What is crypto lending and how does it work?
Do you want to make more money with cryptocurrencies? Lending and borrowing cryptocurrencies could be the way to go.
Many crypto enthusiasts believe in buying, holding, and selling cryptocurrencies to make a profit. However, many are unaware that they can also use their holdings to get loans or even lend cryptos for more profit.
What exactly is crypto lending? Is this an option you should explore? Keep reading to learn more.
What is Crypto Lending and Borrowing?
Crypto lending allows crypto holders to lend their cryptocurrencies to borrowers. By doing this they will earn some interest as a profit. It’s more like putting money in a savings account, which earns interest.
You can grant or obtain a crypto loan through a Decentralized Finance (DeFi) lending platform or a cryptocurrency exchange. Interest rate and loan terms vary from one crypto lending platform to another.
How to lend or borrow cryptocurrencies
The cryptocurrency lending process involves three parties: the lender, the recipient, and the decentralized exchange or crypto exchange offering the service. The lender is the person who makes the crypto loans; the recipient is the borrower, while the exchange is the platform that facilitates the transaction. We will briefly consider how these parts interact during the process.
To obtain a crypto loan, the recipient (borrower) must have deposited an amount that would act as collateral for the loan. He would then request a loan from the lending platform. Once the conditions are met, the lending platform connects the lender and the borrower. The lender then begins to receive interest from time to time on the loan they have granted. However, the borrower will not be able to access the amount he used as collateral until he fully repays the loan.
Take the example of a borrower who wants to trade Ether (ETH) but has no money. If, at the same time, he has an investment in, say, Dogecoin (DOGE), he could use the DOGE position as collateral to get the loan to invest in ETH. At this point, he will not have access to his Dogecoin until he repays the borrowed loan. Also note that the borrower can use the borrowed loan for whatever he wants; this includes removing it for use outside of the platform it borrowed it from.
The collateral the borrower deposits is usually greater than the amount they wish to borrow. You may be wondering why you should take out a loan if you need to provide more collateral than the amount you want to borrow. “Since I have the value, why should I borrow it?” Most people who take out crypto loans take it to add to a particular position they held, meet expenses without having to touch their current trading positions or have new investments.
The expected annual return for crypto loans varies from platform to platform, but it is usually between 3% and 15% per year. The coin you lend also determines the rate. Information about the expected return per coin can usually be found on the lending platform. Not all platforms have coins available for lending; you need to research whether the desired crypto is available and the expected annual return.
Liquidation can also occur when the borrower’s collateral can no longer cover the value of the loan – if the value of the collateral decreases or if the amount borrowed increases in value relative to the collateral. To keep a borrowed loan active, the value of the amount borrowed must always be less than the value of the collateral. Borrowers must ensure this by adding more to their collateral or paying off part of the loan when it decreases.
Types of crypto loans
There are two main types of crypto loans, they are; flash loans and secured loan.
With flash loans, you can borrow money for a short time without the need for collateral. They require liquidity to be returned in a block of the transaction. To do this, you need to create a contract that requests a flash loan, performs the required steps, and repays the loan plus interest in the same transaction.
Technical knowledge is required to run a flash loan, which makes it better suited for developers. However, tools like CollateralSwap and DeFiSaver help users avail flash loans without the need for coding skills.
Secured loans are the most popular and the main subject of this article; they are more available for everyday crypto users. They require collateral and allow users to use borrowed funds for a longer period. Borrowers typically get loans of up to 50% of the amount they use as collateral.
Some Crypto Lending Platforms
There are many crypto lending platforms. Some of them will be mentioned below.
Aave is a decentralized non-custodial liquidity market protocol where users can lend or borrow cryptocurrencies. The protocol is fully open-source, allowing its users to interact openly and securely on the Ethereum network. Being open source allows its users to create third-party services that interact with the protocol.
This is another DeFi lending and borrowing solution. It is also based on Ethereum and uses smart contract functionality for transactions.
Compound and Aave are completely decentralized; no central authority controls them. You can read our short guide to decentralized finance to better understand how they work.
The company was established in 2017 to provide credit services to markets that have limited access to simple financial products. It aims to bridge the world of traditional finance and blockchain technology.
Binance, which was also founded in 2017, offers crypto financial products for its users to lend, borrow, and earn. It grants crypto-collateral loans on many tokens.
BlockFi and Binance operate like banks; these are the central authorities in charge of the safekeeping of your deposits. The platforms usually take security measures such as offering two-factor authentication, cold storage solutions, among others to ensure the safety of user funds. The key here is that the system is run under human governance; you don’t have to worry about taking many security measures.
Benefits of Crypto Lending and Borrowing
Now that you know what Crypto Lending and Borrowing are, you should also know some of their benefits. Below are some advantages of crypto lending and borrowing.
The procedures are simplified and quick.
As long as borrowers can provide collateral, they will easily get a loan. It’s that simple. The process is not hectic and does not require lengthy procedures like the traditional banking system does
High return for lenders
Banks do not offer high interest on savings accounts. Keeping your money in a bank for a long time will only depreciate it due to inflation. However, crypto lending offers a similar savings method with higher interest rates than banks.
Low transaction fees
Fees for lending and borrowing transactions are generally one-time service charges. It is generally lower than those practiced in traditional banks.
No credit check
Cryptocurrency platforms usually provide loans without performing credit checks. You only need collateral to get a loan. Once you can provide that, you have the loan.
Possible setbacks in crypto lending and borrowing
Even though crypto can be a profitable business, you might encounter setbacks. We will explain some of them below.
Since lending and borrowing activities take place online, your asset is vulnerable to the actions of hackers and cybercriminals. Hackers can hack a smart contract or take advantage of poorly written codes, resulting in loss of funds. Learn how to protect yourself from crypto hackers to learn what steps you can take to curb hacker activity.
We explained it earlier, but we’ll repeat it for emphasis. Liquidation occurs when the price of collateral drops to the point that it cannot cover your loan. Since the crypto market is volatile, the price of your collateral may drop suddenly and cause the asset to liquidate.
Volatility is one of the drawbacks for lenders. The value of the cryptocurrency you lend may decline, leading to losses greater than interest income.
Earn passive income with crypto lending
Crypto lending helps you earn interest on your cryptocurrencies. If you don’t plan to withdraw your crypto positions, you can lend them out and make more money doing next to nothing. However, a borrower must ensure that the value of the collateral remains intact to avoid liquidation. It is also common for lending platforms to send a notification (a margin call) when the collateral becomes low.
Please note that this is not financial advice. We urge you to seek advice from a licensed financial advisor before making any investment or major financial decision.
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