Knowledgeable investors can generate returns regardless of whether the markets are trending upwards, downwards or sideways. Making money during bullish conditions may be one of the the easiest method, as a rising tide lifts all boats. Downward trending markets also provide potential opportunities.
Producing returns during sideways or "flat" markets may be the most challenging option, but there are several strategies investors can use to achieve this objective. This article will review five specific methods for meeting this goal.
One way that cryptocurrency investors can potentially generate returns during periods of low volatility is mining, which involves verifying transactions in exchange for a reward. Bitcoin provides a great way to illustrate the basics of mining. Nodes (devices) on this network confirm transactions, which are then incorporated into blocks in Bitcoin's blockchain.
Bitcoin's mining incentive, which decreases over time, is 12.5 units of the cryptocurrency (or roughly US$50,000) at the time of this writing. This incentive is cut in half roughly every four years, with previous halvings taking place in 2012 and 2016.
Mining bitcoin requires expensive hardware and can consume significant amounts of energy. Further, bitcoin prices can be highly volatile, causing the value of the mining reward to fluctuate substantially.
Fortunately, there are plenty of other digital currencies that can be mined. Investors should be sure to conduct thorough due diligence before getting involved.
2. Deposit Accounts
Another method investors can use to generate returns is depositing their digital currency into accounts that pay regular interest. BlockFi, a cryptocurrency lending startup, announced the availability of the BlockFi Interest Account (BIA) in March 2019, which offered an annual interest rate of up to 6.2% to investors in exchange for depositing their bitcoin and ether.
However, the Terms and Conditions available on the BlockFi website emphasized that the company "will determine the interest rate for each month in our sole discretion." While these accounts may pay up to 6.2% per year, there is no guarantee of what rate they will pay.
The same month that BlockFi launched its accounts and started advertising returns of up to 6.2% per year, it announced that April 1, 2019, accounts with balances exceeding a certain amount would have different rates.
BlockFi clarified by stating that accounts with balances up to and including 25 BTC or 500 ETH would receive an annual rate of as much as 6.2%, but that any balance over that amount would earn a tiered rate of 2%. In other words, an account with 30 BTC would receive a variable rate as high as 6.2% on the first 25 BTC and a fixed rate of 2% on the remaining 5 BTC.
Uphold, a digital currency platform, has announced a similar opportunity, stating that it will offer interest rates of up to 10% per year to investors who lend their cryptocurrency. According to the "Apps Center" section of the Uphold website, investors who lend US$10,000 worth of Bitcoin to the CredEarn platform, for example, will receive two quarterly interest payments of US$250 each, as well as the Bitcoin they lent originally.
Interestingly enough, Uphold's Membership Agreement makes it clear that because the organisation is not a bank, balances "are not deposits" and they are not insured by the Financial Services Compensation Scheme, the Federal Deposit Insurance Corporation or any similar organisation.
Further, the interest rates paid to depositors are subject to change. "A number of factors determine whether we will raise or lower rates for future programs," according to the CredEarn FAQ. "We may increase or decrease the Yield in our sole discretion 30 days after notifying you of the upcoming change in the Yield (a "Yield Change Notice"). We periodically change the Yield to respond to changes in prevailing interest rates, similar to the way banks periodically adjust the interest rates they pay for deposits."
Through a process called staking, investors can earn cryptocurrency by using their digital tokens to verify transactions. This requires them to put their tokens into digital wallets, where they can be used for this purpose.
Investors can earn these rewards through networks that use so-called proof-of-stake algorithms, for example EOS and Cosmos Network. In proof-of-stake, miners are randomly selected by holders of the relevant digital token, so interested parties can increase their chances of being selected by holding more cryptocurrency in a digital wallet.
Another way to participate in staking is by working with startups that offer staking services. Battlestar Capital, for example, revealed in March 2019 that it was offering annual returns of up to 30% after entering a partnership with Celsius Network, a digital currency lending platform.
While there are attractive aspects to staking, this activity also comes with specific risks. Some have voiced concerns that the digital tokens received through staking might be viewed as securities.
Further, any digital tokens put toward staking may be "locked up" for notable periods of time, for example hours or days. If an investor puts a digital currency toward staking and that cryptocurrency starts to plummet in value, they will be unable to sell in order to limit their losses. The downside suffered during a bull run may exceed the gains they receive through staking.
4. Trading Small-Cap Cryptos
Just because the broader digital currency markets seem reasonably calm, that doesn't mean that all of its components lack volatility. The top 10-20 cryptocurrencies could be rather flat, for example, while digital assets outside of this specific group are experiencing strong enough volatility to present investors with significant opportunities.
In situations like this, investors might consider focusing on lesser-known cryptocurrencies, which could potentially generate impressive returns.
Jeff Dorman, chief investment officer for investment manager Arca, spoke to developments like these in a March 2019 research note, where he emphasized that small-cap digital currencies had been generating strong returns and outperforming the broader market.
He provided further detail when speaking with MarketWatch, asserting that cryptocurrency investors were seeking out so-called utility tokens, digital assets that provide a specific value within an ecosystem.
5. Arbitrage Trading
One way crypto investors can make money in sideways markets is arbitrage trading, which involves taking advantage of price differences in the market. For example, if Bitcoin is trading for US$4,005 on BitMex and US$4,080 on Bitfinex, an investor can buy a unit of Bitcoin on the former exchange and simultaneously sell it on the latter, producing a US$75 profit.
This strategy may sound straightforward enough, but it certainly comes with its risks. Price differentials can close in short order, eliminating the opportunity for profit.
Another source of difficulty can be slippage, which is when a trade executes at a price other than what was expected. This can eliminate the price difference an investor was looking to harness.
Another consideration is trading fees. If an investor is looking to take advantage of small price differentials that exist between digital currency exchanges, the associated expenses can eliminate any profit earned or even create a loss.
Investors who are thinking about using arbitrage trading can benefit from conducting thorough due diligence before using this strategy.
Investors have many opportunities to produce returns in flat markets. They can mine digital currency, which involves confirming transactions and receiving a reward. This activity could possibly provide a form of income regardless of market direction. Another option is deposit accounts, where investors can place their digital currency in exchange for interest.
Staking gives investors the chance to receive cryptocurrency by using their digital tokens to verify transactions through certain blockchains. Investors can also generate returns in sideways markets through arbitrage trading, which involves taking advantage of price differences between markets. Further, trading small-cap digital currencies can produce returns when the broader markets are relatively stable.
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…