What is looping, the high-risk strategy that gives crypto traders 60% returns?

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As a decentralized financial publication The defiant reportsa platform called Radiant Capital, promises a 60% return — a return that’s more than 12 times higher than even the best traditional ones savings accounts– using automated loops. Other protocols, including metronomealso provide a way to automate the risky trading strategy.

Bloomberg recently dubbed the looping “crypto magic,” but what exactly is it?

The basics

With traditional banks, customers protect their cash and earn interest on their savings. To make a profit, banks lend part of customer deposits to borrowers, who in turn pay a higher interest rate. Banks make money from the spread, which is the difference between the interest rate they pay their customers to protect their money and the interest rate they pay borrowers.

The same logic applies to DeFi lending protocols, but with one caveat. Many protocols issue their own tokens and distribute them to depositors as an incentive to use the platform. These tokens are worth something and “that’s why you get into this weird situation where the lending happens.” APR actually exceeds the borrower’s APR,” said Sunny Aggarwal, co-founder of Osmosis Labs, which backs the DeFi exchange of the same name wealth.

This offers an opportunity. For example, a crypto investor might pledge $100 worth of bitcoin as collateral on a loan log. The “bank” pays her 8% interest on her deposit plus 2% in its own token, resulting in a total interest rate of 10%, which is above the bank’s borrowing rate. The investor then borrows $80 worth of Bitcoin, deposits it again, borrows a little less, deposits that, and so on. Eventually, an investor has inflated the bitcoin they contributed to the protocol and is earning 60% or more interest on the original amount.

There are analogies to the real estate market, for example, says Mark Lurie, CEO of Shipyard, which develops specialized decentralized exchanges for the crypto market. A real estate investor can buy a property, rent it out, and then take out a loan on the home to purchase another property. Then the investor rents it out, takes out another loan, and “grinds” the investment all over again.

“The higher you go, the more a small shift in the real estate market can cause it to fall apart,” Lurie said wealth.

The Risks

Just as real estate investors buy properties and rent them out through loans, looping puts traders on “a balance beam,” says Lurie.

The delicate balance can be suddenly disrupted if, for example, a protocol changes its lending and lending rates or decides to stop issuing its own native tokens to lenders. “The more people do this and make a trade, the more efficient the credit market becomes and the less arbitrage there is,” Lurie said wealth.

There are also platform risks, says Ahmed Ismail, CEO and founder of FLUIDai, which plans to use machine learning to aggregate cryptocurrency prices across different exchanges. Hacks of DeFi protocols are still common and sometimes hundreds of millions can be lost. “You borrow, you borrow, you borrow, you borrow,” he said wealth. “You multiply the risk.”

Additionally, some looping techniques are not based on the interest rate differential provided by a DeFi protocol, but on interest from yield-producing tokens that offer holders a yield on top of the changing price of the asset itself.

One of the most common examples is stETH, which indicates how much Ether someone has effectively staked or put in escrow to support the operation of the Ethereum blockchain. Similar to the earlier scenario where protocols distribute native tokens to encourage people to deposit, traders can deposit stETH in a lending protocol and earn interest on their collateral as well as the interest that the token naturally offers. This combined interest rate exceeds the cost of borrowing, which is another opportunity for grinding.

However, similar to interest rates on loan agreements, stETH’s yield can change, and the higher a tower an investor builds, the easier it can collapse if stETH’s interest rate changes only slightly. “This is riskier than the other,” said Aggarwal of Osmosis wealthin terms of the loop with stETH as opposed to the loop with say bitcoin on a protocol where lending rate is higher than lending rate.

Automated loop

Looping as a crypto trading strategy has been around for a while, at least since the first DeFi lending protocols emerged and lured users by issuing native tokens. Its popularity ebbs and flows depending on the state of the larger crypto market, says Shipyard’s Lurie. “It happens a lot in bull markets,” he said wealth.

Now that the technology powering DeFi has become more sophisticated and transaction fees have fallen due to the increase in so-called transactions layer-2sSome developers are making the trading strategy more efficient, says Jordan Kruger, co-founder of Bloq, a DeFi company. “It’s getting really difficult to manually do these repetitive loops,” she said wealth.

Because of this, traders can automate which high-yield tokens they want to grind with Metronome, a DeFi protocol developed by Bloq. And because traders don’t have to manually monitor changing interest rates, Kruger says some of the risk disappears. Radiant Capital, the protocol advertised in The defiantalso offers automated looping.

However, the more an investor moves, the more risks he takes. But for those exploring the wild west of cryptocurrencies, the terrain comes with risks.

“People in crypto love to take extra risk for extra rewards,” said Josh Fraser, co-founder of Origin Protocol wealth.