Chapter 7

Alternative Crypto Investments

Besides buying and holding cryptocurrencies there are many other ways to participate in the world of cryptocurrencies.

1. Mining Pools

Mining Pools explained

As we already know, the creation of new Bitcoins is called mining. It is also the way the network is secured. The more miners there are distributing hash power (calculations made per second), the more secure the network.

When Bitcoin was created in 2009 the reward to find the next block was 50 BTC today it's 6.25 BTC, because it's reduced by 50% every 4 years based on the code of Bitcoin. The more computing power a miner brings to the network, the more likely he gets the next reward. Therefore, many people started to buy huge warehouses to install thousands of miners, and make it a profitable business. Today it's almost impossible to compete against these big mining farms, because they are faster, more efficient, and can get extremely cheap electricity. By mining on a few devices, the hashrate would not be anywhere near enough to find a block. This is where mining pools come in. By joining a mining pool one can share the hashrate with the pool, and in reverse a payout will be made based on the contributed power. If mining is profitable or not depends on many factors:

  • The hardware (which is renewed constantly)

  • The costs of electricity in a country

  • The difficulty to find a block which is adjusted every 4 years, and of course, the price of a coin.

This pie chart shows the current distribution of total mining power by pools.

Efforts have been made to make mining more a thing for everyday people. Today it's possible to order a miner over the internet and plug it in at home. Nonetheless, it won't be profitable, and it's more of an interesting gadget.

Pro and Cons of Mining

One of the main arguments against using proof of work hardware to secure a network is the consumption of energy. The puzzles miners have to solve require a lot of electricity. Another problem is that more than 70% of all mining power is located in China. Pools are becoming centralized because the cost of electric power is the lowest out there.

Proof of work is better for the supply distribution of a cryptocurrency, because miners need to pay electricity, and are forced to sell their rewards at some point. Another point is in the adjustments in mining difficulty that can help to control the inflation of a cryptocurrency, because it regulates the amount of newly created coins.

2. Staking Services

Staking explained

Staking refers to an alternative consensus mechanism. While Bitcoin's network uses proof of work to secure the transactions, other cryptocurrencies are running with proof of stake. It involves locking funds in a wallet to support the security of a blockchain network. At particular intervals, the protocol randomly assigns the right to one of them to validate the next block, and receive the reward. The probability of being chosen is proportional to the amount of coins locked up. Each blockchain can make its own rules of receiving staking rewards. Other factors could be how long a validator participates in the network, the inflation rate, or if its just a fixed rate.

Similar to the proof of work method, where mining pools evolved, there are staking pools merging resources to increase the probability of receiving rewards. Other than mining, it's possible to stake coins on exchanges or with a wallet. While some coins require a minimum number of coins in order to stake, there are others without any limits. Some of the most popular staking coins are Tezos, NEO, ADA and Ethereum (coming soon).

Figure 31 - The probability of staking rewards depends on the size of the staking pool
Pros and Cons of Staking

The consensus mechanism, proof of stake, requires a lot less energy than proof of work; this could be better for the environment in the long term. The theory that those who stake the most will help keep the network secure by doing things, makes sense because they're carrying a higher risk. On the other hand, proof of stake encourages hoarding coins, which is not good for the liquidity of a currency, also called the rich-get-richer algorithm because the more you own, the more you get out of it.

Though some might argue that one consensus mechanism is better than the other it's not that easy. While one mechanism does manage some problems, it creates completely different ones. New consensus mechanisms are coming into the market as well, but that would go beyond this scope.

3. Lending Platforms

The concept of crypto lending platforms is as simple as it can get. You can compare it to the traditional financial system that brings borrowers and lenders together. The main differences here are that it doesn't need a third party, nor paperwork, or a bank account. The borrower sends collateral to the smart contract as a security and receives a loan. Some of the biggest lending protocols are Compound, Aave and MakerDAO.

Figure 32 - Two roles exist as part of a lending platform: lender and borrower

4. Token-Sets

Another emerging crypto platform is Token-Sets. Think of the set protocol as a way of algorithmic trading strategies. It allows users to invest in a specific trading strategy on the Ethereum blockchain where each trading strategy is represented by an ERC-20 token that is fully collateralized by the underlying assets such as BTC, ETH or a stable coin like DAI. Anyone in the world can use automated portfolio strategies without the need to sign up for a bank or a brokerage account.

Figure 33 - TokenSets are algorithmic tokens that will react to whatever conditions have been pre-set to them

5. Cryptocurrency funds

Last but not least, there are cryptocurrency funds that are coming into the market. There are crypto hedge funds: venture capitals investing in crypto-related projects and private equity funds. According to the crypto hedge fund report 2020 by PWC, the top 5 traded coins measured by daily volume (stablecoins excluded) are BTC, ETH, XRP, LTC and EOS.

Figure 34 - Top cryptocurrencies based on the percentage of funds trading