Tag: staking

Is Now the Time to Buy Crypto?

To be fully transparent, my crypto portfolio is down 83% from all time highs. My overall net worth is down 40% from all time highs. However, I started seriously investing in crypto in 2018 and my crypto portfolio is up about 700% from then.

Now that 2022 is coming to an end, I have found that this year is the first year when my net worth has declined. In fact, from the start of this year to today, my net worth has declined by 23%, but the peak of my net worth was back in November 2021 and from then my net worth, as mentioned, has declined by 40%.

Focusing on how much your net worth has declined against the all time high is an example of the achoring bias. There are many ways to measure how much you have made or lost from an investment. For example, if you purchased dogecoin for $0.007 back in 2018 and held it until today when it is $0.07, it seems like you have made 10x off your investment. However, dogecoin reached a peak of around $0.70 back in November 2021. If you had sold all the dogecoin back when it was $0.70, you would have made 100x, but because you waited, you only made 10x. Or did you lose 10x because you could have sold back in November 2021 but did not? Did you make 10x or lose 10x? I have thought about this and my view now, after listening to Dave Ramsey, is that it doesn’t matter. According to Dave Ramsey, when you have purchased an asset in the past is a sunk cost. What matters is when you sell it and if you’re comfortable with the volatility when you sell the asset.

Although 2022 has been a hard year, it is important to remember that downturns happen, especially in the stock and crypto markets. In fact, looking at history, none of this is new. The crypto market especially has seen a spectacular decline, especially with the collapse of crypto exchange FTX. However, in my opinion, the collapse of FTX is not as bad as many make it out to be. FTX is merely an exchange, and staff in this exchange stole funds. It doesn’t necessarily mean that there is anything wrong with the actual crypto. To use an analogy, if a bank is corrupt and the staff siphon off money for themselves, it doesn’t mean that there is anything wrong with the currency they stole. If a robber breaks into a vault and steals gold, it doesn’t mean there is anything wrong with gold as an investment.

I have recently started allocated more of my salary into to dollar cost averaging into various cryptos. In my view, there is a real use case for crypto. It is not just imaginary money. The use case for crypto is much clearer in developing countries. For example, if I were an expat or migrant working in Zimbabwe, I would convert my pay into crypto rather than deal with having to send it back to Australia or convert it into Australian Dollars. Look at the recent war in Ukraine. Crypto has been used by many Ukrainians and even Russian who have had to use crypto because their banking system does not work as well during war. Crypto has been used to send money to help the Ukrainian war effort. Crypto is useful when there are problems with the banking system in your country. According to Bitcoin Cash (BCH) user Roger Ver, there is a Russian man who now lives in Saint Kitts and Nevis and spends in Bitcoin Cash because his bank accounts have been frozen.

Although the use case of crypto is clear in developing countries, what about developed countries? Quite simply, there is no telling when a developed country may become a developing country due to a collapse of civilisation. In fact, due to political polarisation and extremism, I think it is becoming more and more likely that developing countries could collapse. And although I currently support the sanctions and asset seizures of Russian oligarchs currently, who is to say that another political party may get into power later and rather than target Russian oligarchs they come after me? Or you?

As such, I view crypto as a safe haven similar to gold. Some people argue that if there is a collapse of civilisation then the internet will not work and therefore crypto will not work. However, just because there is a collapse of civilisation it doesn’t mean that the internet everywhere will stop working. Crypto is useful when there is a situation where there is a collapse where you are but not in other areas. A good example, as I mentioned, is Ukraine.

Which cryptos as best?

After the recent crypto downturn, I have learned again that it is best to diversify across multiple cryptos and to stick to the ones that have been around for a long time. In my opinion, bitcoin, ethereum, and dogecoin are all good cryptos and make up the majority of my crypto portfolio. If you invest in some of the newer cryptos, I recommend investing only a small amount (e.g. PancakeSwap has not done well). If in doubt, diversify. Also I do not recommend staking or investing in stablecoins. If you want exposure to USD, just get actual USD.

As I said, if in doubt, diversify. All good investors are humble enough to understand they don’t know everything, and diversification is the antidote to ignorance. With that being said, I don’t recommend going all in crypto. It is important to not only diversify your crypto but also to diversify into other asset classes such as equities or bonds using ETFs.

How do you hold crypto in a safe way?

As the FTX collapse has shown us (and the Mt Gox collapse before that), holding crypto on any exchange is dangerous. It is much better to hold crypto yourself (self-custody) rather than let an exchange hold it for you. This is one of the reasons why I do not recommend staking crypto anymore because you typically give up self-custody when you stake crypto.

