DISCLAIMER:Crypto-news and the author are in no way liable for any losses you may incur in applying the techniques in this article. Bitcoin lending is subject to high risks. Invest only an amount you can afford to lose.
If Bitcoin is to replace existing fiat currencies, it must carry out all the functions that a centralized currency does. One of the main features of fiat banking is the ability to lend currency at interest rates, or take a loan when funds are required urgently. Bitcoin has its own system of lending and borrowing, and it’s simpler than you think.
The 5 Golden rules of Bitcoin Lending
Bitcoin’s anonymity makes Bitcoin lending a controversial topic: after all, what guarantee do you have that a borrower will return your funds? Most Bitcoin lending websites require the borrower to submit proofs of identity, but there is no financial backing when it comes to the loan itself i.e. the loans are unsecured. This means that the borrower does not have to submit any assets which can be liquidated in case the loan is defaulted.
While this may sound like a major issue—and it is—there are 5 major precautions which can turn Bitcoin lending into a profitable business.
RULE 1: DIVERSIFY YOUR INVESTMENTS
The first rule to Bitcoin lending is to ensure that your bets are distributed over several loans, instead of one single loan. Quite logically, this ensures that even if a borrower defaults on your loan, your other investments will yield enough profit to offset the single loss. There are generally 4 ways to diversify investments:
1. Based on Loan Amount
Fund a very small portion of the requested loan, usually between 10-20%. So, if the borrower has requested a 1 BTC loan, fund only 0.2 BTC at the most. This increases the liability for the borrower as the funds come from different lenders.
Let one loan comprise of only 5-10% of your portfolio. If you have a target to lend 1 BTC in all, don’t lend more than 0.1 BTC to any borrower. Keep your investment in different loans.
2. Based on Geographical Location
While one part of the world could be experiencing an economic boom, the other part could be in recession. As employment falls, defaulters are likely to increase, so ensure that you have a good mix of both developed and developing nations in your portfolio.
3. Based on Loan Duration
Loans can be anywhere from a few weeks to a few years in length. Keeping long loans reduces your workload in reviewing borrowers and can provide long term benefit. Short term loans provide opportunities for re-investment and improve liquidity. You are open to choose your ratio of long-term to short-term loans.
4. Based on Rating Category
Higher interest rates generally have a higher chance of low ratings. Bitbond, for example, rates each borrower from A to E. While choosing lower ratings has a higher risk, it also offers lucrative profit speculations. Try to keep yourself in the middle, holding secured loans with lower rates as well as unsecured ones with slightly higher rates.
RULE 2: Loan Terms for Larger Amounts
If borrowers default on their loans, you have two options in front of you: take legal action against the borrower using his/her details, or sell the claim from this loan to a debt collection agency. Selling the claim is usually a much better option for lenders as it helps avoid the effort needed to proceed with legal action. The recovery amount is usually better with a professional organisation collecting the debt than an individual. However, this option is only feasible when the debt amount is above a certain threshold. Otherwise it will cost more to collect the claim than the claim amount itself.
For this reason, it is better to invest in larger loans where debt collection is concerned. You should keep in mind that different countries have different purchasing powers, and what may be a large loan in a developing nation wouldn’t necessarily be very large in a developed country. My personal recommendation is to invest in loans with a value upwards of 0.5 BTC in the developed world, and about 0.25 BTC in smaller economies.
Remember that the first rule still applies in this case. Investing in a bigger loan doesn’t mean that you have to increase your contribution to the loan (keep your investments diverse).
RULE 3: Check the Purpose and Feasibility of the Project
Before granting a loan, always look at what the individual wants to use the loan for. Does the idea appeal to you? Or is it a scam? Each applicant can write up to 1,000 characters describing what the purpose of the loan is. Analyse its feasibility and profitability in the long run. Try to find some alternate assets that the borrower can liquidize to pay off his/ her loan.
It is also important that you understand that not all borrowers will be native English speakers. Try to ignore their grammatical errors and instead focus on their product. If the funding required for the project and the loan amount do not match, something might be fishy. Also look at how ambitious the project is: if someone needs $1000 to start a car manufacturing factory then it’s probably a scam.
RULE 4: Beware of Risks: Lend only how much you can afford to lose
You must be aware that Bitcoin lending is still very new, so very few people have experience in the subject. Lending can offer returns as high as 20% p.a., but that doesn’t mean that they can leave your balance at 0. If a project fails, or if a borrower refuses to pay out, you shouldn’t be on the verge of bankruptcy. Keep a small part of your earnings in the lending business considering that it is a high-risk investment.
RULE 5: Learn from previous Investments
Check the progress of your investments at least once a month to monitor their progress. Try to find a trend in profitable investments and put your money in similar ventures in the future. Correct yourself if you see too many failed projects. Lastly allow investments to mature. Just because things don’t work out in the first month doesn’t mean that they won’t in the future. Use this link to see statistics on Bitcoin loans.
All in all, it takes is a little bit of caution and awareness while lending Bitcoin to make it from a seemingly impossible venture to a highly profitable side business. In many ways, Bitcoin Lending is like investing in start-ups; your money may make a small garage company a Fortune 500 firm in the future. Just remember to adhere to a healthy level of caution when engaging in Bitcoin lending.