What is crypto lending and how does it work?

The borrower and the lender are two distinct actors in the crypto lending transaction. Borrowers put up cryptocurrency as collateral to secure a loan from a lender.

The COVID-19 pandemic had a deleterious effect on the returns from the conventional instruments of investments such as stocks, gold and real estate, driving investors in hordes toward crypto. Individuals and institutionalized investors alike have tried their luck in the industry that has rolled out decent returns even during the worldwide economic slump that horrified many investors.

Despite an intense debate raging about cryptocurrency offering a great window to grow wealth with alacrity and its extremely volatile ways, there is no denying the fact the industry has grown rapidly over the last two years. It is still innovating, trying different ideas and breaking more barriers in the process. One of these areas is crypto lending.

What is crypto lending?

Crypto lending is an ingenious instrument to obtain the cash you need quickly, as it allows you to utilize your crypto holdings as security to get secure loans. If you are wondering how do I borrow crypto, collateralized crypto lending is a viable solution. It allows borrowers to use their crypto assets as collateral to get a fiat or stablecoin loan.

This enables you to get the money without having to sell your coins, use the cash to fulfill your objectives and then repay to get back the hold on your assets. Crypto loans allow you to use digital assets you hold to generate dividends by lending out part or whole of the holdings.

Crypto lending platforms play a key role in dispensing such loans. Generally, you can borrow up to 50% of the value of your digital assets, though some platforms might allow you to borrow even more. Crypto loans generally don’t have a concept like EMI and borrowers may repay when they can before the fixed term ends. As for the interest rates, it is approximately 4% on Celsius Network on popular non-stablecoin cryptocurrencies.

As for the question, is lending crypto profitable, it depends on a string of factors. If you default on your debts, you end up losing your assets. Inconsistencies integral to crypto assets have led to more takers to stablecoin lending. On Celcius Network and Nexo, stablecoin lenders can earn 8%, while on Compound Finance — a decentralized crypto lending platform — the lending annual percentage rate (APR) for Dai (DAI) and USD Coin (USDC) is 12% and 9%, respectively.

Related: What is yield farming in DeFi?

How does stablecoin lending work?

When it comes to interest rates, peer-to-peer (P2P) lending and borrowing models are closely influenced by the supply and demand scenario. A high volume of loans coupled with a low supply from lenders means high returns for lenders. However, if the demand for crypto loans is low and the supply from lenders is high, the interest rate for borrowers will be low to attract the borrowers.

If you are considering why do stablecoins have high-interest rates, this section may come across as quite informative. The principle idea of supply and demand leads to stablecoin lending, providing annual returns in double digits. Stablecoins are still a budding industry, being just 2-3% of the total crypto market capitalization.

On the lending platforms, a substantial amount of the lending supply comes from stablecoins. Many buy these coins only to lend them on these platforms, but it’s alarmingly low compared to the supply of the top cryptocurrencies. Take the case of Compound Finance, where Ether (ETH) has 50% more gross supply than DAI and USDC combined.

Contrast it with the demand and you will find the figures are staggering. On Compound Finance, the demand for DAI trumps that of ETH by nearly 40 times. Large institutional traders and cryptocurrency payment processors are behind the huge demand for DAI. Institutional traders include the hedge funds and market makers clubbing on crypto loans for speculation purposes.

How does crypto lending work?

Just like a securities-based loan, a cryptocurrency-backed loan collateralizes digital currency. Basically, it resembles a mortgage loan. You give hold of your crypto assets to get the loan and repay it over a predetermined time. These types of loans can be obtained through a crypto lending platform or a crypto exchange. Though you still retain ownership of the collateralized crypto, you forego the right to make transactions using digital coins.

Crypto loans come across as a viable option because of several advantages such as low interest rates, choice of loan currency, lack of credit check, fast funding and the ability to earn passive income on your crypto that is otherwise lying idle. Moreover, you can lend your own digital coins and receive a high APY (more than 10%) on several crypto platforms.

All crypto lending transactions have two distinct parties: the borrower and the lender. It is for the borrower to deposit crypto assets as collateral to secure the loan from the lender. The arrangement works to mutual advantage, as the borrower receives an immediate loan in return for their crypto assets while the lenders earn interest on the amount released as a loan. If the borrower defaults, they dispose of the underlying crypto assets to realize their money.

Steps of crypto lending explained 

Whether you are looking for crypto lending on Binance, Coinbase or any other platform, the basics remain the same. Borrowers have to go through the following steps.

For the lenders, the steps to lending are provided: 

Things to know before getting into crypto lending and borrowing

Crypto lending is a replication of collateralized loans in fiat. You need to be careful of a few factors when dealing in cryptocurrencies.

Related: ‘Big Time’ Margin Call Can Skyrocket Bitcoin Price in Mid-Term: Analyst

Should you lend crypto?

You may be eager to know if crypto lending is safe. Before you go active on a crypto platform as a lender, make sure you are well-versed with the specifics. When you move your crypto to any platform for lending, they hold access to the keys to the cryptocurrency — not you. You just have the bond issued by the smart contract. Check the auditing standards of the smart contract, the history of the project and its team can help you guide your decisions.

If you begin lending with your eyes closed, do not be surprised if your crypto disappears. QuadrigaCX, for instance, is nothing less than a horror story. A Netflix documentary discussed the suspicious death of Gerald Cotton, the founder of QuadrigaCX, the Canadian cryptocurrency exchange and how he misappropriated customer funds. About $190 million worth of digital assets kept on the exchange were lost.

To sum up, you need to do your due diligence before taking a call on the platform you’d be using for lending and borrowing. Regardless of the lending platform, knowing your game and limitations is extremely important when it comes to successful innings. A mistake might prove costly, so better put in the best of your exploratory skills to work.