Borrow at Low Rate and Lend at High Rate DeFi Strategy for Passive Income

The decentralised finance (DeFi) space in Crypto is quickly evolving with new platforms popping up all the time. Because each platform tend to be independently operated the interest and borrowing rates are different to each other. This presents a good opportunity for keen investors to capitalise on the differences and make some relatively low risk passive interest income.

There is only 1 prerequisite for this and that is you need to hold some crypto asset to use as collateral.

DeFi Vs Centralised Finance platforms

I would like to first point out that we should not be confused and classify all the various lending platforms under DeFi. A platform that is owned, controlled and run by a company is not exactly a DeFi platform. Some of the more well known of these would be Celsius, Nexo and BlockFi. These are custodial based financial institutions that hold your deposited crypto for most likely fractional reserve banking. This does not mean that they are not legitimate businesses. In some cases they even offer insurance on held assets and have pretty strong security features.

My strategy won’t work well with these centralised lending/borrowing platforms because you are not in complete control of your crypto assets. You will need to get permission and approval whenever you want to withdraw your crypto. Sometimes withdrawals can take up to 24 hours or in the case of BlockFi, even 1 week.

A DeFi platform should be run on smart contracts and allow you to have control of your cryptocurrency. They are non-custodial meaning the cryptos are held in smart contracts and you are able to initiate deposits and withdrawals of your crypto at any given time.

Now with DeFi platforms it is not as black and white to say something is fully DeFi or not. There are degrees to the current level of decentralisation that can occur. What I look for at a minimum is the ability to deposit and withdraw crypto at any given time. Therefore I am only looking to incorporate the following DeFi platforms:

1. Compound
2. MakerDAO
3. DyDx- The only platform where your collateral also earns interest!
4. Nuo — Here you get an estimated potential payout in the next 30 days. As users pay back their loan repayments do you get paid earnings.
5. Fulcrum

I also like DharmaLever however in this case it doesn’t qualify as loan terms are required to be locked in. We need the flexibility to move assets around at any given time. I have found that withdrawals from Celsius have been quite seamless, however your interest earnings are paid out every Monday. These 2 platforms could also work for you if you are willing to risk that rates remain at a level where you are not losing out. You would be required to leave your crypto locked up on a platform for a potentially longer period.

Borrow Low, Lend High

Essentially the concept is pretty straight forward. It consists of borrowing a stable coin such as DAI at a lower interest rate than what I can lend it out for, therefore making a profit on the difference. What I am looking to achieve can be broken into the following steps:

1. Provide crypto as collateral such as Ether.
2. Take up a low interest stable coin loan by drawing down from the collateral. The loan should be at a safe level with a low chance of liquidation.
3. Transfer the stable coin to a higher interest paying platform.
4. Interest rates are dynamic so you always want to make sure your lending rate is higher than the borrow rate. If none of the platforms have a higher lending rate than your borrow rate then you should pay off the loan.
5. If there suddenly becomes a platform that provides higher interest rate than what you are currently getting then transfer to that platform instead. You may want to limit the amount of times you do this because Gas Fees could quickly add up.

Here is a diagram that illustrates the whole process.

The process can be done manually but someone with the right coding skills could even automate the system since most of these platforms are run off smart contracts.

An example of how it would look if you were to do this right now (01/07/2019):

1. Connect your Metamask wallet to DyDx.
2. Deposit some Ether balance into DyDx. The Ether will be earning 0.57% APR.
3. Drawdown what you consider a safe DAI loan amount from DyDx. Make sure you are comfortable the price of Ether will not fall so much that it will cause a liquidation. The borrow interest rate of DAI is currently 10.36% APR.
4. Transfer the borrowed DAI to NUO where the lending interest rate is currently 15.72%.
5. You will now be earning 15.72 — 10.36 = 5.36% on DAI at NUO that you borrowed.
6. Periodically check to make sure that the NUO lending rate does not dip below the DyDx borrow rate. If it does then check other platforms if their lending rates are higher. Either transfer to another platform or pay back the loan at DyDx.

Conclusion

With anything in finance there is hardly anything out there without associated risks. Beware that DeFi platforms are also not without their risks and you should not invest what you cannot afford to lose. Even though they have had their smart code audited by 3rd party audit firms there is always going to be some inherent risks in code.

Personally I am more comfortable leaving crypto on decentralised applications where I have more control over my assets. Recently a centralised cryptocurrency exchange lending platform Poloniex socialised their margin lending losses with their customers. The exchange suddenly took 16.202% from the principal of all currently active BTC loans even those that weren’t active at the time of the crash.

Do your own research on each of the platforms and form your own opinion and comfort level on where you may want to leave your funds.