Bitcoiners have dreamed of lending and earning interest on their coins for over a decade. With companies such as BlockFi offering juicy 6 percent interest rates, has this dream finally come true? Or is this just a minefield, where you’re just one step away from disaster? Let’s peel back some of the layers of this onion to try to better understand today’s bitcoin lending landscape, so you can make a more informed decision before parting ways with your hard-earned sats in hopes of collecting more sats.
First, let’s review some fundamentals. All parties involved in a business deal should have a shared and equal understanding of what is expected to happen and the risks involved. Lending is just like any other business deal. If you loan me your bitcoin, you should expect me to tell you exactly what I will do with your money, what risks are involved, and what happens if I don’t repay you. It takes some time to work through the details, but that’s where the devil lies. Details matter.
Imagine I ask you to lend me 10 bitcoin. I should be able to tell you not only that I plan to use your money to buy a house, but I will also tell you exactly which house I will buy. This way, if I fail to repay the loan, you can place a lien (a legal claim) on the title of the property that was purchased with your money. This type of arrangement is typically called a mortgage or hypotheque. The title of the property is called collateral.
As a lender, you’re worried about the 10 bitcoin that you have loaned me. You want to be absolutely certain that you will be able to recover as many of your 10 bitcoin as possible if I stop repaying the loan. Because your 10 bitcoin are “in” the property, you’re worried about the value of the property — the value of the collateral. You’ll want to make sure I have insured the property, and that I maintain it. What if house prices fall 50 percent, and the property is now only estimated to be worth 5 BTC? If I defaulted on the loan and you tried to sell the…