What is looping, the high-risk strategy producing 60% returns for crypto traders?

Have you heard of “cycling”? It’s a risky trading technique that has come to the cryptocurrency world and offers potentially incredible returns to those who have the stomach to try it.

As a decentralized financial publication The defiant one reports, a platform called Radiant Capital is banking on the promise of 60% returns — returns more than 12 times higher than even the best traditional savings accounts — using automated looping. Other protocols, including Metronome, also offer a way to automate a risky trading strategy.

Bloomberg recently termed “crypto witchcraft” hype, but what exactly is it?

The basics

In traditional banks, customers keep their money and earn interest on their savings. In order 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, or the difference between the interest they pay customers to keep their money and the interest their borrowers pay them.

Among DeFi lending protocols, the same logic applies – but with a caveat. Many protocols issue their own tokens and give them away to depositors as an incentive to use the platform. These tokens are worth something and “so you end up in this weird situation where the APR of the loan actually exceeds the APR of the borrower,” Sunny Aggarwal, co-founder of Osmosis Labs, which supports the eponymous DeFi exchange, told Wealth.

This represents an opportunity. A crypto investor can, for example, deposit $100 worth of Bitcoin as collateral in a lending protocol. The “bank” pays her 8% interest on her deposit along with 2% in its own token, resulting in a compound interest rate of 10%, higher than the bank’s interest rate. The investor then borrows $80 of bitcoins, deposits it again, borrows a little less, deposits this, and so on. In the end, an investor has increased the bitcoins he put into the protocol and earns 60% or more interest on the original amount.

There are analogues in, say, the housing market, says Mark Lurie, CEO of the shipyard, which is developing specialized decentralized exchanges for the crypto market. A real estate investor can buy a property, rent it, and then take out a loan against the house to buy another property. The investor then rents it out, takes out another loan and “loops” the investment again.

“The higher you make this, a small change in the housing market can cause it to collapse,” Lurie said Wealth.

The risks

Like real estate investors who buy properties and rent them out through loans, looping puts traders “on balance,” Lurie says.

The delicate balance can be suddenly disrupted if, for example, a protocol changes its lending and borrowing rates or decides to stop issuing its own tokens to lenders. “The more people do that and pile into a deal, the more efficient the lending market becomes and so the arbitrage disappears,” Lurie said Wealth.

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

In addition, some looping techniques rely not on the interest differential provided by the DeFi protocol, but on interest from yield-bearing tokens that provide holders with a yield in addition to the changing price of the asset itself.

One of the most common examples is stETH, which represents how much Ether someone has effectively staked or escrow to help the Ethereum blockchain run. Similar to the earlier scenario where protocols gave out their own tokens to incentivize people to deposit, traders can deposit stETH into a lending protocol and earn interest on their collateral as well as the interest the token naturally provides. This combined rate exceeds the cost of the loan, which presents another opportunity for loopholes.

However, similar to the volatility of interest rates on lending protocols, the return on stETH can change, and the higher a tower an investor builds, the more easily it can crumble when the stETH interest rate moves slightly . “It’s riskier than the other,” Osmosis’ Agarwal said Wealthin terms of a cycle with stETH, as opposed to a cycle with, say, bitcoin on a protocol where the lending rate is higher than the lending rate.

Automated looping

Looping as a crypto trading strategy has been around for a while, at least since DeFi lending protocols first appeared and lured users by issuing their own tokens. Its popularity waxes and wanes according to the state of the larger crypto market, says Shipyard’s Lurie. “In bull markets, this happens a lot,” he said Wealth.

Now, as the technology powering DeFi has become more sophisticated and transaction fees have fallen due to the rise of so-called layer 2, some developers are making the trading strategy more efficient, says Jordan Kruger, co-founder of Bloq, a DeFi company. “It becomes really difficult to do this repetitive cycle manually,” she said Wealth.

That’s why Metronome, a DeFi protocol developed by Bloq, allows traders to automate which yield-bearing tokens they decide to spin. And because traders don’t have to manually monitor changing interest rates, Krueger says, some of the risk disappears. Radiant Capital, the protocol advertised in The defiant one‘s newsletter, also offers an automated cycle.

That being said, the more an investor flips, the more risk they take on. But for those exploring the Wild West of crypto, risk comes with the territory.

“People in crypto like to take extra risk for extra reward,” said Josh Fraser, co-founder of Origin Protocol. Wealth.

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