Why do institutes issue interest-related payments on your Bitcoin deposits?
The only reason is that they make even more money by lending your bitcoins to other people. But for whom and for what purpose?
Why would anyone want to borrow Bitcoin?
Could they deposit these bitcoins with another institution that pays even higher interest rates? That seems unlikely. Most companies reduce the amount you earn as your bankroll grows. Even if there was a Gigachad club that pays higher interest rates than they offer the plebs, why would anyone want to pay money to temporarily hold Bitcoin?
Could you use this bitcoin as collateral for a low interest fiat loan? That also seems unlikely, as they would have to pay interest on both loans, which would be higher than a pure fiat loan, and they would expose themselves to margin calls if the Bitcoin price fell.
What other uses for borrowed bitcoins are there? I think it’s to be used in a leveraged trade.
You could use bitcoin as collateral for leveraged long positions, but you could also use fiat so that people are unlikely to borrow bitcoin for long or leveraged long positions.
You can also short the bitcoins you borrow, either with or without leverage. This is likely a reason to borrow your bitcoins.
There are also derivatives, some of which require Bitcoin possession. The most common derivatives are options and futures.
A quick guide to derivatives
Options come in two flavors: puts and calls. Both can be bought or sold.
Put buyers are given the right to induce the put seller to buy Bitcoin from them at a certain price (so-called exercise price) on a certain day (so-called expiry date). If the spot price of Bitcoin at expiry is above the strike price, you are not required to sell the Bitcoin – it makes no economic sense to sell Bitcoin at a lower price than the open market is willing to pay. The put seller is obliged if the buyer wishes to “exercise” the option.
To be a put seller all you need to do is have enough cash to fulfill your possible part of the contract. There is no need to borrow Bitcoin for this.
To be a put buyer, you wouldn’t have to be holding bitcoins as you are buying the right to get someone to buy bitcoin from you. If the contract had value on the expiration date, you could resell it to someone else who holds Bitcoin.
Call buyers are given the right to have the call seller sell Bitcoin at the strike price on the expiry date. If the spot price of bitcoin at expiration is below the strike price, you are not required to buy the bitcoin – you would not buy bitcoin at the strike price if you could buy it cheaper elsewhere. As with puts, the seller of the call is obliged if the buyer wishes to “exercise” the option.
To be a call buyer, you wouldn’t have to be holding bitcoins as you are buying the right to get someone to sell bitcoin to you. You wouldn’t even need the money to buy all of the bitcoins in the contract as you could resell the option for a profit if the contract has value when it expires.
Call sellers are a different story, however. In order to sell a call, you need to prove that you have enough bitcoin to fulfill your potential side of the contract. This often means that you have to deposit all of the bitcoins for the calls you want to sell. But selling a call is essentially a bearish position. You are betting that Bitcoin will not exceed the strike price you have chosen to sell. Call sellers can be the people who borrow the bitcoins you deposit.
Futures are obligations to buy and sell Bitcoin at the strike price on the expiration date. A person buys the contract that obliges them to buy a certain amount of Bitcoin at the strike price on the execution day. A person sells the contract, which obliges them to sell a certain amount of Bitcoin at the strike price on the execution day.
Futures buyers are similar to call buyers, but they must demonstrate that they have the money to fulfill their side of the contract.
Futures sellers are similar to call sellers. You are another candidate for those who might be able to borrow your bitcoins.
Who are the Bitcoin borrowers?
So the list of candidates who might be interested in borrowing your bitcoins are:
- Calling Sellers – People who see a limited upward trend in Bitcoin by a certain date.
- Futures Sellers – Individuals who believe that the price of Bitcoin will be below a selected level on a given date.
- Short sellers – people who believe that the price of Bitcoin will go down in the near future.
And the interesting thing is that they have to make more money with it than you make in interest, otherwise they wouldn’t.
Is Short Selling Necessarily Bad?
When a diamond-handed hodler pays in part of their stake to get a fraction of a percent per month, they feed the short sellers, which increases sales volume. This artificially dilutes the buying pressure that naturally occurs as the user base grows and the existing bitcoiners continue to operate DCA. If the only sale were to Bitcoin holders’ organic conversions to pay for expenses, Bitcoin’s spot price would likely be far less volatile.
While the volatility isn’t bad, sharp moves downward can tend to scare off new users until the volatility has subsided.
Who cares about the spot price of Bitcoin?
Many of us are there for the revolution, for the separation of money from the state. But that perspective doesn’t come until you’ve learned something about Bitcoin.
What will attract the next 100 million Bitcoin maximalists? The 60,000 blast turned heads in late 2020, including those of financial news networks, major banks and their richest customers. The NgU technology (“Number go Up”) will convince the curious Precoiner to look down the rabbit hole. Once you’ve learned enough about Bitcoin, nobody gets any less optimistic.
What would happen if the plebs stopped helping the short sellers?
If everyone withdrew their valuable securities from companies that lend short sellers, the interest on those loans would rise. However, rates would go up for both the short sellers and those who continue to help the short sellers.
From the position of the plebs we have a prisoner’s dilemma. For those unfamiliar with the prisoner’s dilemma, imagine you have two participants. When both cooperate, both benefit. If one cooperates and the other betrays, the traitor will be rewarded. In this situation, the plebs are the participants. When working together, you have to withdraw your satoshis, while when betraying your sats are deposited for others to borrow.
If no one takes off, or what is worse, deposits keep growing, the bitcoin liquid supply will remain high enough to allow short selling and any spot market effect will continue. I cannot quantify this effect, but it is necessarily greater than the value that citizens receive in interest payments, otherwise the big institutions would not be able to afford these payments.
If only a few plebs withdraw, those who continue to work together will be rewarded with higher interest rates. Unfortunately, the good plebs who withdraw their sats are still exposed to the effects of short selling in the spot market.
If every sat is withdrawn, short sellers’ supply of bitcoin will be reduced, perhaps to the point that leveraged shorting bitcoin becomes too costly or too risky to warrant the hassle. You can’t sell something short if no one is loaning it to you. In this scenario, the plebs win. NgU technology will do its thing and the news networks, baffled by the meteoric surge in fiat terms, will market Bitcoin to the masses. Businesses and governments will adopt Bitcoin as a payment method and later as a unit of account.
The Bitcoin user base growth and widespread adoption will come even if we continue to help the short sellers, but without this man-made selling pressure, we could get there much sooner.
This is a guest post by Raymond Walsh. The opinions expressed are solely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.