A Guide to Compounding Strategies
Should you compound or cash out? That’s one of the most common questions I get. Unfortunately, there is no set answer.
The benefit of compounding is that it’s very exponential. In just a few months, even with little initial investment, you can very easily make an insane amount of money per day. For example, if you get just 1 STRONG node right now, costing $1800, in just 100 days you get a 2nd node and then you’re earning $1000 per month. If you wait 50 days, then you can get a 3rd one and now you’re making $1500+.
The problem is that the project might be dead by then. Either it failed and shut down, or the token is devalued to oblivion and those rewards are worth nothing. Taking the example of STRONG again. Now it’s at $180, but on January 1st it was $550. While the token itself has a 100 day ROI, if you wanted to cash that out with a $180 price while buying at $550, the token would be devalued by almost 70%. Meaning that your $5500 investment would be worth $1800 by the time of your “ROI” period. For true ROI you’d need an extra 200 days.
This isn’t me talking bad about STRONG, the token price might recover, or some other great things may happen. This is just outlining the overall problem and something that plagues most protocols. STRONG is already an optimistic example because the team is solid and well-known, so you at least know they won’t just run away with the money, which is a significant risk with other projects
So given that compounding can make you so rich if the token doesn’t devalue, but also make you lose almost everything, what should you do? A very typical approach is to take your ROI asap. Meaning that you cash out every day (or week) until you get all your money back.
After that, because you’re still getting rewards, you can compound. Either everything or some of it. If you do this, you’re playing with “house money”, and you’re essentially risk-free. This is a great and simple approach. The problem is that if the token doesn’t devalue and you happened to be overly conservative, then you just lost the opportunity to make a lot of money.
This isn’t to say it’s bad, you just need to be aware of the trade-offs. In my opinion, there are two factors often not covered in these discussions.
How much confidence do you have in the project?
This will determine how urgent cashing out is. Is it a new project that you’re unsure about? Then cash out ASAP and get your ROI. Is it a great project that you fully believe in? Do you find the team competent? Have they been around for a while? Have they ever messed up? What long-term plans do they have to avoid devaluing the token? Are these plans sound? These are questions you should know about every project that you’re invested in. The more confidence you have, the more you should compound.
But another aspect that is seldomly mentioned is your overall portfolio. Are nodes your only investment? Then that’s fairly risky, if you’re compounding all of it then you may risk losing everything. But if nodes are 20% of your portfolio… that changes it completely. Within nodes, it also matters how you’re distributed. If you’re compounding everything and you’re in a single project, then your risk is very high. But if you have 6-8 projects, that risk is reduced. There is some nuance here on what you even consider diversification, but not enough space here. I shared some thoughts about it before.
Remember that you don’t need to have the same strategy for every protocol. You can have a different one for every single project you’re in. There are no fixed rules. You can even change your strategy based on new developments and announcements.
Your broader financial situation also matters. Do you have a stable job? Do you have debt? Do you have other forms of investments (eg stocks)? How much % of your total net worth is invested? Do you have people that depend on you? (eg family)
Because I understand that this might be a bit abstract for people, here is a loose guide.
The crucial issue here is risk tolerance. As we have discussed, there are 3 main variables:
Financial stability and situation
Portfolio allocation
Confidence in the project
Let’s say there are 3 levels of each: perfect, great, okay. Perfect is level 3, good is level 2, and okay is level 1. We can make a scoring system going from 3 to 9.
So here are some recommendations:
9: Compound until you x2, then compound 50% and cash out 50%
8: Compound 50% and cash out 50%.
7: Cash out until ROI, then compound 75% and cash out 25%
6-5: Cash out until ROI, then compound 25% and cash out 75%
4-3: Cash out forever
A MILLION things can be said about this, and everything here is very simplistic. This is very subjective and simply my opinion.
I just wanted to:
1) provide a rough overview of the variables involved and
2) provide an actionable guide that people can use as a starting point.
This isn’t financial advice
Always do your own research