t protect you if the price of the cryptocurrency drops suddenly. The exchange rate is also an issue because you’re not dealing with just the cryptocurrency you have deposited, but also with whatever legal tender or other cryptocurrencies you want to exchange it for.
Risk of Custodian Hack
Hacking has always been a concern for cryptocurrency enthusiasts, and this hasn’t changed. Crypto interest accounts involve sending your cryptocurrencies to a custodian company, which holds and lends them out, often to a primary borrower but sometimes to other borrowers as well. If the custodian is hacked, your cryptocurrency could be stolen. Some companies offer insurance for this sort of thing, but it’s important to read the fine print before you do anything. Some companies protect customers against a hack of their own servers but do not offer protection if their custodian is hacked.
Smart Contract
Customers who aren’t tech-savvy may not understand the smart contract they are interacting with for their accounts. As a result, malicious smart contract developers could exploit these customers. Thus, it’s important to only use smart contract protocols audited by the community and professional auditing firms. However, another risk is that the smart contracts themselves are hacked due to loopholes in the code.
Risk of the Stablecoins
One of the greatest attractions to stablecoins for investors is the high-interest rates account providers are offering to pay. However, there’s more than meets the eye with stablecoins. Each stablecoin is pegged to a currency like the U.S. dollar, but when you read the disclosures, many of them are backed by things other than the currency they are pegged to.
For example, Tether said it is about 50% invested in commercial paper, a type of short-term corporate debt. The Federal Reserve had to fix the commercial paper market in 2020 due to a meltdown, and if something similar happens again, Tether might have a difficult time converting its holdings to cash so that it can meet all the withdrawal requests.
Another potential problem is if the stablecoin breaks its peg, If a stablecoin can’t maintain its value relative to its peg, investors will no longer trust it, and its value will collapse.
Loan Default
Another big concern is tied to the way these accounts work. They aren’t like regular savings accounts because the reason companies can offer such high interest rates is because they are lending the cryptocurrency out. So what happens if the borrower defaults on their loan?
The risk of these loans defaulting is low because most cryptocurrency loans are overcollateralized, often with collateral amounting to 150% of the amount of the loan. However, if the markets crash suddenly, the risk of defaults rises, and they could become an issue if a company faces a rash of defaults all at once.
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