Yield farming is a way for those who participate in specific cryptocurrency-powered products to use their crypto to earn crypto. By promising users tokens (and interest, in some cases) in exchange for their participation, founders and promoters of decentralized finance products aim to whip up interest in their platforms.

What Is Yield Farming?

Understanding yield farming may require you to grasp what “yield” means within the context of finance. Per Investopedia, yields are “earnings generated and realized on an investment over a particular period of time”. Yields may generally come in two specific forms:

• Interest earned on an investment
• Guaranteed dividends paid in return for your investment

Yields can apply to several classes of financial assets, including but not limited to stocks and bonds. Yields can be fixed or may fluctuate with different variables, such as the value of the security being invested in. These same tenets may apply to yields issued in cryptocurrency rather than dollars, but there are also some noteworthy differences between traditional yields and crypto yields.Yield farming is a term particular to cryptocurrency, and DeFi specifically. Simply put, to farm yields is to invest your cryptocurrency in a specific DeFi platform or product in exchange for rewards, which may come as interest and/or dividends. 

Some of the most prominent projects to date for yield farming, such as Compound, involve both lenders and borrowers of cryptocurrency receiving Compound tokens (COMP) as their yield. This practice may also be referred to as liquidity mining, because those who invest their crypto in platforms while earning a yield are providing liquidity to administrators of that platform. In this sense, their role is similar to a lender who exchanges cash for:

• The guarantee of future repayment, plus:
• Interest payments

While the investor farming a yield certainly benefits from the arrangement, they may not be the only ones reaping a reward.

Who Benefits From Yield Farming?

It is clear why someone might invest their cryptocurrency in a platform or product that offers them a yield. If they were not planning to liquidate their crypto shares in the near-term, then why not earn some extra (guaranteed) coin on their stake by farming for yields? Here’s how it goes:

An investor lends their money to the platform, they receive tokens for their investment, they are ultimately repaid their principle investment, and may earn interest on top of it. It’s the classic lender’s benefit, along with some extra token. That extra token is a key distinction between traditional lending and yield farming with DeFi platforms. If the value of the token provided as a dividend skyrockets, then a DeFi lender-investor may experience returns far beyond what they could get in traditional, non-crypto markets.

Heck, if the token being used as a dividend accumulates value quickly enough, it may even be possible to make money farming yields as a borrower. Say someone borrows cryptocurrency and receives tokens as a reward for engaging in the lending platform. So long as the value of that token increases at a rate greater than the cost of borrowing, they may ultimately earn a profitable yield despite paying interest on their loan. There is always risk in borrowing, and one would have to be very confident in the rate of a token’s appreciation to bank on making money by borrowing crypto. Still, this scenario is not out of the realm of possibility, and the rapid increase in value of Compound’s COMP token just months ago serves as real-world evidence.

The last party that may benefit from yield farming is the governors of a specific platform or token. Whether governors refers to a centralized collective or participant-investors in a decentralized platform, the interaction that yield farming incentivizes is generally positive for stakeholders.. As investors flock to a platform offering worthwhile yields, the platform itself and any connected token becomes more valuable due to greater popularity. As the token accumulates value, the yields (tokens) provided by participation in the linked platform become more attractive, more farmers flock to reap those yields, and so the cycle of growth goes…

What Is the Current State of Yield Farming?

Like many specific genres of decentralized finance, yield farming has seen significant growth in participation over recent years, and in the past few months especially. With Compound paving the most viable blueprint for yield farming to date, subsequent projects have garnered similar popularity. Balancer Labs’ BAL token was issued shortly after COMP token’s debut, becoming the second governance token that would facilitate yield farming in the DeFi space, according to NASDAQ. It went on to debut with a single-day 235% spike in value, once again illustrating the fervor for yield farming, and by extension the tokens and platforms that allow for yield farming.

As more and more investors sink their crypto capital into platforms offering yields in return for liquidity, the sustainability of the practice appears real. Unless regulators crash the party, the attractiveness of yield farming may persist. 

How Do Regulators View Yield Farming?

You’d have to be a regulator to answer this question. Generally speaking, there is some worry that regulators will eventually want to have a say in how the DeFi sector is run, including how punitive measures are doled out to fraudsters. Yield farming may not be immune to this development if and when it occurs. Whenever the term “risk” becomes associated, fairly or not, with a financial sector, you can bet that at some point regulators will act. Whatever you think of their motives, this generally tends to be the case.

Like any investment, yield farming carries risk, with questions about the token issuers’ legitimacy being one of those risks. However, it is not yet possible to know for certain how regulation will affect yield farming. For now, yield farmers seem to be of the opinion that they may as well be getting it (yields) while the getting is good.

That’s part of it, but there’s more to the story.

So what is decentralized lending, how does it differ from traditional lending, and what is the outlook for this relatively nascent category of financial products?

What Is Decentralized Lending?

The mechanisms of decentralized lending are fundamentally very similar to traditional lending:

• One person lends assets, doing so in exchange for interest payments (and in some cases, additional rewards)
• Another person borrows assets, paying interest payments for the right to instant funding 

Rather than dollars, however, decentralized lending relies on cryptocurrency as the medium of exchange. Various platforms exist by which users can engage in lending-related transactions (more on that later).

Smart contracts are the mechanisms which facilitate decentralized lending. These contracts are self-executing protocols which may have several functions (distributing interest payments, enacting variable interest rates, and implementing other terms of a loan, for example). 

These contracts are unbiased, incapable on their own of nefarious motives or bad faith tactics, and allow all participants in a lending transaction to see precisely where they stand at any given time. In other words, they’re not banks.

What Are the Perks of Decentralized Lending?

Investment in decentralized lending platforms has absolutely skyrocketed in 2020, but why?

Widespread mistrust of traditional financial institutions may play a large part in bullishness towards DeFi lending. CNBC explains how millennials in particular have shown a wariness towards traditional banks, citing The Great Recession among the reasons for skepticism. 

