Module 2: The Mechanics of Markets Lesson 9: The Time Value of Money in Crypto

Objective:
Learn how to apply the principle of time value of money to staking, HODLing, and long-term crypto investments.

Outcome:
Make informed decisions about the future value of your crypto assets.

Introduction

In the previous lesson, we explored how economic indicators like CPI and PCE shape the crypto market and drive short-term volatility. Now, we’ll focus on a fundamental concept in finance: the time value of money (TVM). This principle states that money available today is worth more than the same amount in the future due to its earning potential. In the world of crypto, TVM plays a significant role in strategies like staking, HODLing, yield farming, and Dollar-Cost Averaging (DCA).

Understanding the Time Value of Money

The time value of money is rooted in opportunity cost—the idea that money can earn more money if invested or utilised immediately. For example, £1,000 today can be staked to earn additional returns, while £1,000 received a year later misses that earning opportunity. TVM highlights the importance of considering both present and future value when making investment decisions.

Example: Imagine I have £100 worth of Bitcoin. If I decide to stake it for a year with a 5% annual return, I’ll have £105 at the end of the year (excluding fees or market fluctuations). However, if I simply hold onto the Bitcoin without staking, I lose out on that £5 potential gain. This is the essence of TVM in action.

Applying TVM to Crypto Strategies

1. Staking: Earning Passive Income

Staking involves locking up your cryptocurrency in a protocol to earn rewards over time. By staking, you leverage the TVM principle to grow your holdings passively.

Let’s say you stake $ETH at a 6% annual return. Over a year, your initial investment of 10 $ETH grows to 10.6 $ETH. This is particularly advantageous for long-term holders who believe in Ethereum’s potential for appreciation.

2. HODLing: Balancing Patience and Opportunity Cost

HODLing, or holding onto crypto for the long term, is another application of TVM. While staking offers immediate rewards, HODLing focuses on the future value of the asset. This strategy often involves weighing opportunity costs, such as staking or yield farming, against the potential for significant price appreciation.

Example: If I hold 1 Bitcoin during a bull market, its value might increase from £17,000 to £108,000. By not staking, I forgo staking rewards but benefit from price appreciation, which may outweigh the lost income.

3. Dollar-Cost Averaging (DCA): Leveraging Time for Risk Management

DCA involves investing a fixed amount at regular intervals, regardless of market conditions. This strategy aligns with TVM because each investment increment starts earning based on when it is invested. By spreading investments over time, DCA helps reduce the risk of buying at market peaks while benefiting from compounding returns.

Example: Imagine investing £1,000 into Bitcoin using DCA over 10 months, with £100 invested monthly. Each £100 grows at different rates based on when it was invested and the market’s performance during that period. While the first £100 may grow the most due to longer exposure, the last £100 helps average out market volatility.

On our website, tools like the DCA Strategy Table and DCA Calculator can help you create a customised plan. The DCA Strategy Table provides insights into historical market trends, while the DCA Calculator helps estimate potential returns based on your chosen intervals and amounts. These resources simplify the process, ensuring you can leverage the time value of money effectively without overcomplicating your investment strategy.

4. Yield Farming: Maximising Returns

Yield farming in DeFi takes TVM a step further by enabling investors to earn compounded returns. By reinvesting earnings, you can accelerate the growth of your portfolio.

Consider $AAVE, a DeFi platform that allows users to lend assets and earn interest. If I lend £1,000 worth of stablecoins at a 10% annual yield and reinvest the earnings monthly, the compounding effect increases my returns to approximately £1,104 by year-end, thanks to TVM.

Risks and Limitations of TVM in Crypto

While TVM is a powerful tool, it’s essential to account for the unique risks of crypto investments:

1. Market Volatility: Price fluctuations can negate staking or yield farming gains. For instance, a 20% drop in Bitcoin’s value may outweigh any staking rewards.
2. Smart Contract Risks: DeFi platforms can be vulnerable to hacks or exploits, jeopardising your funds.
3. Lock-Up Periods: Staking often requires locking your funds for a set period, limiting liquidity and flexibility during market shifts.

Real-World Analogy: Liverpool vs. Manchester United Tickets

To make TVM relatable, think of investing in crypto as buying tickets for a Liverpool match. If you buy the tickets early, you secure a seat and avoid price increases as the match day approaches. However, you could also lend the money to a friend (like Oz) to buy Manchester United tickets and earn interest. Either way, the time value of your initial investment plays a role in your decision.

Conclusion

In this lesson, we explored how the time value of money influences crypto strategies like staking, HODLing, DCA, and yield farming. DCA, in particular, demonstrates how leveraging time can manage risk while benefiting from compounding returns. By linking these strategies to tools like the DCA Calculator on our website, you can make informed decisions to optimise your investments for long-term growth. In the next lesson, we’ll discuss diversification and how lessons from traditional index funds can be applied to building a balanced crypto portfolio.