One of the most reliable tools in my cryptocurrency investing toolbox is lending on the Poloniex exchange. It's the old-faithful, slow-but-steady, go-to champion of my passive investment strategies. And it's an answer to the age old question: if you have a large amount of Bitcoin or some other cryptocurrency lying around, what can you do with it? Make more of it, of course!
I'll be talking mostly about Poloniex, my favorite exchange for a number of reasons: the UI is robust & easy to use, the charting is gorgeous (even on my phone), and there is a very large selection of different cryptocurrencies to trade. But everyone has their own preferences. Other exchanges support lending as well, and the general principles discussed here apply equally well to each of them, though the nitty gritty of the UI aspects will differ.
What does lending mean in this context?
There are two types of trades you can do on Poloniex: you can go long (buy low sell high) and you can go short (sell high buy low). In order to short the currency pair ETH/BTC you would perform the following steps:
- Borrow some amount of Ether (ETH), let's say 50 ETH for this example. You are now obligated to pay back 50 ETH, plus some interest, to the lender at some point in the future.
- Sell that ETH for Bitcoin (BTC). Let's imagine you get 5 BTC for all that ETH.
- Price of ETH goes down. Woohoo, this is good news for shorters!
- Buy back the 50 ETH you sold earlier. But now, because of the lower price, it only costs you 4 BTC.
- Return the 50 ETH (plus interest) to the person you borrowed it from.
- The difference between the amount of BTC you got for selling ETH vs. the amount you paid to buy the ETH back is your profit (or loss) on the trade. In this case, you got 5 BTC for selling ETH, then paid 4 BTC to buy it back. So your profit is 1 BTC (ignoring the small amount of interest you also paid for the loan).
Sounds a bit complicated, but Poloniex handles the mechanics of the borrow / repay process automatically, so shorters don't have to think about it much. All they have to do is press a button to open a short position, and another button to close it & book profits / loss.
Whenever someone borrows money to open a short position, it's called trading on margin. Note that it's also possible to go long on margin by borrowing Bitcoin.
Tip #1: The rule of thumb for Poloniex is: people borrowing Bitcoin are going long (expecting prices to rise), people borrowing any other cryptocurrency are going short (expecting prices to fall).
The lenders make their profit on the interest they get when the loans are repaid by the margin traders. And that kind of lending is the subject of this article.
So how much can I make from lending?
It varies. Individual cryptocurrencies all have different interest rates, and those rates, which you can set yourself, fluctuate constantly according to supply & demand.
The last couple months, BTC lending rates (to give one example) have typically been between 0.02% - 0.04% per day. Yes, that's right: per day. That doesn't seem like much on first glance, but it adds up over time:
| Daily interest rate (%) | APR (%) |
|---|---|
| 0.01 | 3.65 |
| 0.02 | 7.3 |
| 0.03 | 10.95 |
| 0.04 | 14.6 |
| 0.05 | 18.25 |
What you can make in 1 year given various average daily rates.
During periods of high volatility, interest rates can jump as high as 1% or more per day. You can expect this to happen several times per year as cryptocurrencies go through frequent pump & dump cycles. Typically on an upwards price spike, shorters will arrive in droves (anticipating the subsequent dump) and consume all of the available loans, driving interest rates up. But you have to be quick to take advantage, as rates change fast in these circumstances and won't stay high for very long. Once the inevitable dump occurs, short sellers take profits and then loan demands subside again (an interesting consequence of this behavior is that sudden rises in interest rates for no apparent reason can be an advance indicator that the market thinks a large price movement is imminent).
So you can expect low rates most of the time, punctuated by brief periods of high rates that can be exciting for a few days, averaging out to an APR of 7-10%, maybe a bit more if you're lucky.
I am quite content with 10% per year. Unless you're an expert trader (I'm a crappy trader and not afraid to admit it) this is a much safer way to make money than trading, and still way more than you would get from holding your money in a bank. Plus it's less work than analyzing charting patterns and watching trading positions all day long.
Note: I'm not advocating using 100% of your funds for lending, that would be a terrible idea. Lending is just one component of what should be a balanced investment approach (more on this later).
One more note: Poloniex takes a cut of 15% on all your lending profits, in return for offering this excellent service. So don't forget to take that into account when calculating expected profits.
Pros and cons
Like any investment strategy, you have to weigh the good against the bad and decide if lending is right for your circumstances. Let's summarize:
Advantages
- Strategy is mostly automated; very little manual work required
- Very low risk under normal circumstances
- Higher APR than keeping your money in a bank
Disadvantages
- Lower returns than more aggressive strategies
- Potential lost opportunities from being unable to trade while your capital is tied up in loans (you can't exit a loan whenever you want; rather you must wait for the borrower to pay it back)
- Risk of exchange being hacked / going out of business
Regarding that second disadvantage, it's only really a problem if you are an active trader. If you're like me, you have a long-term view and aim to make a little extra from lending while letting your core holdings gain value over time.