With banks required to keep 0% of customer deposits on hand, per the Fed, it seems that willingness to try non-traditional financial products is rampant. Consider the proposed benefits of decentralized lending:

• Rather than having a financial institution with a spotty track record involved in your financial transaction, DeFi lending allows a smart contract to execute the transaction
• For lenders, interest rates on certain DeFi lending platforms may far outpace returns for other centralized investment alternatives
• Rather than a large, faceless bank reaping the rewards of lending, DeFi lending offers a peer-to-peer experience
• Lower barriers to securing a loan than are present in traditional lending processes (if you have the necessary crypto collateral, you may generally be able to secure the loan you seek)

From an investor standpoint, borrowing cryptocurrency may prevent having to sell existing stakes in crypto, which may come with fees and opportunity cost. Based on the massive infusion of capital in DeFi lending platforms in the past few months alone, it is clear that the perks of decentralized lending have legitimate appeal.

What Is the Current State of Decentralized Lending?

DeFi Pulse’s DeFi List shines a light on 12 separate decentralized lending platforms. The amount of digital assets tied up in decentralized lending platforms is substantial, with leading platforms Compound, Maker, and Aave collectively accounting for significantly more than $3 billion in digital assets on their own. DeFi Pulse keeps a running account of the entire DeFi lending industry’s “locked” assets. 

$3 billion and change is noteworthy, and becomes even more eye-catching when considering that DeFi lending markets have seen a massive infusion of capital in 2020. Still, decentralized products for lending and borrowing appear modest when compared with traditional lending. Outstanding consumer debt issued through centralized sources is more than $13 trillion.

The sizable asset gulf between DeFi lending platforms and traditional lending institutions is informative, but says little about the long-term viability of DeFi lending. The headstart that established financial institutions have on decentralized alternatives (2016 spawned the earliest DeFi lending platforms) must be considered when making comparisons.

DeFi lending platforms must be evaluated on their own merits, rather than in comparison to centralized alternatives. Through this lens, decentralized lending is a product that investors are very bullish on.

Some have observed DeFi lending’s transition from “niche” to “mainstream” (injecting billions in capital in a matter of months will have that effect). The de facto marriage between the Ethereum blockchain and DeFi lending products serves as something of a blueprint, and at this point DeFi lending is well established as a force in the projected financial markets of the near and distant future.

How Do Regulators View Decentralized Lending?

If there is one potential threat to DeFi lending, it is the same concern that clouds the crypto sector more broadly: regulation. 

Publications such as Reuters have thrown around terms like “freewheeling” to describe the state of crypto lending. These sorts of terms, generally speaking, are the sort that tend to catch the eye of regulators. 

With its massive and growing popularity to the tune of billions of dollars invested, there is no doubt that conversations about DeFi lending have already been had in the offices of the Securities and Exchange Commission (SEC). But one unanswered question remains: how, exactly, will the SEC treat DeFi lending platforms?

There is some fear that these platforms will receive treatment similar to that of Initial Coin Offerings (ICOs). In 2018, ICOs became tied to unsavory phrases like “securities fraud” and “conspiracy” when the SEC took legal action against multiple crypto firms. CNBC’s take on the SEC’s message: “new digital financial products must follow traditional securities rules”.

If this proves to be the case with DeFi lending platforms, then there may come a time when regulators begin to enforce the “traditional securities rules” to which decentralized lending products may or may not be subject.

What Is Quantitative Easing?

 Quantitative easing is a policy by which those in control of a money supply increase the amount of currency in circulation. There are various motivations behind such policies (more on that later), and bodies such as the Federal Reserve may use several specific tools to implement quantitative easing.

One lever the Fed can pull to engage quantitative easing is the purchase of securities. These include:

• Government bonds
• Corporate bonds
• Equity, which includes exchange-traded funds (ETFs) and could soon include stocks, according to Forbes
• Assets such as mortgage-backed securities

Purchasing a security essentially makes one a creditor to the entity that issues the security. The Fed, or another central bank-like body in another nation, can issue cash to financial institutions in exchange for such securities, and in doing so provide more liquidity into the marketplace. In doing so, it is expected that banks will lend that cash and stimulate economic activity.

In addition to directly providing cash to the open markets, an institution that implements quantitative easing may also reduce interest rates or lower reserve requirements. Lower interest rates may generally stimulate lending, as the cost of borrowing is decreased. Reducing reserve requirements lessens the amount that banks must keep on hand, which means they have more money to lend.

Banks generally lend whenever they are able to, as this is their primary way of earning money on customer deposits and loans they have received from the Federal Reserve. The Federal Reserve may even lend money directly to banks in the name of quantitative easing. In the school of QE, such lending is the primary catalyst for economic activity during times of sluggishness or stagnation.

Who Controls Quantitative Easing?

Those who control a nation’s money supply may generally be the ones to enact quantitative easing. In the United States, this is the Federal Reserve. In certain nations, it may be a central bank, which could be controlled by the political party in power or may be a somewhat independent entity such as the Bank of Japan, Deutsche Bundesbank, or the Bank of England.

The European Central Bank controls the money supply for 19 member nations, and now plays a substantial role in European monetary policy since the widespread adoption of the Euro. Every financial body must decide whether to enact quantitative easing based on the effect it is likely to have on those who use a currency.

What Is the Intent of Quantitative Easing?

The stated intent of quantitative easing is to stimulate economic activity through increased access to lending, specifically in times where economic activity has slowed or has shown warning signs of slowing. The logic is that more money in the hands of the public—business owners, investors, consumers—will lead to growth and spending.

This may generally be the case. Those with money to spend in worthwhile ways, or simply to burn, may tend to do so. And when this is the case, the goal of quantitative easing is achieved.

