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Author Topic: Lending BTC is very risky  (Read 4417 times)
dissipate
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August 25, 2012, 10:01:31 PM
Last edit: September 12, 2012, 09:57:30 PM by dissipate
 #1

After giving it some thought, I realized that lending BTC is quite risky. It is risky because even under the assumption that a borrower is honest and would repay their debt if they could, a sudden rise in the price of BTC would make it difficult or impossible for borrowers to repay their debt. If you lend to an individual, they will simply default. If you invest in a pass through lending operation, what will happen is a number of investors will try to pull their BTC out. They will do this either because they want to take profits on the BTC itself, or they believe the borrowers will not be able to pay back their loans due to the rise in the price of BTC. The operator of the lending pass through will not be able to accommodate all of the payouts and may only recover some of the BTC from the borrowers.

Interestingly, however, lending BTC can sort of act as a hedge against a sudden BTC price drop. If the price of BTC drops, your borrowers will be able to more easily pay back the BTC plus the interest. So, while the value of your BTC holdings will go down, you will suffer fewer defaults in your lending operation.

Thoughts? Any flaws in my reasoning? Discuss.
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August 25, 2012, 10:04:08 PM
 #2

The responsible lendees would take out a Long position somehow...

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August 25, 2012, 11:27:28 PM
 #3

After giving it some thought, I realized that lending BTC is quite risky. It is risky because even under the assumption that a borrow is honest and would repay their debt if they could, a sudden rise in the price of BTC would make it difficult or impossible for borrowers to repay their debt. If you lend to an individual, they will simply default. If you invest in a pass through lending operation, what will happen is a number of investors will try to pull their BTC out. They will do this either because they want to take profits on the BTC itself, or they believe the borrowers will not be able to pay back their loans due to the rise in the price of BTC. The operator of the lending pass through will not be able to accommodate all of the payouts and may only recover some of the BTC from the borrowers.

Interestingly, however, lending BTC can sort of act as a hedge against a sudden BTC price drop. If the price of BTC drops, your borrowers will be able to more easily pay back the BTC plus the interest. So, while the value of your BTC holdings will go down, you will suffer fewer defaults in your lending operation.

Thoughts? Any flaws in my reasoning? Discuss.
The debtor can repay in part, which will still be at a profit for the creditor.
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August 26, 2012, 04:21:00 AM
 #4

The debtor can repay in part, which will still be at a profit for the creditor.

If I receive less than I've loaned out, I'm at a loss, regardless of the exchange rate. Perhaps I've misunderstood you.

you could break even on a lessor amount if the value increases :

loan out 100 coins

agreement of 120 coins  returned in 1 month

coin price incredibly doubles overnight

borrower can only  afford to return 60 coins you have still  profited since each coin  is worth double

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August 26, 2012, 04:35:56 AM
 #5

The debtor can repay in part, which will still be at a profit for the creditor.

If I receive less than I've loaned out, I'm at a loss, regardless of the exchange rate. Perhaps I've misunderstood you.

you could break even on a lessor amount if the value increases :

loan out 100 coins

agreement of 120 coins  returned in 1 month

coin price incredibly doubles overnight

borrower can only  afford to return 60 coins you have still  profited since each coin  is worth double

No, if fiat profit is what you are after, I would have been better off with my 100 coins. Loaning them has provided me with a loss.

you can still ask your debtor to fulfill the contract with 120 coins but if he says he cant afford to since the coins have doubled in price what you gonna do ?

the loaning business is just plain risky  , no matter what your loaning out
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August 26, 2012, 04:40:17 AM
 #6

The responsible lendees would take out a Long position somehow...

Imagine bullion dealers have to deal with such things daily. But how to do it with btc and not increase risk of that hedging failing at the same time?

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August 26, 2012, 05:04:12 AM
 #7

The debtor can repay in part, which will still be at a profit for the creditor.

If I receive less than I've loaned out, I'm at a loss, regardless of the exchange rate. Perhaps I've misunderstood you.

you could break even on a lessor amount if the value increases :

loan out 100 coins

agreement of 120 coins  returned in 1 month

coin price incredibly doubles overnight

borrower can only  afford to return 60 coins you have still  profited since each coin  is worth double

No, if fiat profit is what you are after, I would have been better off with my 100 coins. Loaning them has provided me with a loss.

you can still ask your debtor to fulfill the contract with 120 coins but if he says he cant afford to since the coins have doubled in price what you gonna do ?


You are going to lose (be less well off than if you hadn't loaned).

What if I get robbed and then win the lottery? Yay for robbery because I'm richer now?


