Crypto investors often invest with the concept of holding their assets for a long time in their wallets until they see the price going high. Do you think this is the right strategy?
Well, I would disagree because there’s a lot you can do about your investments. Rather than just keeping all your assets in your bank for some low-interest rates, you can use other ways to grow your cryptocurrency.
This is where the concept of crypto lending comes into play. Isn’t it amazing if you can earn interest on the amount you invest in cryptocurrencies like Bitcoin, Ethereum, etc.? On top of the extra interest, the borrowers can also keep those digital assets as collateral for getting a loan.
A significant advancement is visible in blockchain technology, and an extensive amount of it is visible in the fintech sector. So, if you’re also wondering how you can earn interest on your investments, then you should continue reading further.
Cryptocurrency is becoming a prevalent option for payments. Not a lot of people know, but it is also an excellent opportunity for investments. If you are not planning to sell your crypto assets, you can gain more value for your assets with crypto lending.
First of all, let’s begin with understanding the concept of crypto lending.
What is Crypto Lending?
Crypto lending is similar to the concept of traditional lending. The only difference here is that you will lend different cryptocurrencies to the borrowers instead of paper currency. When investors lend their crypto to borrowers on a decentralized platform, they get interest payments in return. These payments are also termed “crypto dividends.” Several platforms allow the users to not only lend cryptocurrencies but also accept stablecoins.
Let us understand this better with an example. Suppose you are holding five bitcoins. Now, you can lend these bitcoins on a crypto lending platform to gain passive income. You only have to lend the crypto and receive weekly or monthly interest in return. The interest rates will depend on the platform you are using. It can be 3% to 7%, or in some cases, it can even go up to as high as 15-17%.
Crypto lending is also helpful because borrowers can stake their crypto assets as a guarantee for loan repayments. If the borrower cannot repay the loan, the investors can sell those crypto assets and recover their loss.
Now, let us understand the process of crypto lending.
How does Crypto Lending Work?
There are three major components for the accomplishment of a lending and borrowing process. The lenders and borrowers are connected through a crypto lending platform that acts as a third party.
Now, there is an entire step-by-step process involved in lending and borrowing between these three parties.
- Firstly, the borrower goes to a lending platform to request a crypto loan.
- The borrower will stake some crypto as collateral the moment the lending platform accepts their loan request. They cannot get the staked crypto back until they pay back the entire loan amount to the platform.
- The investors fund the loan, but they won’t be aware of the process taking place in the platform’s back-end.
- Investors receive their share of interest payments regularly as per the decided intervals.
- The borrower can get the collateral crypto at stake back only after paying the entire loan amount.
Every lending platform has different rules and rates, but the process is the same on every lending platform.
Investing in Crypto Lending
The first step is to find the right platform to begin investing in crypto lending. There are two types of lending platforms – centralized and decentralized. You have to choose either as per your preference.
As discussed, centralized platforms will involve a third party to handle the transfer of loan amounts and manage it. On the other hand, a decentralized platform will eliminate the third party, and smart contracts will handle everything.
You have to select between a manual and an automated lending platform. An automated one is a better option because everything is simplified on these platforms. Here, your assets won’t end up unattended, and they will be generating profit consistently.
You need to ensure that the platform you choose for lending is safe and legit. Before you lend your crypto, you should go through all the information available on that platform and check the interest rates. This way, you will be spared the regret of finding a platform offering better rates at a later point in time.
Types of Crypto Loans
Crypto loans can be divided into two broad categories:
Custodial Crypto (CeFi) Loans
When it comes to Centralized Finance (CeFi) loans, a centralized authority takes control of collateral. CeFi loans are custodial ones, where the trader has no access to the collateralized assets because the lender has access to the private keys of the collateralized assets.
If you compare custodial crypto loans with traditional loans, you will still notice that they are affordable and easily accessible compared to traditional ones. The only downside here is that there would be a central authority to determine all the loan terms. Currently, more than 80% of the crypto loans are custodial, but with the advancement of decentralized platforms, this ratio is drastically changing.
Non-custodial (DeFi) Crypto Loans
There is no central authority to control the terms of Decentralized Finance (DeFi) loans, which are non-custodial. All the terms are under the control of smart contracts. If a trader is taking up a DeFi crypto loan, they would be able to have control of the private key to their assets unless they are defaulting on their crypto loan.
You cannot get a loan for any fiat currency on DeFi platforms. You can only receive loans in different cryptocurrencies or even get a stablecoin loan that can be exchanged for cash. The interest rates on DeFi loans are high as compared to the custodial crypto loans.
All the protocols are accessible to anyone as they are put up on the blockchain, where everything is transparent. There is no need to go through any verification process on DeFi platforms, and even the interest rates will be less than the CeFi platforms.
There is no need to worry even if you are on the lender’s side on a decentralized platform. Smart contracts make sure that the loan is repaid.
Whether you are thinking about taking up a custodial or non-custodial crypto loan, there are certain things that you need to take care of. You should be aware of certain risks that are involved in crypto loans before you take one.
Risks involved in Crypto Loans
If you look at the assets in the traditional financial institutions, there is always federal insurance for every event of an exchange. Also, there is no federal insurance on any of your crypto assets. If any failure occurs during the exchange process, then you cannot blame anyone. There are three primary risks involved in crypto loans that you should keep in mind.
