What drives a country’s economy like no other? Loans. Yes, lending money to ambitious entrepreneurs and businesspeople helps them generate income for themselves while also creating jobs for other citizens in the country.
With the covid-19 outbreak in 2020, there has been a significant increase in the number of start-ups. These start-ups obtained financial backing from business loans and investment avenues such as cryptocurrencies.
The crypto market has grown at an unbelievable rate, luring millions of investors worldwide. The crypto market value is in the billions, and investors are profiting from selling and holding crypto.
If the cryptocurrency market or a digital asset is solving a problem, it will drive some value. – Brad Garlinghouse
Investors can loan their crypto holdings to others and earn a reasonable interest rate of up to 20% in cryptocurrency. However, the rate fluctuates depending on the deposited tokens. Let’s go through each aspect of crypto lending in-depth.
What Is Cryptocurrency Lending?
The cryptocurrency market is highly volatile. Long-term investors hold digital assets and sell them when there is a high earning potential. However, rather than simply holding the cryptos, investors can put them to use and make money. They can do so by crypto lending.
Crypto lending is a concept of decentralized finance (Defi) in which cryptocurrency holders loan their digital coins to borrowers in return for interest payments known as crypto dividends. The catch is that investors must have a substantial sum of crypto money to earn money via crypto lending.
Investors should also learn as much as they can about the crypto assets they intend to lend, market prices, legal rulings from financial bodies, borrowing agents, and interest rates, among other things.
How Does Cryptocurrency Lending Work?
The concept of crypto lending is simple to understand. Three parties are involved in the process.
- First Party – Lenders hoarding crypto assets in anticipation of a price hike.
- Second Party – The crypto lending platform where the crypto loaning practice occurs.
- Third-Party – Borrowers who need funds most likely for business needs.
Now that we’ve identified the parties concerned in cryptocurrency lending let’s look at the actual process. The process starts with a borrower requesting a loan on a crypto lending site.
However, for the loan to be approved, the applicant must have some crypto assets to provide as collateral. Once the loan is approved, the borrower’s crypto assets are at stake and will be released only when they can settle the loan amount.
The lender’s role, in this case, is to sign up on the crypto lending platform and let the system use its investment to lend to the borrowers. Lenders will not be able to witness the process since it will be automated, but they will enjoy consistent returns in the form of monthly interest payments.
Note: If cryptocurrency prices fall, the borrower may have to pledge more.
This cryptocurrency lending system benefits both lenders and borrowers. You’re probably wondering how. The point is that when borrowers need money, they won’t have to liquidate their crypto assets. They can use their crypto assets as collateral to obtain a loan in fiat currency.
When they repay the loan, they receive the crypto coins back. This allows them to keep the virtual currencies and profit from them in the future once their value grows.
Cryptocurrency Lending for Borrowers
Borrowers must offer their digital assets as collateral to get a crypto loan. Despite retaining ownership, they lose some rights to their collateralized digital assets until they repay the debt over time.
Rights such as the ability to sell or trade the digital asset. However, once they pay off the loan amount, they get their collateral and associated rights back. It is also possible to obtain a crypto loan without providing collateral. However, this is a complex concept. We’ll go over it some time.
The loan to value (LTV) ratio is usually applied to the desired loan amount to determine how much collateral a borrower must pledge. For example, if the platform’s LTV is 60% and the applicant requires a $ 40,000 loan, he must offer $ 60000 in collateral.
Cryptocurrency Lending for Lenders
Lending platforms administer the crypto pool and regulate the entire process. Investors only need to sign up and add their crypto assets to the pool. The lending platform will benefit and distribute a portion of the earnings as an interest to the investors.
Investors cannot see or oversee the process. However, investors can sell the collateral to cover their losses if the borrower fails to pay the debt.
Cryptocurrency Lending Rates
Each crypto lending platform offers varying rates and ROI. As a result, investors’ returns will be dependent on the platform they select. Each forum also carries some level of risk. Therefore, it is advisable to diversify the crypto portfolio and spread the risks, just as one would with stocks and equities.
Normally, loan rates vary between 3% and 8%. However, investors might take anywhere from 10% to 18% when it comes to stable coins. Investors must compare the various lending platforms’ rates and make an informed decision.
Types of Crypto Loans
Borrowers can choose between two forms of crypto loans: flash loans and collateralized loans. Let us explore these types.
- Flash Loans
Borrowers can obtain cryptocurrency loans without pledging any collateral with a flash loan. In this case, transactions occur in a single block, implying that crypto transfers take place on a connected system, thus the term Flash loans.
