“Residual income is passive income that comes in every month whether you show up or not. It’s when you no longer get paid for your personal efforts alone, but rather, get paid for the efforts of hundreds or even thousands of others and on the efforts of your money. It’s one of the keys to financial freedom and freedom of time”, — Steve Fisher, “Residual Millionaire”

Is there life beyond mining and holding? Sure. Passive income is another big step for cryptocurrency: it’s about time digital assets became productive. There are options that vary in time-intensity to fit one’s investor capacity and crypto needs at the same time.

Make cryptocurrency work while you sleep

Cryptocurrencies are complicated so you need to make the point that it could be very easy. It’s common knowledge that institutional investors, specifically from CME, are increasingly embracing the world of crypto. As far as passive income is concerned, institutional clients may be interested in these type of earnings in which case certain conditions are met. For example, the return on investment should be at one level or higher than the return on investment instruments in the classical market. At the same time, risk level must not exceed fiat market risks. Otherwise, investments will be deemed as risky and may be of interest only to highly speculative hedge funds that specialize in this domain.

Cryptocurrencies and passive income: beyond the classical buy and hold.

Staking. Staking is the most simple way to earn passive income, as the market pays you for holding cryptocurrencies for a certain period of time. It offers an investor a potential ROI which is more predictable than others and no investment in hardware is required. Technically, staking means a user stakes his coins to “forge” blocks by maintaining a wallet or node. When staking your coins, investors usually go through a lock-up period while voting — rules on this vary from project to project. After voting, investors get their coins back as well as the staking reward (up to 30% of the coins put in stack).. Staking has been misrepresented as the equivalent of a bond in cryptocurrencies. In reality, it is much more of an instrument to participate in the corporate governance of a project and getting paid for it. As mentioned earlier, you don’t need mining hardware because staking is fulfilled via e-wallets.

Lightning nodes. Blockchain has two layers: application and implementation. The lightning network belongs to the implementation layer or Layer 2. The owner of lightning has the ability to quickly process a lot of transactions. This method does not offer an immediate return on investment, however, they offer transaction fees. Lightning network nodes have strong potential: they are expected to grow in demand within the market. So, if you invest in lightning nodes, your returns will increase in line with their usage maximization.

Airdrops, forks, and buybacks. The concept of airdrop refers to the widespread distribution of cryptocurrency, offering a windfall into one’s pocket based on the amount of current holdings. When a fork happens on blockchain, an investor receives commensurate holdings on the new fork (it’s like benefitting from an error — forks are not a stable source of passive income). Buybacks mean a cryptocurrency is bought to be destroyed or ‘burnt’ afterward. Inflation control in the making. These three options can increase earnings in a short time, however, they are all about luck and little certainty.

Master nodes. The peculiarity of master nodes is that they require time and money. They operate on PoW system, are responsible for PoW consensus mechanism and enable specific services that minors can’t do. Masternodes take part in staking. the method is costly, yet lucrative, and might be very profitable.

Work tokens. This method is also known as resource provision — a combo of staking plus providing the network with necessary resources. It encompasses computational provision, storage, data resources, coding etc. In other words, it is a blockchain-powered marketplace bridging supply with demand. An investor gets fees and inflation rewards.

Lending or repo. Here everything starts with setting up automated lending on a crypto exchange platform. AI is used to manage lending operations. Again, the income depends on the amount of your holdings: the more you own, the more AI works for you, and ultimately, the more your passive income is. While the process of lending is fully automated, an investor can take control of parameters — loans can be varied in size and length.  

Facts over fantasy

The reality of investment markets is full of fictions, misconceptions, and myths. The fact is, there are no free lunches here. One might think that passive income will allow to do nothing except for listening to ka-ching sounds. I should say "Abandon all hope, ye who enter here." We are talking about private investors, but not the large HFs that specialize in analyzing and finding new assets for investment. Investment, just like any other kind of activity, requires effort. Passive income relies on strong analytical skills, critical thinking — you have to define an asset or asset portfolio worth investing in.