Criticisms of Quantitative Easing

The primary critique of quantitative easing is that, while it may stimulate investment, growth, and spending in the short-term, there is a very real long-term cost to such policies, namely inflation.

Fractional reserve banking allows banks to lend out money without removing that money from its asset ledgers.

This has a notable growth effect on a nation’s money supply  from an accounting standpoint. Because quantitative easing both injects cash directly into the money supply and facilitates lending, it tends to have a substantial growth effect.

Any time you grow a money supply, inflation occurs. Generally speaking, having more of something (including dollars) reduces the scarcity of that thing, so long as demand does not increase in concert with supply. Consequently, each individual unit of that thing will become less valuable. This is the core principle of inflation, and illustrates why increasing the supply of currency diminishes the value of each individual unit of money.

Because quantitative easing increases the money supply by its very principle, the most valid criticism of QE is that it trades short-term stimulus for long-term devaluation of the currency—a trade off that many argue is not worth it. After all, there is no guarantee that the stimulus will even work in the short term, while there is a guarantee that QE will contribute to inflation nonetheless.

The University of Pennsylvania’s Wharton School explains that specific QE-related policies in recent history have had ill effects in addition to inflation. For example, the Fed’s stimulus policies following the 2008 financial crisis ultimately reduced direct business investment by banks,  making the quantitative easing of 2008 a failure.

Quantitative easing can be like injecting steroids into the normal course of inflation, with no guaranteed benefit to counteract this downside.

The Case For Scarcity Through Cryptocurrency

The purchasing power of the dollar has plummeted during the past century-plus, and the continued pumping of fiat money into supply (the primary mechanism of quantitative easing) has accelerated this decline. The guarantee of scarcity once provided by the Gold Standard is a distant memory.

Those who seek a return to truly scarce stores of value may consider cryptocurrency, and may already have invested in the likes of Bitcoin. Unlike the dollar or Euro, cryptocurrency is fixed, with the supply of Bitcoin set at 21 million. Though there has been debate over whether to eventually increase the supply of Bitcoin and other cryptos, the type of exponential growth that has ravaged the dollar’s value is unlikely.

Scarcity is a central tenet of cryptocurrency’s value, a fact which is not lost on those who benefit from it.

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1. Decentralization, which is provided by blockchain technology
2. Non-custodial products, meaning that there is no middleman between the user and the financial product being utilized, only a protocol

With these founding principles laid out, what is decentralized finance? What are its benefits and drawbacks, and how is it being viewed through the all-seeing eyes of regulators?

What, Exactly, Is Decentralized Finance?

Breaking down the term “decentralized finance” may be a simple, yet effective starting point for explaining the emerging phenomenon. 

Let’s start with finance.

According to Investopedia, the noun finance refers to “matters regarding the management, creation, and study of money and investments”. For the sake of the DeFi discussion, the management and creation of money and investments may be the most pertinent features of this definition.

The Corporate Finance Institute (CFI) provides specific examples of finance, including “investing, borrowing, lending, budgeting, saving, and forecasting”. Lending, investing, forecasting, and borrowing may generally be the most relevant of these examples when it comes to decentralized finance.

And what about the “decentralized” aspect of DeFi?

Merriam-Webster provides two definitions of “decentralization”:

• the delegation of power from a central authority to regional and local authorities
• the dispersion or distribution of functions and powers

Each of these definitions apply to decentralized finance. Collectively, decentralized finance appears to be the engagement in finance-related activities such as lending, borrowing, investing, and forecasting through means that have no central authority, where instead management over a financial system (insofar as there is management) is dispersed.

From a 1,000-foot view, this is an accurate depiction of the core tenets of DeFi. Now to get a bit more specific…

Decentralized finance comprises financial platforms and services built upon and powered by blockchain technology. These services vary in their purpose and specifics, but may generally allow users to borrow or lend cryptocurrency, purchase and sell coins, speculate on the future value of commodities, and purchase or sell tokenized assets.

Like other evolutions in the finance sector over the years, decentralized finance is a new way of engaging in the economic activities that facilitate the making (or losing, if you’re unlucky) of money. The primary pull factor is that, rather than requiring a middle man/institution, it is the users who control the mechanisms that facilitate their transactions (at least in theory).

What Allows DeFi to Work?

In short, blockchain technology and specific protocols allow decentralized finance to function. Beneath both of these critical elements is the internet, without which blockchain technology would not be possible.

One definition of a protocol is a “set of rules or procedures that govern the transfer of data between two or more electronic devices”. When protocols exist on a blockchain, a network of computers, known as nodes, carry out specific protocols. These protocols govern features of a blockchain such as:

• The algorithmic mechanisms by which nodes communicate
• The means of approving transactions within the blockchain
• The means by which new nodes are accepted into the blockchain

These protocols undergird blockchains in general, and are therefore the enablers of decentralized financial products. The specific ends to which DeFi application founders use these protocols determines what each product can do for its users.

What Are the Benefits of Decentralized Finance?

The benefits of decentralized finance vary from one general DeFi category to the next, and even one application to another.

But, generally speaking, the benefits of decentralized finance lie primarily in decentralization as a principle. Without decentralization, the benefits of DeFi become far less obvious.

The thinking goes that centralized financial institutions are flawed in several ways, including but not limited to:

• Lack of control over how the system works by those who prop the system up (the financial consumer)
• Lack of transparency into how decisions affecting the financial system are made
• Lack of control over and transparency into how your specific deposits are handled
• The potential that arbitrary or bad-faith decisions by financial institutions or regulatory bodies could put your deposits at risk

Proponents of DeFi aim to flip these flaws on their heads. Their goal: to use the antithesis of centralized financial institutions—decentralized financial products—as the selling point for their DeFi products.

