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October 2, 2022

What Is Crypto Lending? Things You Need To Know

What Is Crypto Lending? Things You Need To Know

There are many ways to make money in the cryptocurrency space. Just as with fiat currency, it is possible to borrow and lend crypto. In the crypto space, the majority of investors purchase their assets and leave them in digital wallets to accumulate value, with the hope of selling them for an increased price at a later date.

However, not everyone operates on this premise. Some investors are more active in putting their crypto to work, seeking ways to source a return on their investment while still accumulating value from fluctuating markets.

In this article, we’ll discuss one of the popular ways people use their investment to generate income or to source more crypto for their own investments – crypto lending.

By the time you’ve completed this article, you’ll know what it is, how it works, the different types of crypto lending, and the pros and cons. So, read on to find out everything you need to know.

What Is Crypto Lending?

Crypto lending is a type of loan where the owner of the crypto deposits their tokens. These are then loaned to another party in return for regular interest payments.

These payments are made in the same cryptocurrency that was loaned, or as the ecosystem token of the platform. This will be received on a daily, weekly, monthly, or annual basis.

Typically, when you lend crypto, the loan is backed by collateral, giving the lender peace of mind that they will be able to recoup their investment should the recipient default. Often, these loans can be a lucrative way of accumulating more crypto, as they offer high-interest rates, some up to 20% APY.

How Does Crypto Lending Work?

Lenders and borrowers both use a crypto lending platform to process transactions and ongoing payments. Here, the lender will deposit the specified amount of crypto, while the borrower will transfer the agreed collateral to be held in escrow by the third-party crypto lending platform.

When providing collateral for a crypto loan, the borrower must provide assets that represent 100% of the value of the loan. In some instances, depending on the platform used, this rule is set at 150%, encouraging the borrower to refrain from defaulting and giving the lender confidence that they’ll receive their total loan amount back. Furthermore, this helps with tackling fluctuating market conditions and asset values.

Types of Crypto Lending

There are two commonly used types of crypto lending – interest-earning deposits and cryptocurrency loans.

Interest-earning deposits work more like a traditional interest accumulating bank account. Rather than providing a loan, where repayments are made with interest, the lender is actually supplying funds to the crypto lending platform themselves.

The lending platform will then use the deposited cryptocurrency to lend to borrowers or for their own investment purposes. These accounts return up to 8% APY.

As mentioned, it is possible to lend directly to a borrower – with the use of a lending platform. The borrower supplies collateral in return for the loan amount agreed.

Furthermore, they also agree to make scheduled repayments with interest. One great benefit of these loans is they can be as short as a few days, making them favorable to lenders and borrowers.

Other Types of Crypto Loans

There is a selection of crypto loans that are less commonly used, but we’ll introduce you to them anyway.

No-collateral Loans

In the volatile and unregulated crypto market, uncollateralized loans are incredibly unpopular. Firstly, for a no-collateral loan to be approved, there should be extensive background checks to ensure the borrower has the funds and means to repay the borrowed amount. Furthermore, should the borrower default, there is no collateral to liquidate to recoup the loaned amount.

Flash Loans

Unlike a traditional loan, a flash loan tends to be a short-term, one-transaction loan. With volatile markets and fluctuating prices across exchanges, borrowers use flash loans to take advantage, buying at a low price in one market and selling at a high price in another. These are incredibly high risk and tend to be used only by experts.

Line of Credit

Again, a line of credit is a collateralized loan, but it differs from traditional borrowing as it doesn’t have specified repayment terms and dates. Instead, individuals can borrow a percentage of the value of the collateral put up, and interest is only charged when withdrawals are made.

Crypto Lending vs. Staking

Staking is another way of using your cryptocurrency to earn rewards – usually more crypto. Essentially, when you choose to stake cryptocurrency, this is used to help the blockchain verify transactions and keep the platform secure and functioning correctly. Here, there are no third parties involved – the agreement is between you and the blockchain or project.

As with crypto lending, staking is for a set period of time, meaning as the staker, you won’t have access to your funds until the specified staking period is complete. The benefit to staking, much like lending, is the annual passive returns you make, with APY varying for each blockchain.

The main difference between lending and staking is lending goes directly to another person or lending platform. On the other hand, staking is used by the blockchain to maintain the validity of the ecosystem.

We’ve also produced another article detailing everything you need to know about staking.

Crypto Lending Risks

Unregulated

Currently, all crypto lending platforms do not benefit from any regulation, making using them incredibly risky. Although some are building reputations for being trustworthy, that still doesn’t give lenders any legal protection. If a lending platform ceases to operate – or you’ve supplied funds for an uncollateralized loan, your initial deposit is not protected, and you will not be able to retrieve it.

Interest Rates

High-interest rates are a double-edged sword. For lenders, they present the opportunity to make a higher return.

However, as a borrower, this can make repayments high and unachievable. Before taking out a crypto loan, you should assess if the high-interest payments will inhibit your ability to repay the total cost of the loan.

Slow Return of Loan

When markets are illiquid and moving slowly, it can take a while to receive your original loaned amount back. This isn’t the case for all platforms, with some providing rapid access to funds. Before selecting a platform, you should assess their withdrawal and repayment terms.

Margin Calls on Collateral

As discussed, cryptocurrency and decentralized markets are volatile. On occasion, the value of the collateral put up by the borrower could fall drastically. If this happens, the borrower will need to provide additional funds or collateral. If they do not, they risk liquidation, and the lender will not recoup the loan value.

How To Lend Crypto

If you’re looking to become a crypto lender, the process is relatively straightforward. Before proceeding, research a range of providers to find the best crypto lending platform for you.

Then, sign up to the platform, select the crypto it supports, and transfer the funds.

From there, the platform will do the work of finding a borrower or putting the crypto to work for themselves. When researching, be sure to check if the platform pays interest in kind.

How To Borrow Crypto

To get a crypto loan, you need to sign up for a relevant centralized or decentralized crypto lending platform. Upon applying for a loan, you need to put up accepted collateral against the value of the loan.

Once the application is accepted, you will then need to transfer the collateral into the digital wallet of the crypto lending platform.

Crypto Lending Summarized

Overall, crypto lending doesn’t differ much from the borrowing and lending of fiat currency. However, with unstable markets and unregulated platforms, it can be a risky move.

If done through a reputable platform, lending cryptocurrency can be a simplistic way to generate a passive income from your investment, but unfulfilled repayments and defaulting can be a problem.

It’s imperative to assess loan repayment terms, collateral accepted, and how easy it will be to get your crypto returned with interest. Furthermore, for added security, be sure to opt for collateral-backed lending options. Otherwise, you run the risk of being completely out-of-pocket, with no way of recouping any lost crypto.

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