Crypto Passive Income VS Traditional Investments: Which Is Better?

One of the greatest dilemmas that many contemporary investors are trying to wrap their heads around is whether it is worth their time and effort to move the capital from tradfi instruments into the world of blockchain. Layer 1 cryptocurrencies have been performing quite well throughout the last decade and the DeFi sector seems to be quite enticing. Let’s talk about the advantages and disadvantages of decentralization and how crypto investments fare against traditional instruments.

Traditional passive income strategies

The world of tradfi offers a wide range of investment opportunities to investors who are interested in efficient capital allocation. While one can work with a variety of asset classes such as commodities, precious metals, real investments, and more, the vast majority of people will be limited to several most common and accessible options:

• Real estate is the most expensive asset class. Commercial real estate is really something that only wealthy individuals can access comfortably and without facing too many risks. The residential estate is more accessible with average returns coming close to 7% in mature markets. In many cases, insufficient capital forces investors to use various investment funds focused on real estate.
• Stocks are securities traded on various exchanges. These are common financial instruments used across the globe. Returns vary by country, sector, and other factors. In the US, one of the most common pieces of advice is to invest in the S&P 500 index with its 7.22% average return during the period from 1993 to 2023. The power of compound interest with all dividends and returns invested back in the market can bump the overall profitability by a small margin.
• Bonds are issued by corporations and governments to raise funds immediately. Interest rates vary greatly depending on a variety of factors. The US treasury bonds are paying 4.11% in 2024. 10-year French government bonds have an average return of 3%. These securities are considered to be the safest since countries with strong economies usually remain solvent throughout the bond’s lifespan.

These investment instruments are staples in the tradfi sector and have been used by the masses due to their relative affordability and accessibility. It is possible to put your money into commodities like precious metals or try to buy equity in a company but these are less accessible and can be quite expensive endeavors.

Long-term investment portfolio diversification

The vast majority of tradfi instruments work well if you hold them for several years. The economic environment can change dramatically during such long periods forcing investors to creatively diversify their portfolios by using various strategies such as statistical arbitrage, delta-neutral positions, and spreading capital across multiple asset classes.

Many contemporary portfolios are designed to spread the risk by allocating capital to fundamentally different asset classes:

1. Real estate is a strong foundation that many funds strongly focus on with exposure exceeding 15% in some more conservative strategies.
2. Stocks and indices may represent a significant chunk of a contemporary portfolio with some investors putting close to 50% of their capital in them.
3. Precious metals are often used as a backbone of a strong portfolio that consistently performs throughout decades. Usually, the exposure is quite low and does not exceed 15%.

Cryptocurrencies are becoming increasingly attractive to many investors who are concerned with inflation hedging. Tradfi instruments do not have the same ability to counter fiat inflation even if you spread capital across multiple different asset classes. It makes sense to expose a portfolio to crypto assets at least conservatively keeping the exposure lower than 5%. However, some experts argue that concentrating on cryptocurrency positions is a better idea.

Blockchain vs traditional finance

Decentralization is often cited as an inevitable direction for the global monetary system. This particular idea is strongly pushed by crypto enthusiasts, but other experts believe that financial institutions will never allow something like Bitcoin or Ethereum to exist alongside traditional fiat currencies in the long run. The decentralized finance (DeFi) ecosystem may not survive under strong regulatory pressures.

These are radically different positions that are unlikely representative of what will really happen to the crypto industry. A more probable scenario is the one where DeFi and TradFi peacefully coexist offering unique perks to investors.

Here are several aspects in which decentralized finance (DeFi) is different from tradfi:

• You don’t need a third man. The issue of middlemen ballooning costs for all participants of the economy is one of the reasons for pushing for heavier decentralization. Since blockchain technology allows us to build ecosystems providing a trustless and permissionless environment for all operations, participants do not need authorities to verify and settle transactions. In 2024, the total value locked in the fully autonomous lending protocol Aave is close to $12.5 billion.
• Everything is right on the surface. The DeFi sector is incredibly transparent. The very design of blockchains makes it possible for all participants of the ecosystem to quickly verify the integrity of the ledger and all recorded operations. Smart contracts also operate without any human intervention creating significant difficulties for anyone who may attempt to tamper with records or intervene in transactions.
• Novel investment methods. Contemporary investors have access to unique yield generation techniques that are simply unavailable in tradfi. Some early adopters managed to achieve incredible returns by focusing on protocols like Yearn Finance or Compound with some users doubling their capital within just a year. Achieving an APY of just 5% already beats the vast majority of investment options available in tradfi. For example, typical high-yield bank accounts produce roughly 5% annually while US treasury bonds generate 4.11% on average in 2024. Many experts believe that cryptocurrency staking returns are far superior to what can be achieved using standard instruments.
• Cost efficiency. The DeFi sector is quite cheap with the overwhelming majority of protocols using layer-2 solutions to reduce costs per transaction. Paying a fraction of a gas fee is way cheaper compared to commissions typically collected by banks, institutional lenders, and companies offering account maintenance services. While gas fees on Ethereum can cost upward of $50 per transaction, layer 2 networks like Arbitrum and Optimism significantly cut down the fee and make some transactions cost less than 0.01%.