In an ideal decentralized financial system, benefits would include:

• Democratic control by participants (financial consumers) over how a system works 
• No central authority with outsize power to affect the fate of participants’ deposits
• Greater reach to customers regardless of geographic location, as all one would theoretically need to participate is an internet-connected mobile device
• Less vulnerability to outside breaches due to decentralized security protocols
• Greater autonomy to customize specific blockchain protocols democratically, which may allow dynamic shifting of interest rates for lending cryptocurrency as one possible benefit

Trustworthiness is a key benefit of DeFi, as agreements are solidified by smart contracts which manage the exchange of coins. Rather than simply having faith that a bank will come up with your assets (which they’ve lent out in the meantime) when you request them, smart contracts provide guarantees that your coins will be delivered when predefined conditions are met.

Keep in mind that these are ideals of decentralized finance, and time will tell the extent to which real-world DeFi products live up to these gold standards.

What’s the State of DeFi Today?

As of now, decentralized finance is virtually synonymous with the Ethereum (ETH) blockchain, known for its customizability and user-friendly interface. DeFi Pulse notes how existing, Ethereum-based products in the DeFi space offer:

• Lending and borrowing of cryptocurrency
• Decentralized exchanges for purchasing cryptocurrency
• The ability to bet on fluctuations in the value of assets by purchasing synthetic derivatives
• Peer-to-peer payment services 
• Tokenized asset management

You can view an extensive list of DeFi products, including industry lending leaders such as Aave, Maker, and Compound here. 

It is fair to state that decentralized finance mirrors the slate of non-decentralized financial products, sans the middle man (traditional financial institutions). Another difference between DeFi and more traditional financial products is the relative youth of the decentralized finance sector, which continues to evolve at a rapid clip.

How Do Regulators View DeFi?

There seems to be a looming spectre that regulators will come for DeFi products, sooner or later. Just as the Security and Exchange Commission (SEC) eventually cracked down on ICOs in the name of curbing digital fraud, some have gone so far as to state that “regulators are circling” the DeFi sector.

As with any regulatory matter, speculation and opacity will rule until regulators—the SEC or otherwise—make an overt move. Calls for self-regulation as a means of warding off outside regulation may, if history is any indicator, range from naive to overly optimistic.

The perception that those who create DeFi products are not spawning truly decentralized products, but are rather in it for their own personal gain, is surely not helping the case of those who hope to rebuff outside regulation. 

What Is Monetary Policy?

Monetary policy refers to actions that governing bodies do (or do not) take to manipulate a money supply, as The Balance explains. The importance of the money supply cannot be overstated, as its relative size plays a role in whether inflation or deflation could take hold of an economy.

Commonly-accepted thought states that those in charge of monetary policy—in the United States, it is the Federal Reserve Board of Governors and Federal Open Market Committee—manipulate the money supply with specific goals in mind. It expands the supply to stimulate economic activity, and reduces the supply when the economy shows signs of overheating, which could lead to undesirable levels of inflation.

Who Creates Monetary Policy?

The Federal Reserve wields great power when it comes to America’s financial system, as it is responsible for crafting monetary policy—with this power, it directly controls the nation’s money supply.

The Chairman of the Federal Reserve, currently Jerome Powell, is the public face of the Fed, but two specific leadership groups—the Federal Open Market Committee and Fed Board of Governors—make the power moves. These groups collectively decide how to manipulate the discount rate (the interest rate to banks borrowing from the Fed), bank reserve requirements, and other tools such as the sale and purchase of bonds.

Though you may read that the Federal Reserve enacts the goals of Congress, the mandates are vague: grow the economy, prevent massive unemployment, etc. By the Fed’s own definition, it is an “independent government agency but also one that is ultimately accountable to the public and the Congress”.

In other words, the Fed and the Fed alone decides how to set monetary policy in America.

In other nations, monetary policy may be set by some organization similar to the Federal Reserve, such as a nation’s central bank. In Europe, the European Central Bank (ECB) controls monetary policy for member nations, as the Euro’s widespread adoption allows it to do.

And when those subjected to the negative effects of the monetary policy of the Fed or the European Central Bank are unhappy about policy decisions, what can they do?

Absolutely nothing, aside from investing in alternatives to the dollar or Euro.

Did someone say Bitcoin?

How the Fed Uses Monetary Policy to Affect the Economy

When it wants to expand the supply of money, a governing body can simply print more money (after making a compelling case for the “necessity” of such printing to the token peanut gallery, of course). Though excessive printing of money is generally considered an unsound practice that directly causes inflation, this has not stopped the Fed nor others in charge of monetary policy from doing so.

In addition to printing money (usually under the guise of economic stimulation or saving an “essential” institution from bankruptcy), those who oversee the money supply may take other measures to affect the money supply. They may buy bonds on the open marketplace in exchange for cash, lower the amount of money that banks must keep in their reserves to incentivize lending, and lower interest rates so that banks will borrow money from the Fed and re-lend that money to Average Joe.

The goal of each of these approaches is clear: flood money into the marketplace to grease the wheels of economic activity.

Contrarily, the Fed (or another body in charge of monetary policy) can sell bonds, increase reserve requirements, and increase interest rates to contract the money supply. It may do so when it senses that excessive inflation has taken hold or is imminent.

Some say that this whipsawing of intervention by the Fed only increases the peaks and valleys of booms and busts, and generally results in one consistent outcome: lowering the value of the dollar.

Cryptocurrencies As a Hedge Against Bad Monetary Policy

A Gallup poll shows widespread mistrust of the Federal Reserve by Americans. A historical accounting would suggest that mistrust is fair, as specific recessions and depressions can be linked on some level to the Fed’s monetary policies.

And when the ill effects of financial busts occur, you may find the Fed asking Congress for approval to fire up the money printers for this bank or that foreign government, further degrading the purchasing power of the dollar in the process.

Add in that the Federal Reserve is involved in the lending of money to other (economically failing) nations, and that Americans have no say in the matter, and it’s fair to see why you might consider some alternative to the dollar as a store of your hard-earned income.

