Prime Rate Arbitrage — How does it work?
By Alpha Roc on The Capital
What is prime rate arbitrage?
Prime rate arbitrage involves the process of taking a loan of a crypto asset from one lending source which has a low-interest rate and then lending it out elsewhere to earn a higher interest rate. The profits would be the difference between the two interest rates. Since the investor’s profit is derived from the spread between interest rates, when seeking out crypto lending arbitrage opportunities, you are looking for a coin that you can lend at a higher rate than you can borrow it. Just remember, when calculating the earning potential you need to be aware that the size of the loan may well impact your profit margins, due to the fact that when large sums are involved, the lending platform may adapt their rates accordingly.
When it comes to all the various aspects of crypto lending arbitrage, from borrowing funds, providing collateral, investing, paying fees, and earning from the interest differential, you are entering the emerging world of DeFi. DeFi, also known as Decentralized Finance is the use of blockchain-based infrastructure to aid in the democratization of the financial arena. It makes digital assets accessible to everyone, by offering loans without the strict background and credit checks demanded by banks. DeFi platforms, offering interest-bearing crypto accounts are mutually beneficial to the platform and the trader. The platform enjoys greater liquidity and enhanced revenue potential, while the trader gains interest earnings.
Anyone can now access all cryptocurrency interest rates and exchanges at https://interest.coinmarketcap.com/
As an arbitrage is defined as the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset. For Prime rate arbitrage, the opportunity arises when you can borrow at a lower rate and lend at a higher rate.
By taking a look at the table above, the lowest borrowing rate for Bitcoin will be 3.98% at Bitfinex, while the highest lending rate is 6.2% at Celsius, giving us a net gain of 2.22%.
While the prime rate arbitrage has generally little to no risk, however, to take advantage of any lending opportunity, you will need to deposit some cryptocurrencies to collateralize your loan, leaving you open to the dangers of price fluctuations eating into your collateral. If you are not careful, the reward could be negligible and might not worth the effort involved. Another risk, common to all forms of lending for profit is that the counterparty could default on the loan. In such a circumstance your arbitrage chain would fall apart and you would lose your collateral.
The primary advantage of prime rate arbitrage is that the overall risks are still lower than with almost all other types of crypto investment and by expending very little time and effort you can enjoy lucrative opportunities and see almost instantaneous results. However, it is still important to lower your exposure as best you can, taking precautionary measures, including, of course, never invest more than you can afford to lose.