Is lending crypto currency safe?

Excitingly it is now possible to lend out your Monero and other crypto currencies to other investors. Crypto currency lending is a bit like peer to peer lending for crypto, but the lending purpose is exclusively for other customers margin requirements (so not diversified). Lending crypto currency needs to be done via a crypto currency exchange where your currency is loaned to other exchange customers so that they can establish short or margin long crypto currency trading positions. This article chiefly considers lending out Monero (XMR), but the principal applies to any other crypto currency that allows exchange lending.

lending crypto currency

As an investor annual rates of return on any individual loan have ranged from 3% to over 100%. The rates on exchanges are typically quoted in daily returns, so a daily rate of 0.009% is approximately 3% – you can easily use any online calculators to convert any daily rate to an annual rate. An example annual to daily interest rate calculator is here (no affiliation).

We use Poloneix for lending, and find it gives good liquidity and relatively simple trading interface and order book. There are other platforms like Bitfinex but haven’t used them for lending.

As of October 2016 to our knowledge, no one has ever lost significant money lending Monero (or any crypto currency) on poloniex or other exchanges (so far). However before you go “all in” there are some significant risks to be aware of. The attractive returns are not just a free lunch. Here are some basic risks…

Margin risk

The main issue with exchange lending is it assumes that the exchanges algorithm for exiting customers out of their margined positions will not result in major loss. Essentially when lending on the exchange, your xmr is loaned to other exchange customers so that they can establish short or margin long positions. As usual for margin trading the exchange requires some capital level to be maintained in a customers exchange account, for the duration of their short or margin trade. If the crypto currency market moves against the customers positions and they no longer have the margin capital required to maintain their position, then the position will be exited by the exchange. This will likely be at a sizable customer loss. The theory is that the exchange has modeled the maximum likely amount capital required across ALL customers to meet an extreme move.

In theory the crazy moves should occur rarely and the exchange should be able to control any loses by forcing customers to liquidate their positions in real time. Basically they can take out multiple customers over their margin limit, but in theory not all customers at the same time should be affected (in theory!). However in practice these huge moves tend to happen more frequently than the statistics would predict. A good recent real life example is when the Swiss franc move meant several foreign exchange (FX) trading firms had to eat a few million of customer losses. This was in the FX currency market, but the principal could easily apply to crypto currency lending. Therefore you are depending on your exchange to have well executed customer margin requirements and forced trading position liquidation strategy.

Platform risk

Exchange lending and indeed storing any crypto currency on any exchange is subject to platform risk. That is the risk that the actual exchange platform fails and you lose some or all of your crypto currency balance. This could occur through hacking of poor exchange security or even an issue with the particular crypto protocol that can be exploited. Basically there is a slight possibility that your coin on an exchange just disappears overnight. You can obviously reduce hacking risk on your individual account by using website security features like two factor authentication. However that doesn’t guard against back door hacking exploits at the exchange level. You should probably keep no more than 20% of your entire stash with one website, and even possibly budget for 20% of it disappearing every 3 years! For example, storage solutions for monero are to maintain a cold storage (off exchange wallet) under your control. That requires significant technical know how to setup, but is likely worth it to maintain your stash securely.

If you don’t think that exchange default can happen look at the historical hacks on mtgox Bitcoin (March 2014) and bitfinex (August 2016).

Important takeaways highlight these two possibilities storing your coin on exchanges:
- total loss: many mtgox investors lost all their bitcoins
- partial loss: Bitfinex distributed the losses against all customer balances irrespective of cash or coin.

The Bitfinex partial loss example has an interesting piece of moral hazard. Note that even though only Bitcoins got hacked, ALL the OTHER coin balances on your reduced by 36% and were replaced with an exchange IOU! Essentially you were exposed to Bitcoin security flaws even if you had zero Bitcoin balance – which seems somewhat logically unfair. The point is that you could be exposed to balance loss for any coin on an exchange – even you did not think you were.

Is lending crypto currency safe?

The non bitcoin crypto lending market is typically less than 2 years old for most coins. Lending crypto currency on any exchange may mean that there may technology glitches (eg unable to liquidate as required) or lack of volume (eg not able to lend out all the currency you wish to, because there are not enough people to lend to). However we have tried this though and have been able to lend out several thousand XMR for about a week relatively easily. The % return is potentially good for the risk, typically earning about 5% to 15% annualised on average – even if you have some loans in the 15% to 100% range – typically it is hard to get an entire portfolio allocated at those interest rates.

This also all assumes a relatively low default rate which may not be true for people trading crypto currency on margin in the long term (only have a few months of real data to work from). It maybe long term profitable as well, but given that that there are no statistics yet on this market, it is hard to make accurate projections. However if using US equity lending as an example, most brokerages seem happy to lend to you at about 6%, so assuming the underwriting model for margin accounts is similar, then this could offer decent long term returns.

This approach is also somewhat similar to peer to peer lending (eg prosper and lendingclub), so could offer similar returns, but is probably a level up on the risk spectrum (above say junk bonds). Bear in mind that any defaults that occur could be long term expensive, because you lose out on the long term price appreciation potential of your currency of choice – it would be disappointing if you lost half your coin stash on lending, only to see your chosen coin price rise into the clouds in the following months.

In summary, it is worth a look as an idea, but there is significant “very bad event” risk for any crypto currency exchange platform that is hard to quantify. It would almost definitely not be prudent lending out your entire monero stash, in case in does not perform as expected. However investing about 5% to 25% of your monero stash in margin lending can give you “pseudo dividend” on an investment which otherwise doesn’t yield anything – but you might wish to spread your lending over multiple exchanges.

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