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August 26, 2012, 05:53:17 AM
 #8

As Holliday said, you'd be better off just keeping your coins if you think the price is going to skyrocket instead of loaning (in terms of USD).

The question is, how certain are you it's going to do that?

A person might spread the risk around and do a bit of everything.
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August 26, 2012, 06:00:06 AM
 #9

I think it is more accurate to say that borrowing BTC is risky because it is likely that the BTC used to payback the loan will be more costly than the BTC that was loaned. The risk of default might increase, but the lender can reduce that risk.

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August 26, 2012, 09:51:22 AM
 #10

Thoughts? Any flaws in my reasoning? Discuss.
You are exactly correct.

There IS one good reason to invest though; a low-risk investment may be better than holding inflating fiat IF you fear a BTC price drop coming soon.

(like the bubble burst just recently)

Basically you could get 5% instead of -4% while waiting for the BTC drop you fear. Even if you are incorrect and buy back into BTC at a loss at least your loss is smaller by 9% per year.

Once BTC stabilizes in 2050 or something, invest away.

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August 27, 2012, 02:55:44 PM
 #11

Yes, lending BTC is currently very risky.  Price fluctuation makes the whole process very difficult.  But long term when the price stabilizes, lending in BTC won't be much different than any other fiat currency.  With fiat currencies, interest rates try to account for inflation.  If I give you $10 today, I want $12 tomorrow for taking on the risk of you not paying it back & to fight inflation.  Obviously with deflationary currencies, the situation is a little different.  If I give you 10 BTC today, I may only want 11 BTC back tomorrow because I realize 10 BTC today is worth more tomorrow, but I want a little extra for taking on the risk of you not paying me back.  There is still incentive in lending because I'm getting 1 BTC more tomorrow than I started with today.

In general, lending/investing is risky.  Someone may not pay you back or the stock market could crash.  Unfortunately, despite its riskiness, with fiat, you are forced to lend/invest to fight inflation.  I'm more willing to risk that $10 for $12 because it will be worth even less tomorrow.  Why should you have to be so risky with your hard earned money?  With bitcoin, you won't have to take that risk.  No longer will the average person have to worry about the stock market or save more than necessary just to counter inflation.


The only reason to limit the block size is to subsidize non-Bitcoin currencies
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August 27, 2012, 03:12:44 PM
 #12

The debtor can repay in part, which will still be at a profit for the creditor.

If I receive less than I've loaned out, I'm at a loss, regardless of the exchange rate. Perhaps I've misunderstood you.

you could break even on a lessor amount if the value increases :

loan out 100 coins

agreement of 120 coins  returned in 1 month

coin price incredibly doubles overnight

borrower can only  afford to return 60 coins you have still  profited since each coin  is worth double
No, if fiat profit is what you are after, I would have been better off with my 100 coins. Loaning them has provided me with a loss.
This is why I don't expect loans to be a very large part of a mature bitcoin economy. No lender would ever lend at a negative nominal rate so loans will be very expensive in a deflationary environment.

Consumption and investment will be funded via savings (capital formation) instead of debt.
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August 27, 2012, 03:17:57 PM
Last edit: August 27, 2012, 04:26:46 PM by DeathAndTaxes
 #13

This is why I don't expect loans to be a very large part of a mature bitcoin economy. No lender would ever lend at a negative nominal rate so loans will be very expensive in a deflationary environment.

Consumption and investment will be funded via savings (capital formation) instead of debt.

In a mature Bitcoin economy the rate of deflation will be very low.  While inflation/deflation is a component of interest rates it isn't the only component.

Take CC denominated in USD.  24% APR when the projected inflation over the period of repayment is ~3% annually.   Hypothetically if the USD neither deflated nor inflated and all risks were the same one would expect the market to reach equilibrium at ~21% APR on this CC loan.  

If a large & mature Bitcoin economy is deflating at say 1% per year then we would expect a 23% 20% interest rate on this same loan denominated in BTC.
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August 27, 2012, 03:41:53 PM
 #14

In a mature Bitcoin economy the rate of deflation will be very low.  While inflation/deflation is a component of interest rates it isn't the only component.
Deflation in a bitcoin economy will come from economic output growth and the  reduction in the supply of bitcoin (lost coins). This means probably at least 5% per year, or possibly more in times of strong economic growth.

In the current economy politically favored groups get to borrow at negative real interest rates. In an environment where this is not possible (due to inability to mint new bitcoins at will) and everybody had to borrow at positive real rates you'd see commercial loans going for rates that looked like consumer credit cards. Durable goods loans (homes, cars, etc) would be expensive and require significant down payments, if they were even available.

