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What is Bitcoin lending?

What is Bitcoin lending?

The cryptocurrency community has opened up creative options for making money in the form of lending platforms. A few forms of lending exist for cryptocurrencies at the time of this writing. One way to do it is to make your funds available in a lending market facilitated by an exchange, such as Poloniex, where you can name your interest rate and allow other traders to use your funds for trading on margin.

Most loans will be for 2 days, and you can set your account to auto-loan at the rate you have named or allowed the trading bot to set the loan rate based on market conditions. Detractors from this practice note that since funds are held at the exchange, an incident such as the Mt. Gox attack could wipe out your wallet. If anyone else has access to your private keys, even an entity that you trust such as the exchange, you don’t technically own your cryptocurrency. There is no FDIC insurance for funds that you leave on deposit at an exchange. The risk of losing funds to the borrower with the margin account is actually relatively slim, since they have to have a balance sufficient to repay the borrowed amount, and they function just like traditional margin accounts for the most part.

Other creative takes on lending look a lot like bond funds. You buy into a pool, allow the managers controlling the pool to use it for debt instruments constructed with cryptocurrency, which in some cases is probably just a large-scale microloan regime such as Poloniex, and the managers of the pool guarantee interest, similar to interest payments on bonds. As an added bonus, some allow you to take loans out of the system and not worry about tax reporting since loans are not taxable in the US tax code.

The catch is that since these are unregulated investments companies, you may be putting your money at a high risk of loss. Some of these pools have initial offerings that look like ICOs (initial coin offerings) that are basically seeking crowd-sourced funding for a venture that may or may not work out. A few of these platforms are a few years old, but most are quite nascent. Some of them offer unrealistic rates of return that sound plausible when it’s stated as a daily or weekly rate but become suspicious if you annualize the rate they’re offering and you start to wonder how they plan on upholding a guarantee for a rate so astronomically high.

Buyers beware when it comes to these, as with all of the other risky ventures in the cryptocurrency world, since the crypto-markets are fertile ground for Ponzi schemes, and many optimistic investors have been burned. These contracts may also lock up your principal funds for a year, so you can’t bail out even if you feel that you’ve made a mistake. In many of the lending pools, there is no transparency either concerning who runs the pool, what assets they hold, or what the books look like, all of which have long been requirements of the established international securities markets.

There are also P2P (peer to peer) lending platforms that will allow you make micro-loans to individuals who have community-generated trust ratings and would like the use of the funds for up to a year or so.  The appeal is that you get to name your interest rate; if you want to be paid 5% for letting a Venezuelan shopkeeper take a loan for a year, you can do that.  This is a fairly interesting iteration of blockchain financial markets that looks a lot like a combination of Hawala, which is an age-old unregulated international money transmittal system in the Muslim world, and the international rate swap market.  In the future, with greater trust and identity verification methods, this could integrate with or replace the interest swap market between banks.  In the meantime, some users report being burned by different services, so be sure to do research before deciding that this is the direction you want to go.

Keywords: ponzi schemes, margin account, lending platforms, lending pools, tax-free loans, p2p loans, microloans, Mt. Gox,