What is Bitcoin Borrowing?
Banks and other institutions that lend money are beginning to offer cash in exchange for Bitcoin holdings, but these holdings can only be used as collateral. Once the borrower pays off their loan, their original Bitcoin holdings get returned to them in full, regardless of the change in value that may have occurred.
For banks and other institutions, this potentially has a significant downfall: namely, the question over the volatile value of Bitcoin. They risk, for instance, lending $20,000 in exchange for 2 Bitcoin, only to have the value of the latter fall spectacularly, meaning that they could receive a huge loss on the loan. The game changed when Cboe Global Markets began to trade Bitcoin futures at the end of 2017, giving investors – including banks – increased confidence in what lies ahead.
What is a Futures Contract?
A futures contract is a binding agreement made between two parties, during which they agree to buy and sell commodities or assets at a specified time in the future, at a predetermined price. The idea originates from commodities such as seeds and metals, where farmers and miners needed a way to manage the financial risk they incurred when producing their goods for future years, so they locked in the prices in advance. This has advantages and disadvantages: if the price of the commodity increases in the meantime, the seller has lost out, as they are bound to sell at the previously agreed-on price.
A Bitcoin futures contract currently looks at covering a single Bitcoin, which can be quite lucrative (prices range from $10,000-$15,000). By locking the price into a futures contract, the bank can guarantee that they will receive a return on their loan, thereby lowering the risk they take by lending.
It’s Not Just Banks
While most traditional banks are still – somewhat understandably – holding back on using Bitcoin in their lending, there are other options out there, hoping to fill this gap in the market. Startup companies such as SALT Lending, Nebeus, EthLend, CoinLoan and others have sprung up all over the place, allowing the owners of Bitcoin to put up their currency in exchange for cash. Again, the changing value of Bitcoin makes this a somewhat risky venture for lenders, and as a result it is a market which is growing slowly – just taking baby steps towards the end goal of developing bitcoin into a universally respected currency.
Baby steps are, however, better than no steps at all, and as cryptocurrency becomes more common, understood and prevalent in everyday society, it is highly likely that more and more financial institutions will adopt it in some way, be they traditional banks or high-tech startups. Bitcoin can expand financial possibilities by allowing investors to borrow more money.
How Can I Make Money from Bitcoin loans?
Another advantage is the opportunity to not only borrow money, but also make it. This is quite a nice opportunity if you have a large amount of spare Bitcoin lying around, gathering virtual dust. The safest and most effective method for lending this cryptocurrency is known as ‘margin lending.’ It involves working with individuals or companies known as margin traders; people who speculate with borrowed funds in order to make themselves a profit.
What Are Margin Traders?
Margin traders are the people who pay interest on the loans you provide. Once the loan ends, the principal amount and the interest are paid back, making you profit. Perhaps the clearest real-world example of this idea is in the real estate market when someone buys a property and rents it out, making money on the rent collected. In a similar way, individuals can buy an amount of Bitcoin and ‘rent’ it out, making a profit on the interest collected. This is a great way to earn a passive income stream which is steady and requires minimal input on your part.
However, as with any form of investment, be it lending or savings, there are always risks. This is particularly the case with margin lending, which, being P2P, is more similar to providing a payday or personal loan; there are more possibilities for risk involved. As with any form of lending, a good rule of thumb is never to lend more than you can afford to lose. Abiding by this principle will help you keep your head above water, and ensure you do not put yourself in a risky financial situation.
Understanding the Risks Involved
Due to the digital nature of the world’s first crypto, hacking is of course a risk. Having funds in an exchange naturally makes them vulnerable to criminals and hackers. Although thankfully rare, this is something important to keep in mind. In addition, remember that in the event of a crash, the collateral given by the borrower may suddenly no longer be sufficient. At present, this is only a theory. This has yet to happen for Bitcoin, but it is something worth keeping in mind.
Despite the risks, Bitcoin nevertheless offers the opportunity to earn a reasonable income passively. Providing you are sensible, financially savvy, and have something of a safety net in case anything goes wrong, Bitcoin borrowing and lending can provide a lucrative return on your investment, with minimal input on your part.
You can manage and reduce the risks as much as possible by sticking to two rules: never lend what you can’t afford to lose, and don’t put all of your eggs in one basket. Invest in more than one site – the most popular choices are Bitfinex and Poloniex – in order to spread the risk and reduce the chances of losing your entire investment if something happens to either exchange. In this event, you will at least have a backup supply to work from.
It’s important to remember that the financial markets and especially cryptocurrencies are constantly changing, evolving and growing. Every day new ideas and developments are emerging, and no-one yet knows what cryptocurrency could look like in five or ten years’ time.
What seems clear, however, is that this alternative to traditional banking is here to stay. There is plenty of new terminology to wrap your head around, and the idea of a whole new currency and approach to the way we use, exchange and spend money can seem overwhelming and too risky to invest in. But Bitcoin is continuously developing, and the whole system is growing increasingly accessible, more advanced, and more secure.