Unlike the supply of dollars, Euros, and other currencies not tied to a scarce resource, cryptocurrencies are limited by nature. Unlike fiat paper currencies, they cannot be created at will. There is no governing body with unilateral power to manipulate the supply of Bitcoin as the Fed does with the dollar, or to lend mass swathes of cryptocurrency in a manner that will inevitably devalue each individual coin.

Proponents see cryptos’ independence from direct, legalized manipulation—as well as its inherent scarcity—as a welcome alternative to whatever a nation’s central bank is doing. It is no surprise that cryptocurrencies have become a popular hedge in the age of endless money supply growth, mounting debts, and general uncertainty about the global financial house of cards.

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Hopefully, this specific topic will keep you interest-ed.

What Is Interest?

The way to begin explaining interest rates is to first define interest. Interest is the amount that you are charged for borrowing money, or conversely the amount that you receive from lending money.

You may be subject to interest charges if:

• You have student loans
• You have a credit card (or 15)
• You have a mortgage
• You have a business loan
• You have a personal loan

You may also be the beneficiary of interest. You may collect interest on:

• A personal loan that you have made to a friend, family member, or colleague
• Savings that you have in a bank, as you are considered to be lending the bank the amount of your deposit
• Any bonds that you own
• Investments in money market accounts
• Funds in your retirement account(s)

From the perspective of the investor or lender, interest is good. You may view it less favorably if someone is earning interest off of your borrowed money. Either way, interest is woven into the fabric of the economy as we know it.

What Do Interest Rates Mean?

Interest rates are the percentage that you will be charged (generally on an annual basis) for borrowed money. Alternatively, it is the rate that you will be paid for lending money.

Wait, can’t I make interest simply from putting my money in the bank?

Yes, you can, but you are technically lending that money to the bank. Banks have the freedom to loan your deposit (and other customers’ deposits — you’re not being picked on) and earn interest for themselves through a process known as fractional reserve banking. This means that you are essentially lending your bank money so that they can lend it themselves, and you get interest for doing them the favor.

When discussing the rate of interest that you will receive as an investor or have to pay to a lender, you must be aware of how interest is calculated.

There are two primary ways of calculating interest:

1. Simple interest
2. Compound interest

When you are charged (or receive) simple interest, you pay interest on the amount of money that you initially borrowed or lent. So, if you lend $10,000 at a rate of 10% per month, you should receive $1,000 per month until the loan is paid off.

When you are charged compound interest, the rate of interest that you pay may vary from one pay period to the next, with the cost of added interest factored into your monthly (or yearly) payment. So, if you borrowed $10,000 at a 10% monthly rate, then your initial interest payment will be 10% of $10,000, or $1,000. If you do not make your interest payment, the cost of your loan will now become $11,000.

With compound interest, you will now be charged 10% of $11,000 (rather than 10% of the principal, $10,000) as interest for the following month. This means your interest payment will go up from $1,000 to $1,100. If you were paying simple interest, your interest payment would be $1,000 throughout the life of the loan.

Increase the sums being loaned or borrowed, and even the interest rate, and you have significant ramifications in terms of money being collected by a creditor or being charged to the borrower.

Interest Rates: Friend or Foe?

You may have a love or hate relationship with interest rates depending on your status as a borrower or lender, or the timing of certain investments that you have made.

If you are a net borrower, you may generally loathe interest, and compounding interest in particular. This may be especially true for those with one or more high-interest credit cards that they can never seem to pay down, student loans that seem to grow rather than shrink (despite graduation being far in your rearview mirror), or other types of high-interest debt.

If you are a lender, interest may be the additional revenue stream that you do not have to work for — handing over that initial loan was all you had to do. From Visa’s perspective, your debt is the loan that keeps on giving. But even as a lender or investor, interest rates can leave you miffed.

Imagine you buy a boatload of government or corporate bonds at a 3% interest rate, and the prevailing rate for such bonds goes up to 7% only a year later. You’re making money on interest, sure, but not nearly as much as you could have if you had locked in a rate of 7%.

Remember, at least you’re not the one paying the interest. And even if you are paying interest, keep in mind there’s always someone with more debt that you (hint: it’s your government).

Interest Rates, National Borrowing, and Cryptocurrency

Just like you, your representatives in government borrow money. They just borrow a lot more of it, so much so that the total costs of their debts (interest compounding by the millisecond, of course) is greater than $26 trillion — and that’s just America.

Say you had that level of debt on a personal scale. Your credit score would be virtually nonexistent. And yet, the dollar is based on the “full faith and credit” of a government whose run its would-be credit score through the Earth’s core long ago.

Those who see this framework as unsustainable have turned to cryptocurrency as a fresh slate. No mass-scale borrowing, no fiat currency, no unsustainable interest rates, just a peer-to-peer medium of exchange based on scarcity that once defined the U.S. dollar (but no longer does). If you’re fortunate, your Bitcoin may even compound before your eyes.

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What is inflation?

“Inflation” refers to a straightforward measure: how quickly the price of goods and services increases in a given economy over a specific period of time, per Investopedia. If the cost of a mango at your local grocery store was 20 cents in the year 2000 and is 80 cents today at the same grocery store, then you’re witnessing inflation.

The Balance explains that inflation rates for specific goods and services may be different, but may generally rise or fall together given enough time. Though the cost of an iPhone may steadily rise over a significant period, the price of gas can fall during that same period. Ultimately, however, both goods will cost significantly more in 50 years, just as a car or home was substantially less expensive 50 years ago (in a dollar-for-dollar sense).

The quicker the cost of goods and services rise, the less your dollar can purchase—this, in a nutshell, is inflation. When prices rise at a rate of 50% or more in a month, then hyperinflation has set in, which generally reduces the value of a currency to the point where it has little to no purchasing power except in astronomical amounts.

