On Poloniex we provide a peer-to-peer (P2P) margin lending and borrowing system for our customers outside of the US.
We have created this post to help customers understand the dynamics of Poloniex margin lending and borrowing. There are also detailed margin trading and lending support center articles. This post focuses on the interactions in the system between lenders and borrowers.
Using P2P lending, customers can earn interest on their crypto by lending it to other customers. There are a few key concepts that we’ll dive into:
- Lending and margin trading are linked
- Risk is pooled, or shared, among all lenders
Lending and margin trading are linked
Margin trading allows you to trade with borrowed funds. When you place a margin order, all of the money you are using is borrowed from other customers offering their funds as peer-to-peer loans. The funds in your margin account are used only as collateral for these loans and to settle debts to lenders. Hence margin traders are called borrowers and customers loaning crypto are called lenders.
Without lenders, there are no borrowers and margin trading isn’t possible. Margin trading helps investors amplify their potential returns (and losses). For example, Customer A might only have 1 BTC worth of XRP but wants to buy more because they believe the market is going to rally. They’re faced with a few choices: Don’t buy any more XRP, deposit additional funds that will allow them to purchase more XRP, or borrow funds from other customers.
If Customer A chooses to borrow funds, they’ll have to pay interest to the lender and set aside funds as collateral. Collateral helps ensure they can repay the loan even if the market swings the opposite of what they predicted. (For more information on margin trading on Poloniex, click here.)
If the combined value of Customer A’s position and collateral drop too close to the value of their loan, Customer A’s collateral will be liquidated to return principle to the margin lending pool.
Risk is pooled, or shared, among all lenders
To understand how risk is pooled among lenders, we will talk through a trading scenario where a customer named John wants to take advantage of a market rally. John believes that the price of ETH is going to rise relative to BTC over the next 12 months but doesn’t have enough funds to buy more ETH directly so he needs to borrow funds. He’d like to buy 1,000 ETH.
He wants to borrow BTC so he can purchase more ETH. (Let’s assume that 1 ETH = 0.031 BTC.)
So John needs to borrow 31 BTC to purchase 1,000 ETH)
John decides to open a margin position to buy the ETH. When he opens his position, this opens up a new loan demand for 31 BTC. Another customer, Jane, has 10 BTC that she’s lending at an interest rate of 0.25% over the course of a week. John doesn’t know Jane and never will, but his loan demand and her loan offer match.
John borrows 10 BTC and knows that, once the week is up, he’ll owe 10 BTC + 0.25% interest — again, he won’t know who Jane is at all during this process. Despite the healthy amount of BTC Jane is lending, she doesn’t have enough to satisfy John’s needs. He needs another 21 BTC, which matches with many other open loan offers created by many other lenders.
As these initial loans expire, John’s position is matched up with new loan offers. Poloniex simply matches borrowers and lenders and takes a small fee. Because John’s strategy is to invest in ETH over the course of a year and many of the loans he entered into expire after a few days, he’ll likely interface with hundreds of lenders over the course of the year.
This isn’t uncommon. In fact, the average open margin position on Poloniex is 23 days old, but 50% of loans close within 13 hours. While the majority of margin positions are supported by five loans over the course of the position, we have some large open margin positions supported by thousands of loans.
As the diagram above shows, there’s virtually always a web of lenders involved with any one borrower. That means they’re sharing risk. In most instances, lenders will be paid in full because Poloniex requires borrowers to put up collateral. If the market goes the opposite way of a borrower’s margin trade, their position will be force liquidated and their collateral will be transferred to pay the lenders.
However, there’s no guarantee that a borrower will be able to repay lenders. Market volatility, liquidity conditions, and order book activity may lead to borrowers not having enough collateral to pay back lenders. For more details about lending requirements on Poloniex, click here. For more details about margin trading on Poloniex, click here.