After first acquiring cryptocurrency, many holders tend to look to trading as a means to grow their investment. However, less than half manage to turn a profit due to a lack of experience or just pure bad luck.
If you have already lost money through cryptocurrency trading, you might be pleased to discover that many cryptocurrency exchange platforms also allow customers to earn interest through the much-less-risky process of margin lending.
Margin lending is the process of providing loans to exchange users trading on margin. These funds will be used by traders to open leveraged positions in return for a daily interest rate, while margin lenders will be largely protected from losses due to safeguards implemented by the exchange platform.
Although margin lending is arguably less profitable than a well-executed cryptocurrency trading strategy, it is far safer and doesn’t require any knowledge or experience. This makes it much more accessible and better suited for those with lower risk appetites.
How Much You Can Earn from Exchange Lending
For the most part, margin lending platforms will allow you to set your own daily interest rate. This rate will be compounded and can quickly rack up to impressive APR. By setting a daily interest rate of 0.05 percent, this will lead to a 20 percent interest after a year with compounding — whereas a 0.1 percent daily rate would yield 40 percent APR after compounding.
Now, just because you are able to set your own interest rate, this doesn’t mean that anybody will necessarily agree to that interest rate. After all, margin lending is a competitive market. There will be other lenders looking to offer more favorable terms, while low demand for loans can mean interest rates need to be lowered.
Regardless, your interest rate will almost always be tied to the size of the loan, its duration, as well as the type of digital asset that is being loaned. More often than not, larger and longer duration loans attract a lower interest rate — as is the case for loans of less volatile digital assets.
When calculating your profits, you will also need to take into consideration how much commission the platform takes from each deal. For example, both Bitfinex and Poloniex charge a 15 percent fee on any interest you earn from any lending contracts — whereas other platforms may charge a different amount.
Which Cryptocurrency Exchanges Support Lending?
Fortunately, there are several different margin lending platforms available. These are all roughly similar when it comes to how margin loans are provided but do differ somewhat in terms of liquidation policy and margin lending fees.
As one of the oldest cryptocurrency exchanges in operation, Bitfinex is a trusted figure in the cryptocurrency industry.
Bitfinex charges a 15 percent fee on any profits earned through margin lending. For example, if an active loan is earning $10 interest per day, Bitfinex will deduct $1.50 (15 percent) as its fee, leaving $8.50 in profit. Bitfinex will send borrowers a margin call notification if their account equity falls to 22.5 percent of the position size and will forcibly liquidate their positions if it falls under 15 percent.
Arguably the popular margin funding platform, Poloniex was one of the first exchanges to offer margin trading for digital assets.
Like Bitfinex, Poloniex charges a 15 percent fee on interest earned by margin lenders. Like most margin trading platforms, Poloniex will send a margin call notification if a trader’s account equity is too low giving them the opportunity to add more money to the position. However, if the trader’s margin falls below the maintenance margin, their position will be automatically liquidated.
Despite being a recent entrant to the margin lending space, Binance is a well-known cryptocurrency exchange that has been in operation since 2017.
In total, Binance offers margin lending for around two dozen digital assets, and also offers a handful of lending products that offer a guaranteed interest rate. Binance will automatically send a margin call to traders with a margin level equal to or less than 1.3, whereas a margin level at or below 1.1 will lead to forced liquidation.
What to Lookout For
As with any investment, there are risks and potential caveats that can be associated with lending on cryptocurrency exchanges. For the most part, the exchange you use will have provisions in place to protect your investment as best as possible, but there are still situations where it is possible to lose money.
One of the most common ways margin lending exchanges will protect lenders is through a process known as ‘margin call.’ Margin calls are essentially the exchange’s way of warning a borrower that their positions have moved against them and are dangerously close to falling outside of the maintenance threshold.
If the borrower fails to add to their position to bring their margin ratio back into line, then the exchange will forcefully liquidate their position — this is known as automatic liquidation. Funds recovered from the defaulted party will then be returned to the lender, repaying the loan.
Typically, the exchange will be able to liquidate the close the borrower’s positions without the lender incurring a loss. However, during times where there is a sudden and dramatic market movement and a large number of positions are liquidated at once, it could be impossible to automatically liquidate all positions without slippage. This is more common at exchanges that use a common lending pool, such as Poloniex.
As an example, back in June, Poloniex margin lenders found themselves in a loss after a flash crash in the CLAM cryptocurrency market combined with a thin order book left Poloniex unable to liquidate positions quick enough to avoid losses. Because of its common lending pool, this meant that all lenders on Poloniex were subjected to losses of around 16 percent — totaling around 1,800 BTC at the time. Fortunately, Poloniex pledged to reimburse affected lenders.
Because of this, before participating in margin lending or investing in any type of lending product, it is highly advisable to carefully read through the exchange user agreement and any other relevant documentation to better understand the provisions and fail-safes in place to protect your funds.
Best Practices for Cryptocurrency Lenders
When providing margin loans, there are several tips and tricks that can help you minimize your exposure to risk and increase your profitability.
The first tip is to keep your loans short. Although it can be tempting to offer long-term loans to ensure you are earning interest for longer, doing so can increase your risk of suffering losses. Many cryptocurrencies, including the least volatile ones, experience wild price swings on occasion. By offering long-term loans, you run the risk of being caught up in a flash crash that could leave you in a loss.
Not only this but offering short-term loans also ensures that your capital is free should any more profitable opportunities come along. After all, competition between lenders changes on a daily basis, as does the average lending rate — keeping loans short ensures your funds will be free to provide loans when the interest rate improves.
Some platforms will also give you the option to select which digital assets you consider to be valid collateral. This is where you will need to perform a risk assessment — do you want to accept more volatile assets as collateral and increase your loan fill rate, or do you want to stay safe and only accept low volatility collateral?
You can also minimize your exposure to risk by spreading your loans over multiple platforms. Rather than putting all your eggs in one basket and risking your entire portfolio, providing smaller margin loans on several platforms will ensure you are better protected should an exchange be hacked. After all, there have been several hacks in 2019 alone, it is better to be safe than sorry.
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