Besides, you should never commit 100% of your capital to loans anyway. Always leave some in reserve to take advantage of good opportunities as they come along. Of the Bitcoin I keep on Poloniex, 15% is for regular trading, 15% is collateral for margin trading, and the remaining 70% is for lending. If I was a better trader, I might adjust those ratios a bit more toward the trading side.
Okay, you say, sounds like a non-issue, but cryptomancer what do you mean by "risk of exchange being hacked"? Are you serious? Yes. Yes I am. This is a good point to step into
A Cautionary Tale
Let's rewind to late July 2016, just a month or so ago. I had 800 ETH parked on the Bitfinex exchange and was making decent returns from lending, about 10 ETH per month at the time (Bitfinex had much better interest rates than Poloniex when they first started offering ETH margin trading). But I had a two-week vacation to Malaysia coming up at the start of August, and was a bit nervous about leaving my investments on the exchange unattended while I was gone.
So I turned off autorenew on all my loans and let the borrowers pay them back one by one, then on July 29 moved all my ETH off Bitfinex into my private Ethereum wallet. The next day I left on vacation ready to have some fun, with my investments safely secured. A few days later, relaxing in a cafe with free wifi, I decided to check my usual crypto news sources and see what I was missing. This headline was there to greet me:
Source: https://news.bitcoin.com/bitfinex-hack-bitcoin/
Holy crap, I thought, my blood turning cold. Thank God I moved all my ETH off the exchange. Reading further, I found out only Bitcoin had been stolen. So even if my ETH had still been on the exchange, it would have been safe. Or so I thought, until several days later this gem came out:
That's right, all Bitfinex users were taking a 36% haircut across the board, across all asset types. If I hadn't, by pure dumb luck, moved all my ETH out of Bitfinex because of my vacation, I would have suffered a 288 ETH loss, equivalent to more than $3000 at pre-hack prices.
The moral of the story is that although rare, exchange hacks are a fact of life in this young industry, and you can't really see them coming. The chances of being caught in one are definitely non-zero if you lend capital on exchanges over significant stretches of time. Mt. Gox, Gatecoin, Bitfinex... sadly others will be added to this list over time, I'm sure.
Tip #2: Exchange risk is the #1 drawback of lending cryptocurrencies. But it can be mitigated by good risk management strategies. Remember how I said to never lend 100% of your capital? Well, you should never keep 100% of your capital on any one exchange either. The more exchanges you spread it out across, the smaller your loss will be if any one exchange is hit by catastrophe.
For example, ETH is one of the core investments in my portfolio, which I intend to hold for many years. I keep 50% of my ETH in various private wallet accounts. 25% of my ETH is on Poloniex for lending. And I used to lend out the remaining 25% on Bitfinex (since the hack I have been reluctant to resume lending).
However, immediately after Bitfinex resumed trading, I did deposit 1000 ETC (Ethereum Classic) and started lending it out. I don't care so much about my ETC and am willing to lose it if the exchange gets hacked again or ceases operations. But right now, daily ETC interest rates have been holding steady at around 0.2% for over a week, which is quite attractive. I figure that Bitfinex might actually be one of the safest exchanges right now, what with a systems overhaul and increased focus on security since re-opening. I might be wrong, but I'm willing to take that risk.
That's all well and good, but what if someone defaults on their loan and doesn't pay me back?
Poloniex (and other exchanges) have a built-in way to protect against this possibility by force liquidating accounts that get themselves into trouble. When you trade on margin, your account balance is used as collateral to protect against losses, and that balance determines the limit of how much you can actually borrow. If a trade turns into a disaster and unrealized losses become too high, after a certain threshold Poloniex will automatically close your position and pay back the loan from your account balance.
Theoretically it's possible, when the market is extremely volatile, for prices to move fast enough that forced liquidation can't keep up and Poloniex can't get a good enough price to completely pay back the loan. However, these cases are exceedingly rare. I've been lending on Poloniex for over a year and never suffered a single default on any of the thousands of small loans I've given out.
So for all practical purposes, you have a 99.999% guarantee that loans will be paid back.
Great, I'm convinced. Hurry up and tell me how to actually lend!
Okay, okay. The actual mechanics of it are quite straightforward. Let's start by dissecting the controls on the Poloniex lending page and then I'll explain my preferred method.
Step 1: Transfer funds into your lending wallet
First select Balances -> Transfer Balances from the Poloniex main menu. On the Transfer Balances screen you need to decide what cryptocurrency you want to lend, and then transfer some of it from your exchange or margin account into your lending account, as shown here:
Note that the Exchange, Margin, and Lending columns will only show the funds you actually have available to transfer between those accounts. Capital that is locked up in orders or existing loans is not shown.
Also, not every single cryptocurrency on Poloniex is available for margin trading (and thus lending). If it doesn't have an entry in the Coin column, then you can't lend it.