If you are told that there is somewhere an asset that guarantees a yield of 100, 200, 500 percent per annum, then most likely it is a scam or a high-risk investment. Major players in the traditional market take the profitability of global indices as a guideline. Let’s take, for instance, the S&P 500:

Source: Yahoo Finance

The index has shown a yield of about 2% over the past month and over 10% on average within the past 3 years.

High volatility and market immaturity contribute to the controversial reputation of cryptocurrencies as an asset class. However, there is a huge community that is expanding as you are reading these lines. The environment is predominantly filled by enthusiasts and those who know how to exploit the growing demand from retail investors, which often have no deep understanding and knowledge in this field.

Of course, crypto is still in its infancy and players operate as in the Wild West: there are the good, the bad and the ugly. Good guys play fair, create solutions to provide industries with alternatives. But they tend to fail mainly because of big dreams and little expertise. Or they fall prey to attackers who appear to be at the tech forefront. Ugly are those platforms whose limp architecture turns trading into torture. Bad guys play with trade volumes, promise too much and usually don’t want their faces to be seen.

Obviously, crypto cannot achieve in a decade what traditional finance has been nurturing for centuries. However, there is a rationale in taking core principles from the classical market to digital currencies. Therefore, choosing crypto exchanges built upon a huge financial background makes sense, doesn’t it? Since trade is a two-way road, each player in either direction is responsible for safety. Be selective about the people you work with, and choose the ones that are fully transparent.

Portfolio construction - another way to achieve passive investment

Passive investment means creating the right environment to maximise your returns while not actively managing them. As such, cryptocurrencies are a good instrument for investors looking to invest average sums. One of the “laziest” way to invest is via trading robots which select and decide which cryptocurrencies to buy or to sell. However, be very selective in your trading robot selection process and do not jump into the first offer being advertised. Many ads are misleading to say the least, so we can only recommend investors to do proper diligence prior to investing. If you wish to follow this path, we recommend to analyse available options and create an investment portfolio of trading robots that use different strategies.

Armed with mathematical knowledge, you can estimate the expected profit from a certain number of bots with smaller risks. For this purpose, profitability parameters and risk constituent of each robot are taken into account to calculate an optimal share ratio for investment in a particular bot. In this case, risk diversification should be carried out. That is, if one of the robots gives a negative income for a certain period of time, an investor will not suffer losses but only lose part of their income. Why? Because other robots have uncorrelated strategies and thus compensate negative performance with positive ones, reducing the overall profitability of the portfolio, but not turning its global performance into the red.

In the context of this approach the investor’s task is to monitor the portfolio and redistribute investments between bots, depending on their results for previous periods. Underperforming and ineffective bots can be ruthlessly removed from the portfolio and replaced by other bots.

Conclusion: how should you invest?

In summary, passive investments should be approached carefully.

“While it is one of the most promising asset classes, it is also one of the most volatiles. We would advise to start investing via a portfolio of robot trading or in a basket of major cryptocurrencies as a starter. When one gets more acquainted with this asset's classes, such investors could start exploring  more sophisticated instruments like staking or forking which are a genuine way to increase passively the number of cryptocurrencies owned. Last but not the least, investors need to be properly guided into the cryptocurrency ecosystem and, as such I find it really important for beginners to find a mentor who could support and educate. The industry is hopefully getting regulated so it is important to stick with licensed players. Finally, consider cryptocurrencies as a source of alpha which should be combined with other investments in traditional assets. A healthy portfolio shall not have more than 5% exposure to cryptocurrencies”, — said Alexandre Mougel, investment banker, managing director at Renedes Investment Management.

We read a lot about how important intuition is during the investment process. A sixth sense is not of sporadic nature; it comes out of knowledge and experience, so getting a mentor makes tons of sense.

For beginners, I have a few tips to make cryptocurrency a profitable investment.

First of all, always assess the risks cold-headed. You should never invest in an asset if you have heard about or just because it is “hype”.

Secondly, rumors in the cryptocurrency market should be carefully filtered. There is no need to jump on every headline risk before properly checking the news provider and if the story has legs.

Finally, work with credible exchanges — your prudence matters a lot for your own safety and the stability of the entire ecosystem.