In that kind of environment nobody would be borrowing. Individuals and businesses would need to accumulate savings prior to making purchases/expansions, like they did prior to the last hundred years of debt financing.
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August 27, 2012, 04:16:58 PM
 #15

If a large & mature Bitcoin economy is deflating at say 1% per year then we would expect a 23% interest rate on this same loan denominated in BTC.
You mean 20% right?

21% - deflation of 1% = 20% (21 in real interest)

In that kind of environment nobody would be borrowing. Individuals and businesses would need to accumulate savings prior to making purchases/expansions, like they did prior to the last hundred years of debt financing.
But isn't that good?

Prices would drastically lower and people wouldn't be slaves to debt anymore.

It would become easier to sell your home, move and buy a new one.


In depressions of inflating BTC prices massive savings would fly away to solve the problem at hand until deflation and new saving returned.

Basically an automatic, but healthy form of Keynesianism that doesn't pervert markets into over consumption, war and throw-away economies.

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August 27, 2012, 04:20:20 PM
 #16

you'd see commercial loans going for rates that looked like consumer credit cards. Durable goods loans (homes, cars, etc) would be expensive and require significant down payments, if they were even available.

In that kind of environment nobody would be borrowing. Individuals and businesses would need to accumulate savings prior to making purchases/expansions, like they did prior to the last hundred years of debt financing.

It is tough to speculate about this.  But I mostly agree with you - lending rates will be a lot higher.  I reached the same conclusion with different reasons though.  I believe the main source of low rates is the middle class saving for retirement by investing in the stock market to fight inflation.  A deflationary currency eliminates this need.  Creating a huge hole that will cause rates to sky rocket.  But I can also see the reasoning in your logic.  Both of these combined will have a large affect on lending.  I wonder if deregulation & lower taxes will lower the demand for lending offsetting the lack of money to lend dampening the rate hike.  Either way, I personally think it is a good thing.

The only reason to limit the block size is to subsidize non-Bitcoin currencies
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August 27, 2012, 05:52:57 PM
 #17

But isn't that good?

Prices would drastically lower and people wouldn't be slaves to debt anymore.

It would become easier to sell your home, move and buy a new one.
It is good for everbody except for those that benefit from the current system, and those people who basically lost their life savings because they put it all into their house, based on the delusion that it was an investment instead of a durable good.
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August 27, 2012, 06:09:52 PM
 #18

I am having a website built for me where loans can be pegged to different currencies.

So you could loan out $200 worth of btc rather than 20btc.  Might make loaning more attractive.  Site should be up in a month or so, if my programmer doesn't have a stroke or something.
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August 27, 2012, 06:51:21 PM
Last edit: August 27, 2012, 07:13:35 PM by Etlase2
 #19

Individuals and businesses would need to accumulate savings prior to making purchases/expansions, like they did prior to the last hundred years of debt financing.

"The last hundred years" is not at all accurate. With the advent of FRB, financing exploded. This was 300 years ago. And there is certainly evidence to suggest that this is what truly brought about a middle and/or merchant class of people. Now, all this really means is that there was not enough money to bring about productivity in people who had production to offer. It is unfortunate that the some gains of this productivity are siphoned off to the wealthy, but it is the system that brought about some serious economic prosperity. The abuse of it, of course, has brought some very negative side effects though. In particular, there is likely groups of super wealthy that manipulate governments into controlling other governments into getting into debt and putting their people into debt and so on and so forth. Healthy, unmanipulated FRB is probably a good thing, but this is not what exists today.

The over-production/consumption that exists today is most likely due to the fact that our governments are in serious debt and the citizens are forced to repay this ridiculous, fictitious debt in the form of taxes or cut social services or what have you. So even though we are so productive, we have to continue to work ourselves literally to death so that the wealthy can eek out more profits.

A currency where investment is very risky due to the nature of the currency is never going to be significant. Especially one that is so ridiculously lopsided as bitcoin.

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August 27, 2012, 08:49:05 PM
 #20

The over-production/consumption that exists today is most likely due to the fact that our governments are in serious debt and the citizens are forced to repay this ridiculous, fictitious debt in the form of taxes or cut social services or what have you. So even though we are so productive, we have to continue to work ourselves literally to death so that the wealthy can eek out more profits.
The wealthy are certainly taking a signifigant cut but the vast majority of the stolen productivity is going to pensioners.

Those people, especially retired public sector workers, stand to lose the most if the government looses the ability to extract production from the working via the inflation tax.
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