How to Get Started in Crypto Banking

By Anna Serio

Crypto is going mainstream. Some 20% of Americans owned cryptocurrency by the end of 2021, according to a Morning Consult survey, and that number appears to be rising.

But more than that, crypto is infiltrating mainstream culture. New York City’s new mayor used Coinbase to convert his first paycheck into Ethereum. A record number of crypto companies ran ads during the Superbowl. And investors have noticed and are pouring money into the industry.

Crypto banking offers a way to ease into cryptocurrency for those who’ve stayed away from investing in the past because it sounded too complex. While crypto products are considerably riskier than traditional investments, crypto banking offers a more familiar way to earn and grow your crypto holdings through high-APY yield accounts, credit cards and more.

Easing in with CeFi

When cryptocurrency was established in 2009 with the advent of Bitcoin, it was designed to be part of a decentralized finance (DeFi) system that allows users to directly send and receive financial assets to and from one another. It did this using a decentralized public ledger called the blockchain. Users retain control of their assets at all times using the blockchain without requiring permission from a bank or the government to complete transactions. 

It can be technologically intimidating to use DeFi if you aren’t familiar with crypto or coding. One mistake in a line of software code can result in the loss of millions of dollars in assets — or, in the case of DeFi staking protocol Compounder, unexpectedly gain them. But today, there’s a growing market of centralized finance (CeFi) platforms and exchanges that are simpler to use.

Using a CeFi platform is a lot like using an online banking or investment account. Many CeFi platforms ask you to verify your identity as part of know your customer (KYC) protocols before you can sign up for an account. After that, transactions are almost instantaneous.

Most platforms offer crypto banking products, which bear similarities to what you’d find at a traditional bank though differ in structure and regulation. Interest rates are often more competitive than traditional finance, but the risks of crypto banking are also substantially higher and not always obvious to the average consumer.

The general rule with crypto applies here too: Invest only what you are willing to lose.

Build your crypto portfolio without investing your own funds

One way to start a crypto portfolio is to sign up for products that offer rewards in the form of cryptocurrency. Crypto deposit accounts allow you to earn returns on fiat currency — like US dollars (USD) — that are in the form of cryptocurrency. These returns are typically at a higher rate than your traditional savings account. For example, Outlet Finance offers APYs as high as 9% on its USD account at the time of this writing.

A main benefit of using a USD account is that they sometimes offer FDIC insurance to protect your deposits (though not always). But returns don’t receive the same type of protection. Instead, platforms that provide coverage rely on private insurance policies that may cover a fraction of your deposit’s value — if at all.

Crypto credit cards can help you to build up your crypto portfolio without having to buy digital assets. These cards offer crypto rewards each time you swipe, at rates that compare to a traditional credit card. For example, the SoFi Credit Card offers 2% in crypto rewards on all purchases at the time of this writing, while the Upgrade Bitcoin rewards card offers 1.5% cash back in Bitcoin. 

Keep in mind that the FDIC treats crypto investments like securities. This means that capital gains taxes apply to your crypto rewards.

Spend your crypto or expand your portfolio

Once you’ve built up your crypto portfolio, you may want to consider using other crypto banking products to help you tap into those funds. Many CeFi platforms allow you to trade your crypto assets for another coin or fiat currency.

But if you’re trading into USD frequently, you may want to consider a crypto debit card. These do the work of converting your crypto into USD each time you swipe, allowing you to spend the money like cash. (Though bear in mind that each swipe triggers a taxable event.)

For those who want to hold on for future gains or avoid paying capital gains, a crypto-backed loan may be a better choice. These loans are similar to a securities-backed loan in that crypto lenders require you to add more collateral if the loan enters a margin call. If the price drops significantly enough, the lender can liquidate your collateral.

Consider the risks before signing up

Crypto banking may make it easier for beginners to invest in crypto. But there are significant risks to using these accounts that aren’t always obvious to the average consumer.

Despite their resemblance to banking apps, CeFi platforms offer fewer protections than a traditional bank or even fintech company. With the exception of some USD deposit accounts, crypto banking accounts aren’t protected by FDIC or SIPC insurance.

While many platforms advertise using private insurance to protect their holdings, these policies typically only cover a fraction of the actual assets the platform holds. For example, the popular custodian Gemini offers insurance that covers $200 million of its holdings. Crypto insurance also doesn’t typically cover platform bankruptcy or insolvency. When Cred filed for bankruptcy in 2020, for example, customers lost up to $140 million they may not ever see again.

Some CeFi platforms like Unchained Capital try to get around this risk by offering a multisignature, or multisig, wallet. Multisig wallets allow you to share custody of the wallet with the exchange and the custodian, requiring two of the three keys to access the funds. But even they aren’t bulletproof. In 2017, a bug in the Parity wallet temporarily allowed hackers to access the funds with only one key, making off with $32 million in crypto assets.

The changing regulatory landscape also poses a risk to crypto account holders. In March 2022, Crypto.com abruptly asked borrowers in a handful of European countries to repay their crypto loans within one week. A February 2022 SEC settlement with BlockFi not only resulted in BlockFi pausing its yield accounts for U.S. customers, but several others followed suit to avoid trouble with regulators.

Crypto banking offers a simple way to start investing in crypto. But it’s a risky investment that often requires you to hand over control to a company that offers limited protection. Only invest funds you’re comfortable with losing, and do your due diligence before signing up.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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