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Aquiring cryptocurrency is difficult. It is championed to be easy, or at the very least easier than it has been before. But it still isn’t very easy. Exchanges and payment providers advertise that it is as easy as linking a bank account and buying on their platform. Coinbase, probably the largest US platform for buying and selling cryptocurrencies, states on their webpage, “Coinbase is the easiest place to buy, sell, and manage your cryptocurrency portfolio.” That may be true, it may be the “easiest” place to do that, but that doesn’t make it easy. Although this is probably the best time to sign-up with an online exchange for buying or selling crypto, as the demand for verifying customers is probably the lowest since the past bull cycle of 2017.
The compliance requirements for buying and selling cryptocurrencies is high, much higher than opening up a US bank account. There are tiers of verification, based off of purchase and withdraw requirements, there is usually some photo ID requirement, and then a selfie (which is one of the silliest and degrading activities to do). Note: author’s sole opinion.
This isn’t what makes buying crypto difficult; this makes buying crypto annoying. What makes buying and selling crypto difficult is -
Price volatility: The wild price swings may make buying or selling unpalatable
Access to the desired currency: Different platforms have different selections, yours may not have what you want
Fees: Each platform takes a piece, they do not provide the service for free
Storage: It is free to store crypto! Yes but this is not easily done and comes at an expense If cryptocurrencies are left on exchange, the exchange has ownership rights to transfer, not you. Risks are risky. Leaving crypto on exchange is a risk.
Jurisdiction restrictions: Some exchanges are restricted to customers in different countries and/or states.
Suffice it to say, there are some frictions in purchasing cryptocurrencies. Because of these frictions, there is a demand for “loaned” crypto. There are many reasons why someone may be willing to pay a return to borrow crypto -
They may not have access to online exchanges. They may loan it out to others and charge interest. They may allocate it for a period of time, and compensate the lender for this time.
There are many parties that could benifit from the above, and the one that shall be explored here is the lending intermediary. There are a handful of companies that offer lending services for crypto, for both borrowers and for lenders. There are more and more of these lending companies springing forth. And there are a handful of ways to make a passive yield from lending crypto.
Before lending options became increasingly available, interest could be made on exchanges by providing crypto loans for margin traders. Bitfinex still offers margin trading, and has a system for offering margin loans to traders. US customers have since been restricted from participating, however. The author used to make passive interest from lending crypto on Poloniex. There was a time when one could run a loan bot to manage these loan offerings and make a return on crypto loaned out for margin trading. Unfortunately for some (i.e. the author), Poloniex has ceased margin trading since it was acquired by Circle. This aquisition will hopefully make Poloniex a more robust and secure cryptocurrency exchange, but it leaves those seeking crypto yield, searching.
Interest on crypto can be earned by lending out the crypto or locking it up, the same way that locking up money in a Certificate of Deposit at a bank will typically earn more interest than a standard checking or savings account. There are some decentralized options for loaning crypto like Dharma, as well as others, which may be explored in a future post.
Here, centralized lending, will be explored. There are significant risks involved with lending cryptocurrencies. Crypto is a bearer instrument, not in the sense that it is a fixed-income security, but in the sense that whoever has transfer rights for that crypto has ownership rights. Whomever controls the crypto, owns the crypto. When crypto is deposited on an exchange, or on a centralized lending platform, that platform has transfer rights, and effectively has ownership rights. Ownership is transferred to the private keys controled by the exchange or lending platform. This means that if they get hacked, or a goverment freezes their assets, your crypto may not be coming back. Arguably, this is one of the problems cryptocurrency was suppose to solve, but we have recreated concerns of trust in search of yield. There is no reward without the risk. And risk there is.
That was a long winded warning, but caution is to be warranted, there may be dragons.
Once a risk tolerance can be identified, or determining what amount of crypto you are willing to never see again, there are a couple options for lending out crypto for a passive return. Compound is an open-source protocol for earning yield. Another is Celsius. (For full disclosure, the author has used Celsius at the time of writing, and may still do so in the future. The author, however, has no professional affiliations with the company or any of it’s employees.)
Celsius Network Limited is a private limited company registered in the UK. The company provides an app which will manage crypto lending and borrowing. A user must comply with the company’s KYC (Know YourCustomer) and AML (Anti Money Laundering) requirements. If verified the app will allow for depositing crypto currencies into accounts owned and controlled by Celsius by way of BitGo. Each Monday an interest payment is credited to the user’s Celsius account. Note: The accounts that a user deposits into will not hold the crypto, these balances get swept into a co-mingled account address. The user balance is recorded on Celsius’ accouting database.
The interest payment is denominated in the same currency that earned the interest. At the time of writing bitcoin is earning 5.10% APR, which means that every week 0.098% bitcoin is credited into the user’s account. Withdrawals are available at all times, so there are not manditory lockups. But all of the risks discussed above are applicable, and cannot be dismissed. As ye ’ole crypto addage says, only risk what you are willing to lose.
Well, that sounds good, but what’s in it for them? Why do they provide this service, what is their incentive? Money. Celsius takes the crypto that you can “easily” obtain, and then they give it to hedge funds. Those hedge funds take the crypto and short it in the exchange markets. The hedge funds make a lot of money shorting with your crypto, Celsius makes a decent return on charging the hedge funds a healthy premium, and you make the leftovers. Celsius describes it on their FAQ page:
Coins are held in BitGo and lent out to hedge funds/exchanges/institutional traders. Don’t forget! Any time your coins are lent out, up to 150% of the value is provided in another collateral (typically USD). For a more in-depth look check out this article that one of our members wrote up. https://trybe.one/celsius-network-how-secure-are-your-assets/
The yield is out there. There are other ways to make passive income on crypto, and risks vary. Crypto is difficult to get ahold of, and others are willing to pay to use it. Of course, the consequence of lending crypto to hedge funds, is that they will short the cryptocurrency in the market. This drives the exchange rate of the cryptocurrency to US Dollars, or any other fiat currency, down, so there is some vicious, self-harm cycle here: with respect to bitcoin, if enough participants are selling it short, the price of bitcoin may go down by more than the 5% per year a user is compensated for lending it. If a user needed to sell that bitcoin before the price recovered, the user would be disadvantaging herself. Risks abound for there may be dragons, and when there are dragons, there is gold!
(Photo by Arie Wubben on Unsplash)
disclaimer: these musings are offered, at best, as educational, and at worst for entertainment purposes. Do not take action on the descriptions above, as they contain risks, and are not intended as financial advice. Do not do anything above.