Of course, when you say “self-custody” to the average person, it is very difficult to explain the concept to them, and self-custody is very hard to do correctly. This I think is one of the main barriers to mass crypto adoption. To make self-custody easier, many in the crypto community recommend buying a Ledger hardware wallet directly from the official Ledger website (do not buy a Ledger via eBay).

An alternative to buying a Ledger, in my opinion, is to buy an ETF that invests in crypto companies. An example of one on the ASX is the CRYP ETF from Betashares. For those who are familiar with ETFs but unfamilar with crypto and self-custody, CRYP is a good way to gain exposure to crypto without any of the issues with self-custody. Many people who look at the CRYP price will be stocked to see that has been trending down since inception. However, CRYP was introduced right at the peak of the crypto market, so it makes sense that it will go down with the market. In fact, if we compare CRYP to the prices of bitcoin and ether then we notice that CRYP roughly tracks these major crypto (see below).

CRYP ETF (blue) vs BTC (orange) vs ETH (cyan) throughout 2022

It s worth noting that although CRYP gives you exposure to crypto, it doesn’t actually invest in crypto. Rather, it invests in companies that work in crypto such as exchanges like Coinbase or bitcoin miners. This is analogous to holding a gold mining ETF such as GDX or MNRS rather than a physical gold ETF itself such as PMGOLD. It is like buying Woodside Energy (WDS) rather than storing coal and natural gas in your garage. Exposure to companies rather than commodities means that there is risk associated with company scandals, corruption etc but the advantage is that you don’t need to worry about self-custody of gas, coal, gold, or crypto.

Which crypto am I most bullish about?

Of all the cryptos I invest in, I believe ethereum is the most promising. I would not be surprised if, in the future, companies and even governments are run on the ethereum blockchain. Below is a recent video I watched that captures the many achievements of ethereum in 2022 including the monumental transition from proof of work to proof of stake. Of all the cryptos, ethereum seems to be the most open to innovation.

How to Live off Crypto by Staking

Update December 2022: I no longer recommend staking crypto. See this post for my more recent views on crypto.

I primarily invest in the stock market and aim to live off dividends mostly from ETFs. However, the cryptocurrency market is hard to ignore. When you compare the total crypto market to the S&P500 (see chart below) you will notice that crypto makes holding stocks feel like holding cash. In the last five years, the S&P500 has gone up by 109 percent which is almost double. However, the total crypto market cap has gone up 18,942 percent.

Total crypto market cap (blue) vs VOO ETF, which tracks S&P500 (orange) over the past five years.

Institutions are starting to look into crypto. For example, Tesla invests in bitcoin, and the Commonwealth Bank has announced it will soon allow crypto to be used within its app. All this shows that crypto is going mainstream.

Recently ETF provider Betashares has released its Crypto Innovators ETF (CRYP). For those who are interested in exposure to crypto, I highly recommend this ETF, which doesn’t invest in crypto itself but in crypto companies (e.g. crypto miners, crypto exchanges, and companies that hold a lot of crypto). It is analogous to investing in a gold mining ETF rather than holding physical gold itself. What is reassuring about this ETF is that it roughly tracks the price of bitcoin and ether, the two largest cryptos.

The CRYP ETF (blue) is roughly correlated to bitcoin (orange) and ether (aqua) prices.

The benefit of buying CRYP rather than holding the actual cryptos itself is safety and security. ETFs are regulated by government, which is reassuring. The alternative way to securely hold crypto is via a paper wallet, which I do not recommend to beginners as it is complex. If you do not know what you are doing, one small error can cause all your crypto to be lost.

When buying and holding crypto investments such as bitcoin, ether or CRYP, you mainly profit from capital gains made when prices go up. Usually there is little income to be made from crypto. The CRYP ETF pays dividends, but it is likely to be very low. However, a recent innovation in the crypto market that has changed all that is staking, which allows you to earn income on crypto.

What is staking?

According to Binance, the term “staking” is defined as “holding funds in a cryptocurrency wallet to support the security and operations of a blockchain network. Simply put, staking is the act of locking cryptocurrencies to receive rewards.”

To put it simply, when you stake crypto, you are locking it up and allowing it to be used to earn more. The passive income earned via staking is termed “staking rewards.”

Why stake?

What is the purpose of staking? Why not just buy and hold the crypto or invest in dividend-paying stocks? Quite simply, the returns via staking are huge. My favourite place to stake crypto is the PancakeSwap Syrup Pools, and as of November 2021, the average APR from staking is about 60 to 70 percent. Earning 70% from crypto staking is far higher than what you’d earn from dividends. Furthermore, if you buy and hold crypto or CRYP, you are earning either zero or very little passive income.

