DeFi savings accounts offer much higher APY than most banks - here's everything you need to know about them.
A DeFi savings account (sometimes called a crypto savings account) is an alternative to the savings accounts offered by banks.
They offer more than 50 times the APY of the average traditional savings account and usually double or triple the APY of even high-yield savings accounts.
In this article, we are going to dive into what exactly DeFi savings account alternatives are and how they work under the hood. We’ll also preview some of the best available options and highlight their key differences.
So how do DeFi savings accounts work exactly? The first thing you need to understand is stablecoins.
Stablecoins are tokens (or “digital assets”) that are designed to hold a consistent, stable value. Most stablecoins are pegged to the US dollar. These tokens are the backbone of DeFi savings accounts.
The two most prominent stablecoins are Tether’s USDT, and Circle’s USDC. Both are backed by collateral and can always be redeemed for $1. Stablecoins like these allow investors to reduce their exposure to volatile cryptos without leaving the market entirely. They can also be used for executing complex investment strategies, such as leveraged trading.
DeFi savings accounts generate yield with stablecoins because they are in-demand assets with unique value in crypto markets.
To generate yield, DeFi savings accounts utilize blockchain-based protocols. The two most common types of protocols used by DeFi savings accounts are lending protocols and liquidity pools.
In traditional finance, users deposit their money into a bank account and the bank lends that money in exchange for a return. In DeFi, lending protocols match lenders and borrowers directly on the blockchain through automated code.
In this process, lenders deposit their stablecoins into a ‘pool’ of tokens that other people can borrow. To take out a loan, borrowers need to provide collateral greater in value than the amount they borrow. If the value of their collateral drops below a given threshold the loan is liquidated to protect the lender.
Ok, but how does an investor earn a return?
When an investor borrows tokens from a lending protocol, they pay fees continuously until the loan is paid off. The fees that the pool generates are paid directly to lenders. If a lender owns 1% of the tokens in the pool, they will receive 1% of the pool’s fees.
What does that mean for you?
No more middlemen taking a *hefty* portion of the yield that your money earns. With no CEOs to pay and relatively little overhead, that means you can earn a much greater return.
Another method for generating rewards with stablecoins is to provide liquidity to a stablecoin liquidity pool. While lending pools are composed of just 1 token (USDC, for example) stablecoin liquidity pools, such as the ones offered by Curve Finance and mStable, are pools of two or more stablecoins.
The purpose of these pools is to provide liquidity to traders who want to swap one coin for another. So if a liquidity provider contributes USDC and USDT to a liquidity pool, traders can use that pool to swap USDC for USDT and vice versa.
Each time a trader swaps tokens in a pool they incur a transaction fee. Those fees go directly to the pool’s liquidity providers.
There are 3 key advantages of investing in a DeFi savings account as an alternative to a regular savings account.
When you invest your money into a regular savings account, you may earn as little as 0.01% interest on your money. In other words, almost nothing. The highest yield savings accounts you can hope to find are usually around 2% APY. Meanwhile, DeFi savings accounts often offer 5% APY or even higher, depending on market conditions.
DeFi savings accounts make it easy to invest in the best protocols on the blockchain without having to be an expert or learn anything technical. They allow anyone to earn a yield on the blockchain with the tap of a few buttons, making complex investment strategies accessible to non-technical people.
All banks limit withdrawals from savings accounts, usually to somewhere between 6-9 withdrawals per calendar month. Many also have strict minimum account balances required to earn the highest level of rewards.
With a DeFi savings account, neither of these restrictions exist. You can deposit as much or as little as you like, and you can withdraw it at any time without any limit whatsoever.
There are many options when it comes to DeFi savings account alternatives, but they all fall under 2 main categories: custodial accounts vs. non-custodial accounts.
A custodial DeFi savings account is one where your funds and your private key are managed for you. All you do is deposit money and watch it grow.
With a non-custodial account, you retain direct control of your tokens at all times, but you’re also responsible for safely storing backups of the private key to your wallet. If you lose that key, you lose your investment. Forever.
So which option is better?
Deciding whether to go custodial or non-custodial is a decision only you can make, but we can help by highlighting a few of the best options for each:
Donut is another custodial savings account alternative and Outlet competitor, also offering 5% APY. It’s a simple app, available on your mobile device.
Nexo allows users to earn a yield on a variety of tokens and offers as high as 12% on stablecoins. However, certain geographic restrictions apply to Nexo, and you have to hold the NEXO token to get the highest yield. It’s also worth noting that Nexo utilizes complex and experimental strategies to generate yield, which could represent more risk.
Gelt is a newcomer in the DeFi savings account space and is one of the first of its kind to offer non-custodial savings accounts. It offers variable rates between 3-8%. Gelt is still an invite-only platform with limited availability but plans to open up access soon.
Minke is another newcomer and one of the first to the scene with a non-custodial DeFi savings account. Minke doesn’t state their APY on their website, but according to Product Hunt, they offer rates as high as 5%.
While Outlet has traditionally been a custodial service, we will be expanding our product offerings to allow users to open non-custodial wallets and generate yield directly on the blockchain soon. Stay tuned!
Anytime you invest your money, there is risk involved. Although DeFi savings account alternatives do not experience the same volatility as other cryptocurrencies, there are still risks you should be aware of.
So what are the risks?
The lending protocols and liquidity pools that make DeFi savings accounts possible are built using something called smart contracts, which are automated code stored on the blockchain. This automated code is how users lend, borrow, and swap tokens on the blockchain without any middleman.
Smart contract risk refers to the potential for a smart contract to have a bug in its code that could either result in tokens getting lost or stolen by a hacker.
If you do choose to invest in a DeFi savings account, there are two ways you can mitigate your exposure to smart contract risk. First, only invest in protocols that have a long track record of success. The longer the better! Second, invest in protocols that have been audited by professional crypto auditing organizations.
The longer a given platform exists without any record of hacks or lost funds, the less likely it is that an exploit will be found in the future.
Stablecoins are designed to maintain a consistent value. They are ‘pegged’ to a specific currency, usually the US dollar. However, these tokens are not issued by a government, so there is always some risk that they could depeg.
Before investing in a stablecoin it's important to know how that stablecoin maintains its peg. If it is employing any ‘experimental’ practices, it is probably best to avoid it. If a stablecoin is not backed by sufficient collateral, the token has a much higher risk of depegging.
Even the leading stablecoin, Tether’s USDT, could have some risk involved. While Circle’s USDC is fully backed and regularly audited, USDT has come under scrutiny for not being as transparent. Some critics have questioned whether or not Tether has the proper practices in place to ensure all USDT will always equal $1.
If you choose to use a custodial DeFi savings account, understanding exactly how your funds are managed is a top priority. You need to know what stablecoin you are invested in, and how that stablecoin is used to generate rewards.
The crypto markets learned this lesson the hard way in 2022, as we’ve seen Celsius and Voyager collapse and halt withdrawals of customer funds. It’s unclear when, if ever, those customers will be able to recoup their investments.
BlockFi also suffered massive losses and came under heavy scrutiny from the SEC, and is no longer allowed to offer custodial accounts in the United States.
If you entrust your money to a third party, be careful who you invest with. Always expect clarity concerning how your funds are managed and don’t invest with anyone who doesn’t provide it.
Investing in a DeFi savings account alternative can be a great way to generate a steady yield that blows your savings account out of the water. That being said, there is no such thing as a risk-free investment. Always exercise caution, only invest in the safest protocols, and make sure you understand exactly what you’re investing in.