We are going to talk to you about why you should avoid the potentially ruinous temptation to try and earn interest or ‘yield’ on your hard-earned Bitcoin stack.
We completely understand the temptation. Earning 18% APY while you sit and HODL your bitcoin? What could possibly go wrong? It sounds ‘too good to be true…’
But what do we know about things that sound ‘too good to be true’ folks?
Read on to learn why it’s simply not worth the risk…
The first and most overlooked risk of trying to earn a yield on your Bitcoin stack is that it will require you to deposit your funds with a third-party custodian. As history has shown, this is a particularly risky thing to do. If you had left your Bitcoin with any number of custodians over the past 15 years you would have very likely ended up losing all your Bitcoin. Look at just a small handful of examples below:
MtGox – One of the earliest Bitcoin exchanges. They suffered a catastrophic hack in 2014 losing 650,000 Bitcoin. They tried to keep it quiet at first by running a fractional reserve (“As long as all the customers don’t withdraw at once, no-one will notice”) but ultimately everyone did notice, and the exchange collapsed.
Moolah – Another well-known exchange and escrow service that went into liquidation in 2014 losing millions in user funds. This case was particularly unusual as details began to emerge that the CEO was using a fake name and was in fact a serial scammer who had previously faced court restrictions for his scams before.
BitGrail – An Italian exchange that suffered a similar fate after being hacked in 2018. Needless to say, lots of creditors ended up suffering serious losses.
Cryptopia – Yet another exchange that was put into liquidation in 2019 after suffering a hack that saw almost 15% of all user funds stolen.
Consider that this is just a handful of examples of when things go wrong at third party custodians. It happens more often than you realise and the list of failed or bankrupt exchanges is long and always growing.
The moral of the story?
“Not Your Keys? Not Your Coins” is more than just a catchy phrase. The only method available to you to avoid these kinds of custodial calamities is to hold the keys to your Bitcoin yourself, in self-custody.
But there is more than just counterparty risk that you should be concerned about when it comes to these yield products.
The next thing worth considering is that these products are often promoted as being a ‘low risk’ method for generating cash flow while you ‘HODL to the moon’. Sounds like a win-win, right? You get to avoid divesting and facing a taxable event, whilst you continue to HODL and enjoy a new income stream on top. What’s not to love?
It’s ‘low risk’ after all right?
It's an attractive pitch because it preys on impatience and greed. Why just be patient and wait for Bitcoin’s value to appreciate? Why not HODL AND earn cash flow from your stack at the same time to compound your gains?
Well slow down for a second and consider that Bitcoin is just ‘money’. It doesn’t generate yield. With this being true, the key question you should be asking yourself when looking at these products is “Where does the yield actually come from?"
If these custodians can offer you a ludicrously high 18% APY then they are going to need to use your funds to seek a return greater than 18% to make it worth their while. If that doesn’t start setting some alarm bells off in your head nothing will. Does it sound plausible to you that these firms can generate this level of outsized return by making ‘low risk’ bets with your money?
If that sounds ludicrous to you, that’s because it is. Marketing these products as ‘low risk’ is demonstrably false and highly unethical.
We have already shown examples of custodians suffering hacks and ultimately becoming insolvent, but are there specific cases where yield products were the source of the problem?
The short answer is yes. We aren’t making this appraisal without decent precedent.
Bitcoin’s history is littered with examples of custodians playing ‘banker’, taking customer deposits, offering outsized dividends on them, and then investing or loaning out these funds to make a profit. The problem is that in most cases, to offer such attractive dividends to customers, the loans and investments these firms needed to make would turn out to be extremely risky.
To demonstrate how these collapses happen let’s take a closer look at the story of Celsius, a ‘Crypto Lending Firm’ that at one point had as much as $25bn in assets under their control before their catastrophic collapse in 2022.
Before their demise Celsius was busy hoovering up customer deposits by offering them a whopping 18.6% return on them annually. To offer these returns they were taking these deposits and investing them in the wholesale crypto market, specifically DeFi platforms that offered products such as insurance and loans outside of the traditional finance system.
Celsius’ problems first started to emerge when it was discovered that they had invested in something known as BadgerDAO which then suffered a hack to the tune of $54m. Celsius didn’t disclose how much they lost on this investment but assured customers it was a small loss.
