4 February

|

6:36 AM UTC
4 February

|

6:36 AM

Compound Interest: The Eighth Wonder of the World

Compound interest is frequently used in investing strategies and is regarded as a wonder of the world. How can we make the most of compound interest in the crypto market? Let’s explore this wonder with Jade Forest in this article.

What is compound interest?

Compound interest means reinvesting the interest you receive. Specifically, the received interest will be added to the initial principal to continue the new investment cycle. The more interest accrues to the principal, the higher the profit of the next cycle. Thus, the addition of interest to the initial principal is called compound interest. 

For example: You invest $1,000 for 20 years at a fixed interest rate of 10%.

Case 1: If you periodically withdraw, your assets will amount $3,000 after 20 years (total interest is $2,000).

Case 2: If you add interest to the initial principal, your total assets will be $7,328 after 20 years (total interest is $6,328).

The aforementioned example demonstrates that compound interest offers opportunities to boost profits. Compound interest is usually used in Yield Farming, Stake, etc. and on a variety of protocols, such as Aave, Compound, Synthetix, and Curve Finance, etc.

The formula for calculating the amount of compound interest is as follows: 

Where:

P = principal (initial investment capital)

i = annual interest rate (decimal)

m = number of compounding periods per year

t = number of years

Fn: Amount received after n years

In addition to the formula described above, a lot of websites offer tools for calculating compound interest. You can refer to Calculatorsite, which includes:

  • Initial balance 
  • Interest rate 
  • Years 
  • Compound interval 
  • Deposit/ Withdrawal 

The power of compound interest

The majority of investors in the crypto market use compound interest to increase profits. Early investment, long-term investment, and repeating the process frequently are the three components that make up the advantages of compound interest.

Take Warren Buffett as an example. According to statistics, he made investments from the age of 14 to 50, and his total assets progressively climbed. Therefore, applying compound interest from the start will result in the profit being proportional to time of investment.

In actuality, however, few investors actually succeed in their initial objectives. The investing process will be influenced by a variety of factors, including time, psychology, FOMO, financial requirements, and cost of living, impacting on investing choices.

Learn about the power of compound interest with the following example:

Default annual interest rate is 8% (it can be investment interest or savings interest).

Investor A: Invest $5,000/year from age 25 to 34. Then he does not invest any more capital and earns 8% annual interest (no withdrawal).

Investor B: Invest $5,000/year from age 36 to 65 and earn 8% annual return (no withdrawal).

Total investment:

Investor A: invest $50,000 in 10 years

Investor B: invest $150,000 in 40 years

At the age of 65:

Investor A has a portfolio worth $787,180

Investor B has a portfolio worth $611,730 (less than Investor A $175,000 despite investing more capital)

Compound interest in crypto market

The crypto market has high returns and great volatility, making it an ideal environment to use compound interest when making investments. Additionally, the crypto market aids investors in earning high interest rates, allowing them to allocate capital, make more flexible investments, and avoid “burying” money.

It costs a lot of money to invest in several areas, such as the stock market. With the crypto market, though, investors just need a little amount of money to start. Crypto market has the potential to be a “land” for projects, attracting cash flows from numerous large funds and creating chances for the community.

When compared to other financial markets like currency and equities during the past ten years, the Bitcoin (crypto) growth index has consistently been regarded as the best. The value in crypto is still quite low and inflation is limited.

We can distribute capital by splitting it into several parts to invest in, hold, or trade in the ratio 4:2:2, in order to benefit from compound interest. Avoid using insecure DeFi programs, refrain from investing in shitcoins, and limit Futures/Margin trading.

When investing, you should prioritize holding coins in the long term (increasing the number of coins if possible), understanding the nature and risks in DeFi, skin in the game properly and most importantly, strengthen your crypto knowledge as much as possible.

With a capital of 10,000 USD, we apply the 4: 2: 2 method in stablecoin, holding and trading, the profit will be 26% after a year (equivalent to 12,600 USD). We retain the complete capital and profit from year to year, which sums to $3,276 USD, in order to take advantage of compound interest. Due to accrual mechanism, interest will increase as the investment period lengthens and vice versa.

If compound interest is used appropriately in investment (by holding), long-term interest might “rescue” investors in market saturation.

However, psychology plays a significant role in determining investors’ success. You should limit your FOMO of projects with no potential or that have grown rapidly. Instead, you should choose coins with many supporting platforms such as the ecosystem of Layer 1, Layer 2, etc.

Conclusion

Jade Forest Capital has provided you with an overview of compound Interest. If you are a beginner or want to enter the crypto market but have “limited” capital, taking advantage of compound interest is a valuable investment strategy. The right strategy and a strong mentality are required for successful investing.

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