Have you encountered the term “looping” lately? This high-stakes trading method has entered the cryptocurrency arena, promising substantial returns for those willing to embrace its inherent risks.
According to a report by the decentralized finance publication, The Defiant, a platform called Radiant Capital is offering potentially lucrative returns of 60% via automated looping. This exceeds even the most generous traditional savings account yields by a factor of twelve. Several other platforms, including Metronome, have also begun providing methods to automate this risky trading tactic.
Bloomberg recently called looping “crypto sorcery” What exactly is it, though?
Understanding Looping
In traditional banking, customers deposit funds and earn interest. To generate revenue, banks loan out some of these deposits to borrowers at a higher interest rate. The bank’s profit comes from the difference between the interest paid to depositors and the interest collected from borrowers.
DeFi lending platforms work similarly, but with a unique twist. Many issue their own digital tokens as rewards for platform usage. These tokens possess monetary value, “which leads to a situation where the lending APR can surpass the borrower APR,” stated Sunny Aggarwal, co-founder of Osmosis Labs, a supporter of the Osmosis DeFi exchange, in an interview with Fortune.
This creates a potential opportunity. A crypto trader can, for example, deposit $100 in Bitcoin as collateral within a lending platform. The “bank” pays 8% interest and an additional 2% in its native token, resulting in an overall rate of 10%, exceeding the bank’s borrowing rate. The trader then borrows $80 of Bitcoin, redeposits it, borrows slightly less, and repeats the cycle. Ultimately, the trader multiplies the Bitcoin within the platform and earns 60% or greater interest on the initial deposit.
Mark Lurie, CEO of Shipyard, a developer of decentralized exchanges for the crypto market, sees similarities to real estate. An investor can purchase a property, rent it, and then take out a loan secured by the house to buy another. Then rent it out, get another loan and “loop” the investment again.
“The more times you do that, a small change in the housing market can cause it to fall apart,” Lurie shared with Fortune.
The Associated Risks
Looping, similar to real estate investors securing loans to acquire properties, places traders in a precarious situation, according to Lurie.
This fragile balance can be disrupted if a platform alters its lending or borrowing rates or halts the issuance of its native tokens. “As more people engage in this activity, and the trade becomes more crowded, the lending market becomes more efficient, thereby eliminating the arbitrage opportunity,” Lurie told Fortune.
Ahmed Ismail, Founder and CEO of Fluid, which uses machine learning for crypto price aggregation, emphasizes platform risks. Hacks of DeFi protocols are still frequent, and losses can amount to hundreds of millions. “You borrow, you lend, you borrow, you lend,” he explained to Fortune, “you are multiplying the risk.”
Furthermore, some looping methods rely on yield-bearing tokens, which provide holders a yield beyond the asset’s price.
A common illustration is stETH, which represents Ether staked on the Ethereum blockchain. As with native tokens incentivizing deposits, traders can deposit stETH into a lending platform, earning interest on the collateral, in addition to the yield naturally produced by the token. If this combined rate surpasses the borrowing cost, another looping opportunity emerges.
The yield from stETH is also subject to fluctuations, and the greater a tower an investor builds, the more likely it can collapse as the stETH interest rate changes. “This is riskier,” Osmosis’s Aggarwal shared with Fortune, referring to looping with stETH versus looping with Bitcoin on a platform where the lending rate exceeds the borrowing rate.
Looping Automation
Looping has existed as a trading strategy since the arrival of DeFi lending platforms. Its popularity fluctuates with the state of the crypto market, according to Shipyard’s Lurie. “It happens a lot in bull markets,” he stated to Fortune.
Jordan Kruger, a co-founder of Metronome and Vesper and head of DeFi at Bloq, explains that enhanced DeFi technology and decreased transaction fees are making the process more efficient. “Performing repetitive looping manually becomes very challenging,” she explained to Fortune.
Metronome, a DeFi protocol developed by Bloq, enables traders to automate the yield-bearing tokens they use to loop. As traders do not need to monitor rate changes manually, some risk is alleviated, according to Kruger. Radiant Capital, the platform highlighted in The Defiant’s publication, also supports automated looping.
Remember that the more an investor loops, the more risk they assume. For those exploring the unpredictable world of crypto, risk is part of the journey.
Josh Fraser, co-founder of Origin Protocol, told Fortune, “People in crypto love taking on extra risk for extra reward.”