But of course that wasn’t the only questionable investment they made. They also invested into something known as the Anchor Protocol who in turn were offering outrageous 20% returns to their customers on deposits of the now worthless stablecoin, TerraUSD. To cut a long story short, As TerraUSD lost it’s ‘dollar peg’ and spiralled out of control, so too did these investments. Again, Celsius’ CEO Alex Mashinsky claimed they didn’t lose ‘much’ money.
You might think it would stop there, but no. The list of wacky and ridiculous high-risk ‘investments’ Celsius made is a long one. One of the most egregious was using customer funds to prop up the price of their own token called CEL whilst the company owners were busy selling their own stake in the coin for profit.
As the market took a nosedive Celsius’ various shitcoin investments would start to head south and Celsius would find itself completely insolvent. As panic spread across the markets and the price of Bitcoin began to plunge people started running for the exits to sell or withdraw their funds. It was at this point that Celsius descended into a full-blown Ponzi, paying out customer withdrawals by using other customer’s deposits.
Ultimately, on July 13th, 2022, it was revealed that Celsius had a $1.2bn hole in its balance sheet and the company declared bankruptcy. In the restructuring that took place afterwards those with custodial accounts would only see 72.5% of their holdings returned to them. Ouch.
Celsius is a great example of why these products are extremely risky but they certainly weren’t the only casualty. Bitcoin’s bear markets see fast and brutal price drops in $ terms and it turns out this is a good thing. These events are extremely efficient at wiping out greed and speculation from the market.
Some other notable casualties included big names like BlockFi, Voyager Digital and Genesis. Each of these firms failed for a variety of different reasons but ultimately, they were all engaged in the business of ‘crypto lending’. Each of them became insolvent due to poor investments and making ridiculous unsecured loans. In most cases these firms were also close counterparties with each other so when the music stopped, the dominos fell quickly.
Sadly, the data shows that the majority of investors in companies like BlockFi had deposits of less than $10,000 suggesting that those bearing the brunt of these failures were small retail investors.
Part of the problem, and the reason these products become so popular, is because a rising tide raises all ships. When Bitcoin is doing what it does best and pushing to new all-time highs then critical thinking goes out of the window to be replaced by wanton greed. A lot of people fall into these traps because even your favourite podcaster will probably be shilling these risky investments to you amid the bull market hype.
Inevitably though, the tide eventually goes out and we all get to find out who wasn’t wearing a bathing suit. The losses are often catastrophic and permanent because unlike in traditional finance these products don’t come with any investor protections, deposit insurance or anything resembling a government backstop.
But don’t worry, the influencer who shilled these products to you will be sure to make a thread breaking down ‘what went wrong, and the lessons learned’. That should be an enjoyable read…
What we hope you take from this article is two things….
1) Don’t ever let anyone else hold the keys to your Bitcoin. It significantly increases the chances of you never seeing it again. Whenever you give someone control over your coins you are taking on unnecessary counter party risk. This isn’t conjecture, history has shown us this time and time again over Bitcoin’s 15-year history that custodians can and will fail.
2) Beware anyone offering you a ‘passive income’ or ‘low risk investment’ that allows you to earn yield on your Bitcoin. All you are doing is giving them free licence to take your hard-earned BTC and gamble with it. Again, Bitcoin’s history is littered with examples where those offering these products either blow up entirely or simply abscond with your funds never to be seen again.
What we are witnessing with Bitcoin is the emergence of a new world reserve currency and arguably the largest wealth transfer ever to occur in human history. There is absolutely no need to get greedy and chase yield when Bitcoin’s historical CAGR is a staggering 155%
Instead, you should be focussed on ensuring your Bitcoin stack remains under your control indefinitely via secure self-custody. Regardless of the size of your Bitcoin stack your wealth is likely to increase significantly. You don’t need to be chasing an extra 10% gain per year, you need to be focussing on securing your wealth properly for the future and having plans in place to pass it down your lineage.
If you’re ready to do things properly and learn the skills you’re going to need to safely navigate this financial paradigm shift then you should give us a call.
We are here to teach you exactly how to do it!
Disclaimer: Please note, The Bitcoin Way does not provide financial, legal, or tax advice. This article is for educational purposes only and is intended to offer insights into the technical aspects of Bitcoin management. Always consult with a professional advisor for advice specific to your situation.
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