The huge risks of staking crypto

Of course, if returns from staking are 70% or more, why not just go all in? The answer is that staking is very risky, so I do not recommend putting in too much, and any amount you put in should be an amount you are prepared to lose. When staking crypto, you are giving up control of your crypto and handing it to a protocol. Protocols are merely code, and code can have flaws that hackers can attack. There have been many hacks recently e.g. billionaire Mark Cuban lost a lot of money following the hack of Iron Finance. Other examples of major hacks of decentralised finance networks include PancakeHunny and Poly Network.

So then if crypto staking is so risky, what is the point of staking? Basically you will need to consider whether the high gains are greater than the risks. Everyone has different risk tolerance. Thankfully there are many ways you can reduce the risk of crypto staking. The first is to stake on more reputable networks e.g. PancakeSwap and ApeSwap are examples. Research whether these networks have been audited by reputable crypto audit organisations (e.g. Certik). Furthermore, it is always a good idea to spread your money across different networks just in case one gets hacked. I currently stake crypto on PancakeSwap, ApeSwap and BiSwap.

How exactly do you stake?

In terms of the nuts and bolts of how to stake, more detail can be found on YouTube. In terms of how I stake crypto on PancakeSwap, I deposit Australian dollars into Binance and then convert it into BNB (Binance Coin). Then I withdraw the BNB into a crypto address generated using the Trust Wallet app. Using the Trust Wallet browser, I go to PancakeSwap and convert the BNB into CAKE. I then go to the syrup pool and stake the CAKE. When the staking pool generates a reasonable amount of staking rewards, I harvest the staking rewards, convert it back to BNB, send it to Binance, and then convert it back to Australian dollars before withdrawing it into my bank account.

Conclusion

As mentioned, staking is very risky, so I am relying on both staking rewards from crypto and dividends from ETFs to fund my living expenses. The staking rewards provide high returns whereas the ETFs provide safety and lower risk. Indeed the staking rewards are taxed in full. There are no franking credits on staking rewards. Regardless, for argument’s sake, even if you pay 50% in tax, staking reward of 70% means you have 35% after tax. Dividend yields are about 5% and assuming franking credits completely offset income tax, 35% is higher than 5%, so it is better to simply pay the tax. Often investors are focused too much on tax or other aspects of an investment (such as how much leverage you can achieve). What matters is total return.

Returning to Living Off Dividends

There is a large body of personal finance advice that states that investing for dividends is unwise and tax inefficient. The argument is that when a company pays a dividend, the stock price must decline by the amount of the dividend to reflect the declining assets on the balance sheet. Hence receiving dividends is no different to simply selling shares except the difference is that the company makes the decision to sell rather than you. The argument goes that while you are working and earning a relatively high income, it is better to not receive dividends, which will be taxed heavily (because of your high income). It is better instead to let the earning accumulate as capital gains and then realise those gains after you retire when your income (and hence the tax bracket you’re in) drops.

About two or three years ago, I was strongly persuaded by these views (known as the dividend irrelevant theory). In a 2019 post titled My Changing Views, I said the following:

I believed that financial independence depended on dividends alone. If you generate high dividends, you will have enough to live off the dividends and become financially independent quickly. When I read back on my earlier posts (e.g. Dividends vs Capital Gains and 4% SWR vs Living off Dividends), I now notice that I seem quite cultish and stubborn in my views that dividends from Australian equities with franking credits was the only legitimate route to freedom and that anyone who does anything contrary to this is a slave! When I was in my twenties, I would dream of a life in my thirties, forties, and beyond flying around the world, relaxing on beaches, and living off dividends drinking coconut by the beach as I read books. Perhaps I am becoming more mature as I head into my mid-thirties. I have since relaxed my views on a pure Australian dividend focus. Even though I did invest in some foreign equities, I had the bulk of my investments in Australian equities, and one of the consequences of that is that capital gains were not as high. Had I invested in foreign equities, my net worth today would be much higher. Things may change in the future. I will not tinker too much with my portfolio. For all I know, the Australian stock market may perform very well, but what this illustrates is the importance of global diversification. Australia only makes up 2% of global equities, which is almost nothing, and you never know what policies may be implemented within a country that impacts on every single company in that country.

My scepticism of dividend investing and growing belief in the dividend irrelevance theory didn’t start in 2019. I had been thinking about it for a while. When I think about it today, I may have been strongly influenced by FOMO after seeing the performance of Australian equities (high dividends) relative to foreign equities (high growth). As a result, I did divert more money into foreign equities and even cryptocurrency. I also used my margin loan to leverage more into foreign equities.

