Letter 62: Passive Income
Myths, Yield Farming, Staking, DeFi, and, of course, Ponzis
A recurrent them that comes up whenever I’m talking to people about crypto is the idea of passive income. I think this extends even outside our bubble. Everyone wants passive income. It sounds so great. The holy grail. The final goal of the FIRE (financial independence, retire early) movement.
I’m here to quell some common myths and misconceptions (sorry to be a downer), but also to share some methods you can use to achieve mostly passive income, and how by doing it via crypto you can often find a better return on your investment than elsewhere.
Myth 1: That passive income is passive
This is the biggest one. I’m a firm believer that there’s no such thing as truly passive income. It’s a spectrum, and even at the most extreme passive end, there’s some amount of active work required. And a lot of the best and most diversified (and safest) approaches to passive income requires a moderate level of active monitoring.
Probably the most egregious common example that the naive and uninitiated think of when it comes to passive income is via real estate. You’ll often hear people say “I’ll work my way up to 5-10 rental properties and live off the rent”.
Mfer have you even owned one rental property and dealt with the upkeep of it? Property taxes, utilites, repairs, finding tenants, managing tenants, the list goes on. Even if you do what a lot of people do and pay a person or management company to manage the property and tenants for you, they still need your input on a lot of things and will frequently be coming to you with questions and input. And there are still certain things that they won’t be able to do for you.
And that’s all without even considering the time investment required to buy the damn properties, to monitor the market, and to potentially sell them if and when the time is right.
Passive income via property is one of the most egregious oxymorons in finance vernacular.
This is clearly towards one extreme end of the spectrum. At the other extreme end, you have the simply sticking all your cash in a savings account with a bank. This is pretttttty much passive, although still not entirely. You’ll want to monitor the rates to see if you can get a better rate elsewhere, and you’ll want to consider splitting the funds up between banks for insurance/derisking purposes. But it’s about as passive as you can get.
The problem? Your return (after tax) often doesn’t even outpace inflation. Not great.
Accepting that passive income is more like relatively passive income is a helpful reframing so that you know what you’re getting into, and can hopefully compare apples with apples.
Myth 2: The higher the APY, the better
There’s no such thing as a free lunch, and if something sounds too good to be true, it usually is. In crypto you will frequently see yields of 20%, 50%, 100%, 4000%, and I have even seen and participated in a protocol doling out an over 100,000% APY (rip OHM).
These numbers are not inherently bad or even wrong, but they are at best unsustainable and at worst blatant ponzi schemes.
Whenever you see any yield — but especially the very high yields — you want to ask the question:
Where is it coming from???
It’s amazing how such a simple question can tear down entire protocols, but it does. If people asked this about Terra Luna and their flat 20% return on their stablecoin, and if they dug into the response they recieved, they would have been able to see it for what it was — an utterly flawed system, a sandcastle that will eventually get washed away.
There are instances where the high APY is not a scam. Most often this is where the yield is subsidized by the protocol, and the earnings are in their native token. These can be good to farm for a while if you are selling the token regularly, but eventually the token price will drop as the circulating supply balloons in size.
A good general rule: the higher the APY, the riskier it is, or the shorter lived it will be — or some combination of both.
It’s simply not possible to expect a 20% or greater return on your money from here until the end of time. If it was, everyone would be doing it. It’s possible to get 10-25% returns for a short amount of time, and it’s possible to get higher returns by actively farming protocols.
But neither of those make up truly passive income. I’ll write a full guide on yield farming and providing liquidity in the future to cover this.
Myth 3: Staking is good
Staking is one of the most insane narratives ever concoted and co-opted in crypto. It had respectable and humble beginning — stake tokens to secure a network (blockchain) via a Proof of Stake model.
These days, most of the time it’s used by teams and protocols to get you to lock up your tokens in order to… get some rewards? To prove commitment to the token? To reduce circulating supply?
Almost all of these forms of staking are silly. They are teams doing mental gymnastics in order to ascribe the illustrious utility to their token. Very occasionally a team will come up with a tokenomics structure where staking makes sense outside of a proof-of-stake model, but they are far and away the exception rather than the rule.
Note that there’s nothing inherently wrong or bad about staking your tokens in one of these systems. Oftentimes they pay decent rewards, and if you get out early, you can make a healthy return. Getting out early is the crux of it though — in almost all cases, the house of cards will come crumbling down, and, ironically (albeit depressingly), it is the holders with the highest conviction that end up getting burned the most by the protocol’s staking system.
If you want to read an even more detailed evisceration of most modern day staking, there is no better read than this post by cobie: apecoin & the death of staking.
Myth 4: You can extrapolate your daily earnings
This one is particularly baleful. It’s a tale as old as time, and something I have seen since the early days of NFTs. It begins when a person starts receiving emissions from whatever. Let’s use the above staking as an example. They stake their NFT or tokens, and start earning 30 tokens per day, with the tokens worth $5 each. That’s $150 a day! Incredible! But wait..
That’s $1050 a week… $4500 a month… $54,750 a year!!!
I hope you can see the flaw in this logic by now. The above is only true if you make certain assumptions — ones that are extremely unlikely to hold up. You have to assume that you will continue to earn 30 tokens per day, and that the tokens will continue to be worth $5 each. The former is perfectly capable of happening; the latter? In almost no universe will the tokens maintain their value.
“Okay” you say, “even if it drops to $1, that’s still a good amount of money!”
Ahh my dear friend. My first cycler. Come have a look at a couple of charts…
Basically every similar system you’ll come across will eventually have a token price chart that looks like this.
There’s a recent ponzi making the rounds on Abstract, called $BIG. I don’t know how the specifics work, but it’s something along the lines of you have to spend some up front money to buy things (I think maybe “mining equipment”), and you then mine the BIG token.
Posts like this have become commonplace on Twitter:
The token price has held up fairly well so far, all things considered. But I will bet the house that if we come back a year or two from now, it’ll be down 99%. Probably won’t take that long, I’m just being extra careful because I like my house 😭.
So when you’re doing your calculations, don’t think the worst case scenario is that it drops 80-90%.
Think worst case is it drops over 99%, and then decide if your math still holds up (note: it never does).