One must understand the causes of inflation to fully grasp the concept of hyperinflation.

What causes inflation?

Inflation-causing behaviors taken to an extreme generally produce extreme inflation—in other words, hyperinflation.

 At its core, inflation is the result of expanding a money supply. One measure of money’s value is scarcity. When the U.S. dollar was backed by gold, scarcity was virtually guaranteed. Because paper dollars and coins were legally redeemable for gold, the amount of money in circulation was tied to the amount of gold in reserves. Those tasked with redeeming dollars for gold when requested—ostensibly the U.S. government—could not print more money than they would be able to redeem for gold at any given time.

Once a currency is decoupled from a scarce medium of exchange such as gold (America began its rejection of the Gold Standard in 1933, per HISTORY) then a government is free to print money as it pleases. 

Have mounting national debts? Print more money.

Need to bail out banks who blew a fortune lending customer deposits to high-risk borrowers? Print more money, then “lend” it to those banks.

Members of Congress deserve a pay raise? You know what to do: print more money.

Ultimately, the ever-expanding money supply means a constant decline in a currency’s scarcity, which lessens the value (i.e. purchasing power) of your dollars. This is how inflation happens. Take this expansion of the money supply to the extreme and you have hyperinflation.

Piles of German money in a Berlin bank during the post-World War I hyper-inflation. In 1923 an American dollar was worth 800 million German marks.

What are the pros of inflation?

The Federal Reserve notes that the ideal rate of inflation is 2%, or just below that mark. The stated benefits of moderate inflation are to promote economic growth and stave off deflation. The general idea is that deflation is a fate worse than inflation, as it could lead to lower prices, businesses contracting, and the economy moving backwards.

By the Fed’s thinking, inflation should produce higher wages (to keep pace with rising prices), though this may not always be the case. Another pro: as each individual dollar becomes less valuable due to inflation, the real cost of your debt decreases. That dollar in debt that you owe is now worth only 50 cents, the theory goes.

Yet, these supposed benefits are often outweighed by the downsides that occur when extreme inflation takes hold.

What are the cons of inflation?

A column published in Forbes touches on the downsides of inflation, as the author wonders openly whether America could be in for a period of hyperinflation itself. Consider the indicators correlated with extreme inflation, and whether these are characteristics of 2020 America. They include:

• A stressed government budget (The United States national debt is beyond $26 trillion and increasing rapidly by the second)
• Sociopolitical upheaval (no elaboration is necessary)
• A “collapse” of the supply of goods (McKinsey notes that the food supply is among the victims of the pandemic)
• A decline in borrowing and lending (Quartz reported earlier this year a notable decline in business loans)

The signs for extreme inflation are there, and some argue that it is only a matter of time before Americans feel the pain in their wallet directly, even more so than they already have.

The downsides of extreme inflation become abundantly clear to those who live it, and generally include:

• A higher cost of goods, often without a corresponding increase in wages to match rising prices
• Less investment and lending amidst massive economic uncertainty
• Less production of goods and services due to less business investment, which further increases prices because of scarcity of in-demand products and services
• Loss of savings because the value of each dollar saved decreases drastically
• Hoarding of goods and assets with tangible value, which further restricts supplies (think: toilet paper and ammunition in the early days of the pandemic)
• Job losses as the effect of lesser investment leads to contraction among individual businesses

Because the U.S. dollar plays a central role in the global economy, hyperinflation in America could spark a chain reaction of global financial uncertainty.

Is Crypto an alternative in times of inflation?

 Some see cryptocurrency as an answer to the volatility of unbacked, non-scarce paper currency. Cryptocurrency is scarce by design, meaning that it is not subject to the dilution caused by expanding the supply of money supply—that is, cryptocurrency is not subject to inflation as we understand it.

For this reason, many are turning to cryptocurrency as a hedge against increasingly volatile fiat currencies including the U.S. dollar.

Interested? Start mining cryptocurrencies with us. Read this if you want to understand Why Mining makes sense.

We found out through a recent study titled Perceptions and Understanding of Money — 2020 that half of Americans may have no clue what the Federal Reserve does. And yet, the policy decisions of the Federal Reserve could have a direct effect on:

• The value of your paychecks
• The amount of money you have once you retire
• Your ability to become and remain employed
• The general state of the American economy, and by extension the global economy

The Federal Reserve has an outsize impact on the state of money in America, and the state of money in America has an outsize impact on the global financial network. You’re a part of it all, and so you may want to understand just a bit about what the Fed does and how its policies may impact your life.

Why the Federal Reserve Matters

It is not possible to explain why the Federal Reserve (commonly known as the Fed) matters without laying a basic groundwork for what the Fed is. The Board of Governors of the Federal Reserve System notes that the Fed is, at its core, the central bank of the United States.

Created in December 1913, the Federal Reserve’s purpose is to “provide the nation with a safer, more flexible, and more stable monetary and financial system”, per the Board. This stated mission means little without more context.

What the Fed Does

There are specific mechanisms that decision makers within the Federal Reserve system use to manipulate monetary policy in the United States. The Chairman of the Federal Reserve (currently Jerome “Jay” Powell) is generally the face of the Fed’s policy decisions.

In terms of influencing monetary policy, the Fed may:

• Adjust the federal funds rate (commonly known as the interest rate)
• Regulate (and thus alter) banking practices
• Make asset purchases on a scale that may influence the American economy

Interest rates are generally the metric by which the Fed’s leaders are judged, as changing the interest rate dictates the relative cost of lending and borrowing, which may heat or chill the American economic furnace.  

In addition to setting monetary policy, the Fed also provides oversight for American financial institutions (with varying degrees of success), conducts payment services like check clearing and digital payment processing, oversees the printing of money, and issues loans to banks. 