Indeed, in the past few years, foreign equity and crypto (especially crypto) has outperformed Australian equity. In the past five years, Australian equity as represented by VAS went up 32% whereas foreign equity as represented by IWLD went up 58%. However, the total crypto market cap has gone up 20525% in the last five years.

Returning to living off dividends

Recently I have decided to shift my focus back to dividend investing. I have learned that going into debt and focusing on capital gains has some negative side effect.

I will not be selling my high growth and low yield investments (mostly foreign equity ETFs and crypto), but new money from my salary will now be invested into investments that pay high passive income e.g. Australian equity. (I am also looking into crypto staking as a way to earn passive income, but I am very new to this and that is a topic for another blog post.)

Sometimes it’s worth paying extra for professional service

According to the dividend irrelevance theory, receiving dividends is no different to selling shares except the company sells for you. In other words, the board of a company, a group of professionals, make the decision on how much earning to distribute to shareholders as dividends. Because professionals are making this decision, I like to use the term “professional dividends” as it contrasts with the term “homemade dividends.”

Homemade dividends refer to a form of investment income that investors generate from the sale of a percentage of their equity portfolio. The investor fulfills his cash flow objectives by selling a portion of shares in his portfolio instead of waiting for the traditional dividends. Usually, if a shareholder needs some cash inflow, but it is not yet time for a dividend payout, he can sell part of the shares in his portfolio to generate the required cash inflow.

Corporate Finance Institute

In my opinion, there is a benefit to relying on professionals to decide how much to spend and how much to reinvest. The 4% rule is a rule of thumb and is not perfect. It takes historic stock market performance in the US and assumes that what has happened in the past will likely happen in the future, but we don’t know if what has happened in the past can be extrapolated into the future. The high stock market returns of the past may have been fuelled by an abundance of natural resources, high fertility rate, and central bankers continually dropping interest rates. What happens now that natural resources are more scarce and the world faces climate change risk, low fertility rate, and interest rates dropping to near zero?

One of the principles of index investing is that you let the market decide rather than engage in “active investing.” The idea of letting an index weight companies by market capitalisation is that you have a higher exposure to companies that the market deems as better. In my opinion, the same idea applies to dividends. Generating homemade dividends seems like active investing. You are making very bold predictions about the sustainability of your wealth when using rules of thumb such as the 4% rule. By relying on the boards of multiple companies to decide the dividend payout ratio, you are crowd-sourcing what professionals and the market believe is an optimal amount of earnings to distribute as dividends. When boards make this decision, they are considering many factors such as risks they foresee in the future. When COVID-19 hit, many companies decided to reduce dividend payouts based on their judgements. Even if the judgment of these boards are not great, if a company pays out too much in dividends then the market should be able to detect this and reduce the share price, which, assuming you’re investing in a market cap weighted dividend ETF, means that your exposure to these types of companies is reduced.

We rely on professionals for many things in our lives e.g. accountants, lawyers, doctors, and even personal trainers. Often it is better to relying on professionals rather than do it yourself. The same idea applies to dividends.

Investing is emotional

One of the benefits of letting boards and professionals decide how much to distribute as dividends is that it takes out emotion. If you are generating your own homemade dividends by selling down stock, you will likely be overcome with emotions. If you sell too much, you might deplete your wealth before you die. If you sell too little, you will deprive yourself right now, and a stock market correction in the near future may wipe out all those gains anyway.

If you try to take away this emotion by relying on rules of thumb such as the 4% rule then you run the risk of being overly simplistic and extrapolating historical performance into the future. By outsourcing this decision to professionals and the market, you reduce emotion significantly.

When saving money, it is often advised that you should “pay yourself first” or “set and forget.” You should ideally automate everything so that you don’t need to think too much about it. Those who try to time the market tend to mess things up. The same logic applies to homemade dividends vs professional dividends. Living off dividends is automatic. Everything occurs in the background and you only see the dividends hitting your bank account.

A bird in hand is worth two in the bush

Another argument for dividend investing is that we do not know if a catastrophic market crash will hit us in the future. If we live off dividends rather than let those earnings compound on a company’s balance sheet, then certainly the growth of our net worth may be lower, but we spend more today, which can help address feelings of deprivation associated with aggressive frugality. If we focus entirely on capital gains, who is to say that just before we retire or during our retirement, an enormous market crash won’t wipe away everything? At least if we invest in high dividends and spend all our dividends, even if everything collapses near the end, we can look back and be happy that we lived off dividends.