We’ve all heard the stories of those that got into bitcoin at an early stage and now live millionaire lives. Many try to follow in their footsteps and hold a basket of cryptocurrencies with high hopes.

In the physical world, real estate is bought by investors who speculate on value appreciation. Many of these investors also rent it out to generate some rental income. What many don’t know is that in the world of bitcoin, it’s also possible to generate some ‘rental income’.

In this article I’m going to explain what bitcoin lending is, why you should and shouldn’t do it, how it operates and how you can get started. This article focuses on lending on exchanges (margin lending), so not the much riskier peer-to-peer lending for e.g. start-up financing.

What is margin lending?

Margin lending is the process of loaning out bitcoins to margin traders on exchanges. Margin traders are people who wish to increase their exposure by speculating with borrowed funds so they can potentially earn or lose more.

Margin traders are also the ones who pay interest. When the loan ends, the principal and interest are returned to the lender.

Why should(n’t) you do it?

Lending out your funds can be very attractive if you want to generate a bit of extra return on your funds. Interest rates vary and can be found here. For bitcoin, the average interest rate has been averaging at around 8% annually for the past three months. US Dollars fare a bit better with ~22% interest annually (0.06% daily) on average for the past three months. Interest rates however always fluctuate and should be checked before loaning out your funds.

Average daily dollar lending rate

Risks

There are some risks involved with lending. The main risks are associated with having your funds on an exchange. In the past it has occurred that exchanges were hacked and people have lost funds. Another risk is that the collateral of the borrower does not prove sufficient in the event of a flash crash. Up until now it hasn’t occurred yet that lenders didn’t get their loans back, however that does not provide a guarantee for the future.

Of course, make sure you understand what the risks are before you decide if the returns weigh up against the risk for your personal situation. Read more about the risks here.

How to get started?

1: Requirements

If you want to lend out bitcoins, this is what you need:

An account at Bitfinex or Poloniex. Funds in your lending wallet on Bitfinex or Poloniex. Optional: API Keys to automate the lending process.

If you don’t have an account at an exchange yet, you can create an account at Bitfinex or Poloniex. At Poloniex you also need to go through a verification process which takes several minutes. After depositing funds, you can start earning interest by loaning out your funds on the exchange. Another exchange that offers peer-to-peer margin lending is Quoine.

2: The lending process (Bitfinex)

This tutorial covers Bitfinex

If you want to loan out your funds, you can do it in three ways which I’ll briefly cover.

Manually With the “auto-renew” function from the exchange With a lending bot

Manually

You can offer the loans at the exchange by creating new loan offers in the funding (Bitfinex) or lending (Poloniex) page. After you have created a new loan offer, your funds will be loaned out if someone decides to borrow your funds for the interest rate that you specified. Doing it manually is easy, however it has some serious drawbacks because you (1) need to renew loans all the time and because (2) you need to determine an optimal interest rate. If the interest rate goes up after you have placed your loan, you could have potentially made more.

Auto-Renew

The first drawback of lending manually can be solved by toggling “Auto-renew” on a loan. This causes the funds to be offered again when the loan is returned. The same interest rate is used however for each recurring loan, which can cause your funds to sit idle for a long time, or to underperform badly because they could have been loaned out for a much higher interest rate.

You can click on “Renew funding” here (Bitfinex).

Lending bot

To solve the last problem you can use a lending bot. Lending bots offer loans immediately after they are returned and determine an optimal interest rate based on different types of algorithms.

If you want to make use of a lending bot you’ll need to “plug-in” the lending bot to your account at the exchange. This can be done by providing a pair of API keys to the lending bot which is essentially like a username and password but then for a robot. These keys can be generated on the exchange via account settings. You can decide which capabilities the API keys have. It would be advisable to disable trading and withdrawing access on the API keys so the bot only has the capabilities you want it to have.

Dollar lending is also possible on Bitfinex.

Algorithms

Different types of lending algorithms exist. Some bots decide to always offer loans X amount of currency deep in the order book, frequently adjusted to the market activity that is applicable in that lending market. Other bots have algorithms where they place microloans in different depths in the order book. If one of them gets hit they can “sense” that the market has eaten their order. This information can then be used to measure market activity.

Other algorithms make use of statistical analysis and historical loan information to calculate the expected value of a loan. Our algorithm bases its prediction on average loan holding time, recent lending volumes and the current volume of the order book. This way it can be calculated which interest rate is likely to yield highest given an expected duration of the loan and the waiting time (before the loan offer gets hit).

Conclusion

If you would like to generate some extra return and think that the interest rate offered weighs up against the risk, you may want to consider lending. Its advantages are high liquidity and (at times) an attractive interest rate. After you’ve set up the lending process, all goes automatically and you can earn some passive income.

Disclaimer: This is not investment advice and should therefore not be seen as such. Don’t lend out more than you can afford to lose. You may lose some or all of your funds. This article is meant to be purely informational. The writer of this article is affiliated with Marcopolobot.