The system flags the transaction if the borrower fails to pay the loan and interest amount. It then tracks the cryptocurrency amount on the borrower’s wallet and deposits it to the investors’ account. Here the smart contract manages the entire process.
Cryptocurrency is unquestionably making this world a better place.
Borrowers must quickly create top-level transactions with sub-transactions when using smart contracts. As a result, if a sub-transaction fails, top-level transactions will not proceed. Hence, borrowers don’t get much time to make the most of the crypto loans.
- Collateralized Loan
A collateralized loan is one in which the borrower must pledge digital assets as collateral to get the loan. The borrower has adequate time to use the loan in this case. Borrowers receive their collateral back once they pay the loan amount plus interest.
What Are the Benefits of Cryptocurrency Lending?
Sure, cryptocurrency is a risky investment avenue, but the benefits outweigh the risks. The same is true for crypto lending. The following are some of the amazing characteristics that lure crypto believers.
- Low-Interest Rates: Crypto lending is a cheaper alternative to personal loans. One can avail of a loan with an interest rate below 10%.
- Asset Value Determines the Loan Amount: Borrowers can quickly secure a loan of up to 50% of their portfolio. If they are fortunate, their choice of exchange may also pass loans up to 90% of their holdings.
- Loan Currency Options: Borrowers can receive a loan in the form of fiat currency of their choice. They also have the option to choose from selected cryptocurrencies.
- No Checking of Financial History: The lending platforms do not run a credit check on the borrower’s credit history. This enables people to obtain a loan despite having a bad or no credit score.
- Quick Funding: Borrowers receive funds within a few hours of loan approval.
What Are the Pros and Cons of Crypto Lending?
Crypto loans are certainly the best way to supplement your earnings and secure funding in decentralized finance. However, there are some drawbacks to it. Here are some of the pros and cons of crypto loans that crypto enthusiasts must know.
- Crypto Lending Pros
The plus points of crypto lending include the following:
- Easy Approval – Unlike traditional financing, borrowers do not need to pass a credit check to sanction the loan. They only need to provide collateral to obtain the loan quickly and hassle-free.
- No Middleman – There is no human involvement in the process, ensuring that the transfer of crypto assets is not manipulated or tampered with.
- Passive Income – Crypto lending empowers investors to earn interest in the form of annual percentage yield.
I am very excited about the prospect of using cryptocurrency, not just as a money equivalent, but using it as a way to earn something as a result of doing some work. – William Mougayar
- Crypto Lending Cons
No financial or federal authority regulates the cryptocurrency market. Hence, there is no federal insurance in case crypto lending backfires. As a result, getting into a crypto loan is crucial after assessing the risks. The following are the primary risks associated with crypto lending.
- Technical – Algorithms control all aspects of Defi operation. Protocols are in danger of breaking down in the event of a technical breakdown or system hacking. When it comes to non-custodial or flash loans, the threat is increased.
- Counterparty – The Federal Deposit Insurance Corporation (FDIC) mandates the bank to maintain a particular liquidity threshold to repay the collateral to the borrower.
However, because the FDIC has no say in the crypto market, the crypto market might be unable to return the collateral to the borrower in the case of a market crash, causing many investors to default on their loans.
Points to Consider Before Investing in Cryptocurrency Lending
It is natural for anyone to be intrigued by cryptocurrency lending and decide to engage in it. However, some aspects must be considered, as discussed further below.
- Margin Calls – Because the cryptocurrency market is volatile, the value of the collateral may decrease. In such cases, investors demand that the borrowers increase their holdings or sell their assets to reduce the LTV ratio.
Whenever the price of cryptocurrency is rallying, people start spending a lot more. – Erik Voorhees
- No Control Over Assets – Borrowers in a rush or an emergency cannot trade or sell digital currencies until the debt is settled. They regain their rights only when the loan is paid in full.
- Varying Repayment Conditions – The borrower may be required to repay the amount within a year. They can create their payback schedule, but it will also be shorter. Thus, the borrower must be able to afford the installments.
- Uninsured Transactions – Since the cryptocurrency lending platform is unregulated, lenders’ investments are at risk in the event of an exchange failure or market meltdown.
- Slow Withdrawals – Typically, cryptocurrency platforms take days to release funds and interest earned. This becomes a problem when asset values fall, and lenders want to sell quickly to recover the maximum amount possible.
Final Verdict
Crypto lending is intended for people with emergency cash problems who can afford to lose money. If a borrower needs money but does not want to sell their crypto holdings, crypto lending is the ideal option.
Similarly, if an investor holds or stakes digital coins for an extended period, they may earn interest by lending money. Whatever side you will be on, it is strongly advised to assess the risks and rewards to make a wise choice.