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What Is Compound Interest, and What Does It Have to Do with Crypto Investments?

The cryptocurrency market and the related field of decentralized finance, or “de-fi,” may seem like the realm of science fiction to some. But given how the two have been evolving, there’s more common ground between crypto, de-fi, and traditional finance than one may expect.

One point of convergence lies in investment strategy, as crypto traders and advocates of a decentralized future have something to learn from those who invest in more conventional assets. This is especially true on the issue of pooling compound interest, which is now emerging as a viable strategy for some cryptocurrencies.

What exactly is compound interest, how does it differ from simple interest, and how can it work in the context of today’s crypto coins—for example, with Monero (XMR) tokens kept in a Monero wallet? Here’s a briefer on everything you need to know if you want to explore this investment strategy for your own crypto assets:

Simple Interest vs. Compound Interest: A Briefer on How They Work

First, to understand how compound interest works, let’s review its definition alongside that of simple interest.

Simple interest is always based on the principal amount that’s being invested. The final amount with interest can easily be determined using the formula A = P x R x T, in which A stands for the final value plus interest, P stands for principal, R stands for the rate of the interest, and T stands for the time period. By that logic, if you were to collect a simple interest of 5 percent on 1,000 crypto coins over a period of three years, then you would end up with a final amount of 1,150 coins.

Conversely, compound interest involves receiving interest on the principal amount, adding that collected interest back to the principal, and then letting more interest accrue over that increased amount. The formula for determining compound interest is a little more complicated than the formula for getting simple interest; for compound interest, the equation is A = P x (1 + R)T. Thus, if you had 1000 crypto coins with a 5 percent annual compound over a period of three years, you’d be left with the final amount of 1,157.63 coins. The difference becomes even more significant as you keep compounding the interest and as you continue to let the final amount accrue.

How Will Compound Interest Apply to Cryptocurrency?

For investors who deal with conventional assets like fixed deposit investments, the idea of accruing compound interest is nothing new. However, now that the field of cryptocurrency investment has burgeoned in recent years, the same strategy is now being applied by crypto traders. This is especially true for those who are active proponents of de-fi.

De-fi advocates seek alternatives to the controls that banks and other traditional financial institutions have on current forms of currency. One form of investment activity that’s become popular with de-fi traders is staking cryptocurrency or using crypto coins in crypto wallets as collateral for transactions in a proof-of-stake or PoS blockchain system. If certain consensus mechanisms are adjudged to have been met by the blockchain technology. The traders who’ve staked their coins on those transactions can earn rewards like compound interest on their crypto investments.

Like in the example detailed above, crypto traders who stake more interest and let the principal amount accrue continually can gain significant rewards from their platform. If both the crypto market and the de-fi community continue to grow, this investment strategy will eventually become more mainstream, too.

Points to Ponder on Your Future Cryptocurrency Investments

If you’re new to crypto, the investment strategy that you’re probably most familiar with involves buying coins and selling them when it’s profitable for you to do so. You may not have thought about a strategy that involves holding onto your coins for a long time and accruing interest in them.

But crypto technologies and platforms are constantly evolving, and some cryptocurrency investment and management platforms offer options for helping you earn compound interest on your assets. You may want to explore these options if you get serious about crypto or if you’re willing to pool accrued interest on your tokens. It’s also a worthwhile investment to make if you think there’s long-term potential in your crypto assets.

Whichever investment strategy you choose for your crypto coins, and whether you see crypto as a medium-term asset or a long-term asset, just remember to invest what you’re capable of. Never invest large amounts if you can’t afford to lose them, and don’t cave into any pressure to change up your crypto trading strategy just because everyone else is doing so. Continue to learn about developments in the field of cryptocurrency, and using that knowledge, choose an investment strategy that reflects your financial interests. That is the surest way to add value to your crypto trading experience and get the rewards that you truly aspire for.

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