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

Have you heard of “loop”? It’s a risky trading technique that has arrived in the crypto world and offers potentially mind-blowing returns for those with the guts to try it.

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As a decentralized financial publication the defiant reportsa platform called Radiant Capital has dangled the promise of 60% returns, a return more than 12 times better than even the best savings accounts— using automated looping. Other protocols, including Metronomealso offer a way to automate risky trading strategy.

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

The basics

In traditional banks, customers protect their money and earn interest on their savings. To make a profit, banks lend certain customer deposits to borrowers, who in turn pay a higher interest rate. Banks make money from the spread, or the difference between the rate they pay customers to protect their money and the rate they are paid by borrowers.

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

This presents an opportunity. A crypto investor can, for example, deposit $100 worth of Bitcoin as collateral in a loan protocol. The “bank” pays him 8% interest on his deposit and 2% on his own token, resulting in a compound rate of 10%, higher than 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 put into the protocol and earns 60% or more interest on the initial amount.

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There are analogues, for example, of the housing market, 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 house to buy another property. Then the investor leases it, takes out another loan, and “loops” the investment again.

“The higher you do it, a small change in the housing market can cause it to crash,” Lurie said. Fortune.

The risks

Like real estate investors buying properties and renting them out through loans, the foreclosure puts traders on “a balance beam,” says Lurie.

The delicate balance can suddenly be upset if, for example, a protocol changes its lending and borrowing rates or decides to stop issuing its own native tokens to lenders. “The more people who do this and pile into a transaction, the more efficient the loan market becomes, and so arbitrage disappears,” Lurie said. Fortune.

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. DeFi protocol hacks are still common, and sometimes hundreds of millions can be lost. “You borrow, you lend, you borrow, you lend,” he said Fortune. “You multiply the risk.”

Additionally, some foreclosure techniques do not rely on the interest differential provided by a DeFi protocol, but on the interest yield tokens, which provide holders with a return on top of the price movement of the asset. -even.

One of the most common examples is stETH, which represents the amount of Ether that someone has actually staked or escrow to help the Ethereum blockchain run. Similar to the previous scenario where protocols distribute native tokens to entice people to deposit, merchants can deposit stETH into a lending protocol and earn interest on their collateral as well as the interest the token provides naturally. This combined rate exceeds the cost of borrowing, presenting another closing opportunity.

However, like the variability of interest rates on lending protocols, the yield of stETH can change, and the more an investor builds a tower, the easier it can collapse when the interest rate of stETH move slightly. “It’s more risky than the other,” said Aggarwal of Osmosis Fortunein reference to looping with stETH as opposed to looping with, say, bitcoin on a protocol where the rate to lend is higher than the rate to borrow.

Automated looping

Looping as a crypto trading strategy has been around for quite some time, at least ever since DeFi lending protocols first emerged and enticed users by issuing native tokens. Its popularity waxes and wanes depending on the state of the biggest crypto market, says Shipyard’s Lurie. “In bull markets, this happens a lot,” he said. Fortune.

Now, as the technology that powers DeFi has become more sophisticated and transaction fees have come down due to the rise of so-called diaper-2s, some developers are making the trading strategy more efficient, says Jordan Kruger, co-founder of Bloq, a DeFi company. “It becomes really difficult to manually do this repetitive looping,” she said. Fortune.

This is why Metronome, a DeFi protocol developed by Bloq, allows traders to automate the yield tokens they decide to loop. And because traders don’t have to manually monitor interest rate movements, Kruger says, some of the risk disappears. Radiant Capital, the protocol announced in the defiant‘s newsletter, also offers automated loops.

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

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

This story was originally featured on Fortune.com

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