The Fed does a lot, but you may be concerned with one matter over all: how the Fed’s decisions impact your life.

How Fed Decisions May Directly Affect You

When the Fed changes the federal funds rate, it effectively alters interest rates for consumers. By doing this, the Fed may directly affect:

• The likelihood that a bank or other financial institution will issue you a loan such as a mortgage
• The terms of any loan that you are approved for
• The rate at which you accrue interest on your savings

As if these direct impacts of the Fed’s policies were not substantial enough, you could be further affected by the greater effect of interest rate changes on the economy. If Federal Reserve policy enacts a material change in economic activity, then it may dictate:

• Whether you are hired for a job
• Whether you are laid off for a job
• Whether you are forced to take a pay cut at your job
• Whether you may secure a promotion or receive a bonus
• How the stock market performs

You know better than anyone how these sort of professional consequences could affect you day to day. The global woes precipitated by the 2008 housing crisis and following recession reminded many of the importance of understanding monetary policy on some level and protecting yourself to whatever extent possible. Understanding and following Fed policy is a start to fiscal literacy.

Losing a job or feeling a sense of anxiety about your job security can take a toll on your health and general quality of life. Conversely, receiving a bonus or promotion can enhance your sense of accomplishment, security, and zest for life. In this sense, the Fed’s potential to impact you is incalculable.

When framed in these terms, it becomes clear that the Federal Reserve has a greater effect than the average person might realize. Seeing the Fed’s decisions through the lense of self interest may prompt you to pay a bit more attention to the next headline involving an interest rate hike or forecast for American economic performance.

Conclusion

You’ll be hard-pressed to get Joe American to attend a seminar, even a webinar, about the importance of the Fed. This is no knock, but is only meant to say it is tough keeping up with the Kardashians and the latest Fed-related news. 

General malaise about economic matters is not unique to America, as financial systems have become entangled webs which can induce migraines upon even surface-level examination. Plus, no news about financial institutions such as the Fed may generally be considered good news. Despite such hurdles, understanding the Fed and financial systems in general has its merits.

For some, the primary benefit of learning about the Fed is to realize the tenuousness of fiat currency and to shift some portion of their assets to more simplistic and scarce value stores such as cryptocurrency, and Bitcoin in particular.

If you wouldn’t mind some independence from the Fed, consider acquiring some cryptocurrencies. Why don’t you start mining Bitcoin with us? Create your free dashboard, and buy some hashpower! Sign up now!

The average consumer is lacking an understanding of the Federal Reserve in particular, despite it being arguably the most important institution in American economics.

Our study found that 54% of respondents believe the government owns the Federal Reserve network, which is not technically true. 22% of respondents confessed not knowing who owns federal reserve banks, while 16% believe that a state-corporate partnership owns the Federal Reserve System (hyper-realists, perhaps?).

7% of respondents cited corporations as the owners of the Federal Reserve. Assuming that those who believe corporations or a corporate-state partnership own the Fed are not simply exercising a healthy cynicism, it seems clear that most Americans could use some clarity on who, exactly, lords over the Federal Reserve.

The Federal Reserve, Explained

Those who don’t have a clear understanding of who owns the Federal Reserve (the “Fed”) may not have a strong understanding of the Fed itself. The Federal Reserve is comprised of:

• The Federal Reserve Board of Governors
• 12 Federal Reserve banks
• The Federal Open Market Committee (FOMC)

The Federal Reserve System is, chiefly, the central bank of the United States. Within this seemingly-simple designation lie many duties and functions, including setting monetary policy for the United States. 

The Board of Governors is the conduit between the federal government of the United States and the Federal Reserve system. The Board of Governors has seven members who set discount rates (also known as interest rates) and requirements for what percentage of deposits banks must keep in reserves.

The Federal Open Market Committee (FOMC) has 12 members centered in New York City. Seven of the members are the Board of Governors plus the head of the Reserve Bank of New York and four rotating heads of other Reserve Banks. This Committee meets eight times per year and is said to formulate their monetary policy through these meetings.

Federal Reserve Banks Span the Nation

12 Federal Reserve Banks make up the physical network that is the national Federal Reserve System. The Reserve Banks lie within 12 geographical districts spanning the nation, and each bank services the states within its jurisdiction. While banks were originally given leeway to set their own policy, they were eventually resigned to being outlets for FOMC-set policies.

Reserve Banks do not have the impact that the Federal Open Market Committee or Board of Governors do. Reserve Bank heads alone cannot change interest rates, implement new regulations, or change reserve requirements. The Reserve Bank heads do, however, serve on the Federal Open Market Committee and so the specific presidents of Reserve Banks are important in that respect.

On an individual basis, Reserve Banks’ importance includes:

• Regulating FDIC member financial institutions within their geographical region
• Providing financial services to depository banks in their region
• Implementing Fed-dictated policy on a regional level

You can think of Federal Reserve Banks as the arms of the Federal Reserve’s greater body. You may be able to live without them, but you probably wouldn’t choose to. 

Federal Reserve Banks, and the Fed Itself, are Independent

I have a confession: the question of who owns the Federal Reserve was something of a trick one. The Democratic Staff of the Joint Economic Committee (p.4) notes that, upon the creation of the Federal Reserve, “Congress designed the Fed to be an independent agency within government.”

Independent, but of the government. Huh?

This unique arrangement essentially means that the Fed is, at least in theory, supposed to make the decisions it believes to be in the nation’s best interest without being subject to political pressures. Despite this supposed independence, Fed leadership is still “accountable to Congress”, as the Democrafti Staff puts it.

Noted features that support the view of the Fed as independent include:

• That it is not federally-funded, but instead funded by its own revenues created by lending, fees, and investments
• Long, staggered 14-year terms for Fed appointees intended to limit the impact that any single presidential administration can have on Fed policy

These features are intended to make the Fed independent, but it certainly does not make the Fed beyond reproach.