Step 2: Put your loan offers out there in the wild!
Once your lending account is funded, you're ready to let the good times roll! Click on Lending from the main menu, and you'll get this screen:
Let's go over each part of it.
My Balances - shows your free capital in each account, just like the Transfer Balances screen. To create new loan offers you must have a number shown in the Lending column. Click on an entry in the Coin list to see the lending information for that specific cryptocurrency.
Loan Demands - don't even look at this. It's worthless. Most people, when they open a margin position, don't really care what interest rate they have to pay. The system will automatically loan out money at whatever the lowest offer rate happens to be at the time. That said, there is a feature that allows margin traders to specify they won't accept a loan if the interest rate is higher than a specified threshold. And that's where these loan demands come from.
Loan Offers - this is a list of all available loans that lenders are currently offering, sorted by interest rate. The current lowest rate plus total amount being offered gives you a way to see how much demand there is for margin trading of this particular cryptocurrency. Typically you will want to offer a competitive interest rate near the top of the offer list or your offer will rarely be taken (since Poloniex automatically loans from the top of the offer list whenever a new margin position is opened).
Offer BTC - to add a new loan offer to the Loan Offers list, fill out the information in this box.
- Duration means the maximum amount of time you will give the borrower to pay you back. The borrower may pay you back and close the loan at any time up to this limit (sometimes when rates are very volatile, you may notice loans being paid back within seconds!). So you will be guaranteed to get your money back plus interest within this timeframe. Of course the amount of interest you get will depend greatly upon how long the loan is open. Remember that listed rates are how much you would get in 1 day (loans paid back within seconds will generate just a negligible dust amount).
- Auto-renew, if checked, will instruct the system to automatically create a new loan offer with the exact same terms as the previous one, whenever a loan is paid back. Note that you can disable auto-renew on active loans whenever you want.
My Open Loan Offers - these are loan offers you have created, but nobody has taken the loan yet (i.e. your loan is still sitting in the Loan Offers list).
My Active Loans - when an open offer is taken by a margin trader, it moves to this list and you start making interest on it. When someone pays back a loan, it will vanish from this list (or move back to My Open Loan Offers if you have auto-renew turned on) and the interest paid will be added to your lending account balance shown in My Balances and the Offer BTC box. The green numbers in the Fees column represent the total interest accrued on each loan, which will be paid to you when the loan is closed by the borrower.
Awesome! Now let's talk strategy!
Here is my preferred method of lending. Do this for each cryptocurrency you want to lend:
- Set your rate to be just a smidge lower than the current lowest rate. For example, if the lowest rate is 0.0499%, set yours to 0.0498% or 0.049% if you want to be aggressive. Don't worry if someone instantly undercuts you, it's not worth getting into a bidding war with a bot and dragging down the rates. But in general try to make sure you're at the top of the offer list or very close to it.
- For the amount, go all in with as much as you've got in your lending account (but as discussed earlier your lending account should never contain 100% of your total holdings).
- For duration go with 2 days. Anything longer and you'll regret it if there's a sudden spike upwards in lending rates. However, if rates are ludicrously high (say 1% or more) go with 5 or even 10 days to try to lock in the high rates.
- Leave auto-renew turned on. This means you won't have to micro-manage loans so much. If rates start to rise, then you can turn auto-renew off and wait for the 2 day duration to expire before manually offering a new loan with a higher rate. Conversely, if rates fall and your loan offers stop getting taken, cancel them and set a lower rate.
- Every morning, spend the first 5 minutes of the day checking your loans and make any adjustments necessary (basically repeat steps 1-4 whenever you notice unused money sitting in your lending account and try to keep all your loans active as rates change). I like to do this as soon as I wake up, before I take my morning shower.
Got any more tips?
You bet I do!
Tip #3: Always follow the above strategy religiously. After a while, it should get to be like muscle memory: you should be able to go through the steps in just a few minutes by rote, without even thinking about it.
Tip #4: Keep your money working for you in active loans all the time regardless of whether the current rates are high or not. That's better than setting too high rates and then having your money sitting around useless when your loan offers don't get taken.
Tip #5: It's OK to have dozens of small loans open. Typically you'll start with one or two big loans, and then those will fracture into smaller and smaller loans with various rates as time goes on. It makes my OCD twitch, but it's normal, don't worry about it. Also, your entire loan offer might not be taken all at once. People could take small bites out of it, generating several active loans from one single loan offer.
So there you have it. Now go forth and loan, my fellow Steemians. And may the interest rates be ever in your favor!
This is so exciting. I want to read more!
Poloniex has some great documentation on margin trading & lending: https://poloniex.com/support/aboutMarginTrading/
For a different perspective on Poloniex lending, check out this excellent article by @nxtblg. He offers some good case studies of lending Factom and Bitshares.
Got some cool lending stories / anecdotes of your own? Know other good articles on this subject? Feel free to share in the comments below!