Everything in the crypto trading world happens in the digital world. There is a considerable risk of any technical problem in the protocol or any hacker taking control of the protocol. As all the activities on DeFi are only governed through algorithms, the risk gets higher in non-custodial loans. Other than that, if there is an issue with the smart contract, the entire platform can fail and result in the loss of crypto assets.
When it comes to traditional banks, there is a rule to maintain a certain level of liquidity. But, this is not the case in the crypto world. The investors providing crypto loans to the borrowers are not subjected to this requirement.
If there is a market crash by any chance, then there would be a considerable number of clients defaulting on their loans. On the other hand, if there is any case of platform exploit or breaking scenario, there would be no liquidity available for returning the collateral at stake by the borrower.
For preventing the issue of illiquidity during a market crash or downfall, the lending platforms issue forced liquidation or margin calls. Suppose any crypto asset’s value drops to a certain point when a significant amount of borrower’s LTVs (loan-to-value) is too high for the lending platform to maintain. In that case, they will instruct the borrower to increase the value of their collateral at stake, or they may have to face liquidation.
If the borrower doesn’t meet this margin call, then the platform will liquidize enough collateral that the borrower’s LTV is back to the maximum ratio allowed. This is a risky scenario for both the trader and the borrower.
What are the Crypto Lending Rates?
Every platform has different lending rates for cryptocurrencies. So, your returns will be entirely dependant on the platform that you choose. Every crypto lending platform has a specific ROI, and certain risks are also connected with it. This is why you should consider choosing multiple lending platforms to lower the risk and also have some diversity in your investments.
You will find different lending rates for different cryptocurrencies on various platforms. Usually, the lending rates for cryptocurrencies are 3% to 8%, while the rates for stablecoins vary from 10% to 18%. So, the best strategy is to fix a platform for any particular coin by comparing the returns on different platforms for that specific coin. With this strategy, you can optimize your returns and get a better ROI.
Now, you might be wondering what stablecoins are. Let us get an idea about it.
What are Stablecoins?
Everyone will agree that cryptocurrencies are highly volatile. To reduce the amount of risk and also offer price stability, stablecoins are introduced. These coins are backed with reserve assets. Now, what does that mean?
The value of a stablecoin is pegged with the value of a non-crypto asset. It can even be pegged with the value of any fiat currency like dollars or anything. This adds stability even to the crypto world because the value of a dollar or any other fiat currency is not highly volatile, just like crypto assets.
The main reason why stablecoins gained a massive amount of traction is because it provides both stability like fiat currencies and instant processing, the privacy of payments, and security like cryptocurrencies. So, it is like the best coin to combine both worlds.
How do the Crypto Loans without collateral work?
Another option is to go through a decentralized platform for crypto lending. Crypto loans without collateral are also known as Unsecured crypto loans. The borrower can have short-term liquidity and pay back the loan amount in cryptocurrency or fiat currency.
Here, the idea is to borrow the loan amount directly from a lender by keeping cryptocurrency as collateral instead of staking other assets like properties or gold on stake. Flash loans are currently the most popular unsecured loans on the DeFi (Decentralized Finance) space, where you don’t have to stake anything for collateral. The only thing you need to be careful about is having enough knowledge about crypto and DeFi before taking up a flash loan.
Flash loans are instant ones that are controlled directly by smart contracts. You should perform thorough research before you move towards any unsecured loan.
What do you need to get a Crypto Loan?
You don’t need to go through a lengthy process like you have to go through during a traditional loan. No one will check your credit score or income slip when you are taking a crypto loan. The only thing that matters here is that the amount of loan you will receive will depend upon the amount of collateral you will be allowed to use.
The loan-to-value (LTV) ratio is applicable. It is the ratio between the approved loan amount and the value of the collateral. As crypto markets are highly volatile, the LTV ratios are usually low on cryptos. So, if you are putting $5000 worth of crypto as collateral and receiving a loan of $3000, then your LTV ratio is 60%.
So, you don’t really need any documents for getting a crypto loan. You only need to have sufficient crypto assets for staking them as collateral.
Let’s now look at some of the pros and cons of lending cryptocurrencies.
Pros and Cons of Cryptocurrency Lending
- Crypto loans are accessible to every individual without looking at any income slips or opening an account in the bank.
- Usually, the borrowers can receive the loan within a few hours.
- Crypto lending is a much safer option as compared to the P2P lending option. The crypto assets used as collateral in crypto lending are highly liquid.
- If you go with automated lending platforms, earning passive income through crypto dividends is effortless.
- The borrowing rates are pretty low on lending platforms as compared to other bank loans.
- Crypto assets are highly volatile. You can lend stablecoins on different platforms to overcome this issue.
- For taking part in crypto lending activities, you have to place your crypto in a digital wallet. The problem here is that digital wallets are less secure than a physical wallet like a Ledger.
- The security of a platform is becoming a massive concern with an increase in the cases of crypto thefts.
- Specific platforms only allow you to stake your crypto for a fixed period. You must choose a platform that doesn’t have fixed period conditions.
If you have decided to begin with crypto lending, then you can check out several platforms like Celsius, BlockFi, Youhodler, and more. These platforms will help you to determine which is the right one for you. The right platform can make things easier and also increase your investment yields to the next level.
So, you have to be careful while choosing any lending platform.