Criticisms of the Federal Reserve System

A 2009 Gallup poll found that the only federal entity Americans viewed more negatively than the Federal Reserve was the IRS. When tax collectors are the only ones you are looking down on popularity-wise, you know that you have your fair share of critics.

Some criticisms of the Fed include:

• That it is, despite its design, susceptible to political sway
• That it has an outsize impact to contribute to financial busts
• That it lacks transparency
• That it does not truly have the interests of the American people at heart, with bailouts of investment banks with taxpayer dollars being one specific critique

Critiques of the Fed, fair or not, shine a light on why cryptocurrencies have been embraced as what some see as a more trustworthy, less manipulable store of value than the U.S. dollar.

Conclusion

The Federal Reserve remains a lightning rod for criticism despite our findings that many Americans do not fully comprehend the Fed’s role in the American and global economies. The Fed shapes American monetary policy, which ultimately contributes to the ebbs and flows of global markets and economies.

Though it purports to be an independent entity, proponents of cryptocurrency often beg to differ. We argue instead that decentralization is the only true building block for financial independence.

Yet, our findings in the study Perceptions and Understanding of Money — 2020 indicate that the significant majority of Americans are not psyched about parting with their paper money on a permanent basis. 

To be more specific, we found that 60% of respondents are opposed to the idea of paper money being replaced with “digital-only money”. This could be a devil-you-know versus devil-you-don’t situation where familiarity with paper money is the driving force behind wariness of giving it up. Understandable, but if resistance to change for resistance’s sake were humans’ driving principle then progress of any kind would be impossible.

It is possible that better acquaintance with the pros of digital transactions could change the minds of those willing to have their minds changed. 

It is also possible that the movement towards a cashless society is a non-Democratic issue—that is, it could be inevitable depending on who wishes to see a cashless society emerge. Embracing the benefits of digital money could ease your transition into a new financial frontier.

Covid-19 Has Accelerated the Cashless Revolution

Axios cites several figures and facts indicating that increased health-consciousness amidst the global pandemic has accelerated the migration towards a cashless society. Its findings include that:

• People in various nations are wary of physical money, which they see as a potential conduit for viral transmission
• 63% of consumers report using cash less often than they did before the pandemic
• Payment for goods and services through apps and websites, rather than with physical money, has increased

Of course, we must consider the fact that quarantine measures have prevented many from accessing ATMs, paying for goods and services in person, or engaging in activities where they might normally use cash. In some sense, the increase in cashless payments has not been completely reflective of voluntary consumer attitudes. It may, however, be habit-forming.

The idea that your dollars and coins are dirtier than you would like to consider is—unlike the coronavirus—not novel. A 2017 study found that a collection of bills circulating around New York City contained various bacteria and viruses.

Many people’s aversion to unnecessary risk has been illustrated by widespread willingness to wear masks, quarantine, and take other health-conscious precautions. Foregoing physical money in favor of primarily-digital payments could be increasingly viewed as yet another way to protect oneself from possible viral infection.

The Benefits of Going Cashless

Even before “Covid-19” became a universally-recognized term, advocates for digital payments were touting the perks of completely or largely-cashless societies. We’ve already touched on the potential health benefits of eschewing dirty cash for cleaner forms of payment.

In addition to health benefits, the advantages of cashlessness may include:

• Greater difficulty for muggers and thieves to rob you of your physical money
• A greater ability to trace illegal activity, namely money laundering, that could be more easily perpetrated by washing cash through businesses, banks, and other means without a trace
• Commerce-related perks, which Visa notes includes faster transactions (on average), less hassle for customers who would otherwise have to procure, store, count, and dole out cash, and the fact that customers are statistically more likely to spend more at a business using a card rather than cash
• Ease of currency exchange 

Some forms of digital payment may also provide greater security. Security standards used to protect cryptocurrency wallets are being adopted for other purposes, as Deloitte notes, and the further adoption of such practices could further bolster asset protection in a cashless society. Cryptocurrencies themselves may emerge as a more widely-adopted means of exchange as consumers grow increasingly comfortable with cashless transactions as a rule rather than merely an option.

The move towards cashlessness falls in line with the general shift towards global uniformity, for better or worse. Some note that uniformity itself is not necessarily a net positive—one of several critiques of emerging cashless societies.

Critiques of Going Cashless

It would be unfair to pose the prospective benefits of going cashless without mentioning known drawbacks and still-unfounded critiques of the cashless concept. 

For one, there is the notion that moving all nations and individual cultures towards a universal standard of exchange is akin to whitewashing. There is something to be said about coming home from a vacation with a paper bill or coin that you had never before seen or held as a keepsake of your trip. Losing the uniqueness of different currencies is a fair concern, to be certain. But is it a greater loss than the potential benefits of cashlessness?

The answer to that question may vary depending on your values and beliefs. Other critiques of taking societies cashless include that:

• The elimination of cash will be followed by the imposition of ubiquitous transaction fees for businesses and consumers which, without the alternative option to pay with cash, may be unavoidable and costly over time
• Cashlessness represents a greater trend towards limited choice and autonomy 
• A reduction in cash services will eliminate a substantial swath of jobs that revolve around cash processing, issuance, and management
• Less cash and more easily-traceable digital transactions mean less privacy

These are not illegitimate concerns, and there is debate to be had. Alleviating these concerns with robust security measures and good faith will be necessary to make a fully-cashless society work as it should.

Conclusion

Cash was once king, but it appears that digital and card-based payment may increasingly rule the day. With proper oversight and security, the move towards cashless payment mechanisms could provide numerous benefits, and cryptocurrency-level security may be an integral feature of the move towards cashlessness.

There are certainly kinks to be worked out and concerns to be addressed, but the age of Covid-19 has further reinforced that a shift towards all-cashless payments may be not only beneficial, but more necessary than many previously realized.

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