All these advantages make decentralization an enticing proposition for a wide range of potential investors seeking efficient capital allocation ways. While it is true that the DeFi sector provides amazing benefits, there are some dangers that must be considered by new users.

Risk assessment in crypto investments

Exorbitant interest rates, diverse opportunities, and flexible tools, which are considered normal for the sector, come with a set of risks that are also novel and unique to the industry. Before putting your hard-earned savings into the DeFi ecosystem, you must consider them.

Here are some risks that investors face when working with various crypto assets:

• Potentially exploitable smart contracts. Any technology has a risk of being used in a malicious way. Smart contracts make the DeFi sector as flexible and diverse as it is today thanks to the absence of middlemen, trustless transactions, and many other perks. However, badly designed contracts can result in massive losses like in the case of Poly Network in 2021 when hackers managed to steal over $610 million by exploiting the protocol’s smart contract.
• Regulatory compliance is a two-sided issue. On the one hand, some believe that the lack of oversight from central authorities is a good thing. However, many users feel vulnerable due to the absence of consumer protection and insurance. Cautious users must also remember that governments may simply ban the use of cryptocurrencies. With over 40% of protocols not complying with KYC and AML guidelines, this particular risk is quite meaningful.
• Market volatility is very high. One of the defining characteristics of the crypto industry is the speculative nature of digital assets. When investors do not have a good reference, such as in the case of stocks and bonds, they quickly panic or get hyped leading to massive price swings. Since such fluctuations affect everyone whether they are staking directly on layer 1 networks or engaging with various protocols, the high level of volatility negatively affects investment outcomes.
• Centralization risk is another big deal in the crypto community. One of the theorized issues with Bitcoin is the possibility of a 51% attack when someone takes control over 51% of the network and can adjust in any way they like. While such attacks are unlikely due to the massive scale of Bitcoin’s blockchain, it is possible that some individuals collude to take control over DAOs or validation nodes to control networks. 

Liquidity and overcollateralization are also significant risks that must be accounted for when trying to assess the quality and potential profitability of investments in the DeFi sector.

DeFi yields VS stock dividends

Comparing gains acquired from protocols to dividends received from stocks is rarely productive. Theer are several key differences that are summarized in the table below.

In essence, DeFi yields are rewards from protocols that are paid in various tokens which can be traded on the open market. Stock dividends are cuts of the profits generated by a company. In some cases, holding stocks that pay well can be a good diea for conservative investors. For instance, British American Tobacco investors earned 32.7% (dividends included) in 2024 while the expected yield was just 8.04%.

The issue with dividend paying stocks is that they are usually expensive and can be a gamble if you do not have the necessary expertise in the field. Understanding the quirks of contemporary industries is also important. For example, many experts blame ESG investing guidelines for poor performance of many entertainment brands such as Sony Entertainment, Disney, and some others.

In general, purchasing blue chip dividend paying stocks is a good idea if you have the necessary capital. Some portfolios are heavy on these assets and may dedicate up to 50% and more to stocks. On the other hand, it can be a great idea to strongly focus on crypto yield farming if you do not have enough money to get into the stock market.

One of the best DeFi investment tools

Staking and lending platforms are considered safe and profitable allowing crypto holders to efficiently utilize their capital. Yields here depend on a variety of factors including the level of asset utilization in pools, market circumstances, and many others. What makes them interesting is the technological disruption in finance where the absence of middlemen and the nullification of the counterparty risk create an low-cost financial environment safe for all participants.

Many lending platforms offer relatively low yields but sweeten the deal with additional rewards in governance or native tokens. It can be quite easy to make good money by focusing on these protocols. Usually, investors who provide stablecoins and layer 1 tokens enjoy the best yields and high asset utilization.

Crypto lending platforms comparison

If you are interested in investing in the DeFi sector, you should check out some of the best lending protocols out there. Below is a table comparing three distinct industry leaders. All numbers are as of the time of writing (October 2024).

The main takeaway

Contemporary investors should not think about the crypto industry as an alternative to traditional finance and allocate their capital exclusively to one or another. DeFi instruments can be used as excellent hedging mechanisms against fiat inflation or act as high-risk/high-reward investments in an otherwise conservative portfolio. We strongly believe that these instruments can and should coexist!