How to think about crypto lending?

It's a way of accessing liquidity while holding on to your asset's appreciation and avoiding capital gains tax on it. If you're very long on your crypto holdings, but you still need money, that's ideal way of accessing it imo.

But many people confuse borrowing with lending, companies like blockfi offer you both. If you borrow to get yourself into leverage, you're running risk of liquidation. If you're simply lending it, you can make back 3-7% back interest in your crypto and blockfi and other places will provide that crypto as liquidity to institutions (presumably to short-sell).

You can also do it through DeFi protocols, MakerDAO is the most popular, you can see some stats at daistats.com (roughly 3B+$ in collateral and debt). It creates this weird cycle where if the price goes up, you can borrow against your increased collateral value to buy back even more which in turn increases the price further. I suspect there's some things slowing that dynamic at the moment, but it certainly plays some role.

And I should also add that this is a fairly common way for wealthy people to access liquidity while keeping their assets, I believe Larry Ellison is one of the famous example of this[1], but now it's democratized for anyone who has cryptocurrencies.

1: https://www.steubencourier.com/article/20140926/BUSINESS/309...

The tax thing is mostly to avoid the taxable event that arises when you sell crypto (if you’re up, which most people will be right now) + keeping exposure to the crypto in question.

The way it works (~roughly) is that instead of selling the crypto, you deposit it into a smart contract that then issues you a loan in eg stable coins (DAI, USDT), with your crypto locked as collateral.

After watching a few interviews with BlockFi[0], I come to understand:

There are probably hedge funds or other large institutions who want to trade USDC or BTC without owning it. I am not a professional investor, so I don't understand quite why they wouldn't just buy USDC or Bitcoin outright and trade it...

But, every market needs liquidity and you basically are providing it by lending out your assets. There are some protocols emerging which lets you keep ownership of your coins and still lending them out.

I would go to BlockFi or other 2-3 bigger institutions (maybe even Kraken or Coinbase) and lend USDC out for currently 10%.

I don't know about taxes much, it depends on the country. All crypto is tax free in Germany after 1 year, so people mostly hold for a year and sell.

I am lending out USDC because, well, where do I get 10%? Also, lending out BTC means you can still keeping it while profiting from it.

Few people here understand that people actually don't want to sell Bitcoin since it seems to be a hard asset, and you don't want to get rid of it. So you can profit from the gains on the BTC price WHILE ALSO profiting around 5% a year of it. It's like a dream.

I don't expect this to go on for ever, but the market needs liqudity and its a perfect time to do so.

[0] https://www.realvision.com/shows/the-interview-crypto/videos...

I don't personally have much experience in the field, but one of my old IRC buddies ended up getting fleeced this way. He used to lend Bitcoin quite frequently, which normally turned out fine - until someone anonymously made 3 accounts to max out the borrow limit, and then never paid it back.

It ultimately comes down to accountability, which Bitcoin is designed to distribute among it's users. The more accountability you add to the system, the more pointless your cryptocurrency becomes. All of this is basically impossible without some sort of middleman facilitating the transaction, hopefully with collaterals on either side. Again though, it's kinda a self-defeating premise.

There are tax related benefits to taking a loan (in fiat currency) using your cryptocurrency as collateral. You may also be betting that your cryptocurrency goes up in value at a higher rate than the interest you're paying on your loan. So if you'll end up paying less interest than the amount of taxes you'd pay by selling and the amount of appreciation you'd be missing out on, then the loan makes sense financially.

Most companies that do this take custody over your collateral, and often times lend it out (pocketing some or all of the interest earned). This is called rehypothication, and is very risky. I do know that Unchained Capital is one company that let's you take a loan using your bitcoin as collateral without giving them custody of your coins nor rehypothicating them. You have a 2 of 2 multisig wallet where you hold one key and they hold one key.

I'd be worried about counterparty risk.

With crypto, one cannot simply short by temporarily minting a new coin. If you borrow a coin from me and sell it on to someone else, there is no way, if you default, for me to claw it back. Someone more-clever may have found a way to mitigate that risk somehow, but I don't immediately see one.

You keep your Bitcoin as collateral with a lender. They give you a loan which you can use for whatever you please. You pay off the loan with cash flow from other activities. You never need to sell your Bitcoin for liquid money then and your Bitcoin continues to appreciate. The only sketchy part is "not your keys, not your Bitcoin". The lender can make off like a bandit with your Bitcoin, so you need to be careful.

There's alot more to it and details on all the different platforms, I would take your questions away from HN though. People here are very anti crypto.

In your citation [0], table 3. "No counterparty risk" on bitcoin is listed as "High" and "Moderate" for treasuries. It also lists real estate and gold as having more volatility than bitcoin.

I would question some of those assertions. Especially the ones about counterparty risk.

There's a lot of decentralised finance clone websites with nice ui's , but also a lot of centralised ones doing the same thing. all offering very good interest rates

To the IRS, from a taxation standpoint, Bitcoin isn't treated any differently than any other tangible asset. Whether real estate, art work, gold bullion, FOREX, or practically anything else the IRS position is more or less "bought, sold, gains and anything else whatever it's worth in USD, we'll tax it with current law". Sure there are very specific loopholes (for real estate development, famously) but those are an entirely different topic.

I'm not the most sophisticated in tax avoision strategies but other than straight up illegal evasion I don't see how Bitcoin changes the picture at all. Oh yeah and as far as Bitcoin having it all on a public ledger that just makes their job easier. Don't even start with tumblers or whatever else... Taxing authorities have been tracking down income since the days of Rome. They know what they're doing. I believe the current stats for IRS enforcement measures are they return $4 for every $1 spent on investigation, recovery, and prosecution. When it comes to a government agency they likely provide the best ROI (and I'm betting by a large margin).

Simply put, if you're evading taxes with bitcoin (or virtually any other method) and they decide to even take a peek at you you'll likely get caught and upgrade your charges to criminal tax evasion. While there is some cherry picking of cases to game this statistic last I checked the Government has a 97% conviction rate in Federal cases. Once again, unless you're "too big to fail" if they investigate evasion you're going to prison.

As for loans, you've ALWAYS been able to take out loans against other assets - it's a common leverage tactic and some would argue it's stupid not to. Loans against secured (real) assets typically come with comically low interest rates because there's less risk to the lender (the asset can always be seized). Think mortgage vs credit card.

I haven't looked at this crypto lending yet but I would imagine that as part of the loan either the private keys of the wallet or the wallet itself would need to be placed in escrow (or similar). If you default on your loan the escrow company just moves it to your lender (much like a bank, storage facility, etc receiving a lein or judgement against you would). It's just that in the real world for physical assets the bank has to pay for the police to show up at your house and kick you out or seize the asset at gunpoint. Once again, Bitcoin just makes their job easier.

When comparing interest rates to potential asset appreciation it's borderline stupid to have liquid capital sunk in to an asset you can loan against. Sure you're kind of rolling the dice in some regard but if over the term of the loan the asset appreciates more than what you paid in interest you made money from the loan. Trump famously got into trouble with this in the 80s/90s with some EXTREMELY risky leverage strategies.

But at level, as was said then and now: "When you owe $100,000 to the bank you have a problem. When you owe $100,000,000 to the bank they have a problem."

EDIT: When talking about escrow I completely forgot about smart contracts and the like. Either way it's quite possibly the easiest collateral to recover.

Never take legal, financial or tax advice from anyone you aren't paying for it.