You would be familiar with the concept of money lending in a traditional setup. A bank loans you money, and you pay interest on the same to the bank. We can also take a different example; you have an empty apartment and want to cash it temporarily. The ideal solution is to lend the apartment on lease to someone and receive monthly rent.
These were easy to comprehend, correct? Well, crypto lending is a similar concept. We can replace the ‘money’ and ‘apartment’ in the above examples with crypto to define crypto lending.
This article aims to solve all the doubts and questions you have on crypto lending, how it works, and how you can enter this space. So, let’s get started!
What Is Crypto Lending?
Crypto lending is a breakthrough in digital lending and digital asset industries. In crypto lending, you can lend your crypto to another individual and get interest payments on the same. It provides utility to your crypto assets as you receive cash in return.
Crypto lending is, however, not controlled by a single authority such as a central bank. CeFi or DeFi platforms have that authority in this space.
You can expect an interest return of around 1% to 20% per annum on crypto lending. Though the ultimate interest return depends on the kind of crypto lending platform you choose.
Crypto lending, if done on DeFi exchanges, does not have any intermediary; all the agreements over repayments, expenses, maturity, etc., are done using smart contracts. If you are on the other end of the spectrum and taking a crypto loan, know that you are liable to park sizable collateral in exchange.
Because crypto loans do not have any regulatory authority and omit Know-Your-Customer (KYC) requirements, the probability of default exists. Thus, by requiring collateral, exchanges safeguard the interests of lenders. If you miss payments, you lose your collateral, which can be cash or other cryptos like Bitcoin.
While there is a need to provide collateral for crypto borrowing, a benefit for borrowers is that they can undertake leverage trading using the borrowed cryptos. Leverage allows traders to trade more than their real financial capacity or, in other words, allows traders to trade on borrowed financial capacity. Leverage allows borrowers to widen their position and earn significant profits.
How Does Crypto Lending Work?
As mentioned, there are two ways to undertake crypto lending: Centralised Finance (CeFi) Exchanges or Decentralized Finance (DeFi) Exchanges.
Crypto lending on CeFi platforms
Coinbase, BlockFi etc., are examples of CeFi platforms. If you want to avail a crypto loan from these platforms, you need to undertake a simple KYC procedure and an active account on these platforms.
See the snapshot below of Binance:
As you can see, if you want to borrow 1 Bitcoin, you need to provide around 108 BNB in collateral along with paying interest at 0.0062%. You have different tenures to borrow Bitcoin ranging from 7 days to 6 months.
You can find details on available cryptos for lending on the website of your preferred platform.
From the snapshot, if you are wondering what is Loan-to-Value or LTV ratio, here is the answer. LTV is the percentage of your collateral that you can avail as loan.
As you can see, it is 65% in this case. This means against 108 BNB coins that you have put as collateral, you can take a crypto loan for 70.2 BNB. The LTV ratio varies on different exchanges in addition to which coin you are proceeding with as collaterals.
Crypto lending on DeFi exchange
Crypto lending done on DeFi exchange is quite risky as it does not have any document requirements from borrowers. Some examples of these exchanges are Compound, MakerDAO, AAVE, etc. DeFi platforms perform crypto lending using smart contracts. There is no third party involved, and your tokens are under your custody. You can know your eligibility for the loan almost immediately using these platforms.
However, due to its risky nature, DeFi exchanges often require borrowers to overcollateralize their position by a minimum of 110%. The rate of interest also depends on the demand and supply rules in most cases.
You should know that crypto lending on DeFi exchanges is less safe compared to CeFi exchanges.
What Are the Types of Crypto Loans?
There are four types of crypto loans.
1. Collateralized loans
This route of crypto lending requires you to put collateral in terms of other cryptos to avail the loan. If you pledge higher collaterals and if the LTV ratio is low, you pay fewer interest payments.
2. Uncollateralized loans
In order to get a crypto loan in this manner, you have to provide certain information via KYC to prove your creditworthiness. You may also need to go through verification. This gives security to the lender in case you default. However, this is not a popular crypto loan type.
3. Line of credit (LoC)
This is very similar to you taking a LoC from a bank. In a line of credit, you deposit your collateral, against which the exchange allows you to borrow a certain percentage. You do not have any repayment schedule, but you do pay interest on your borrowed money.
4. Flash loans
Flash loans are typically taken to take advantage of arbitration. Arbitration means benefitting from the different rates of the same crypto on different markets. If the price of Bitcoin is lower in one market, you can buy it from there and sell it on another market where it has a higher value. The difference in price does not last for long; thus, the loan transactions, including disbursal and payback, are done in a single go. Because of the speedy loan procedure, these types of loans are called flash loans.
What Are the Benefits of Crypto Lending?
Here are a few benefits of crypto lending.
1. Lower interest rate
If you are a borrower, the rates on crypto lending are pretty competitive with other traditional loans like mortgages or personal loans. In some cases, you pay less money in interest payments in a crypto loan.
2. Quick cash
If you are lending cryptos, you are likely to earn passive income quite rapidly with lower maturity periods, such as seven days or fourteen days. On the other hand, if you are a borrower, your loan disbursal is also relatively quick. You also have the option to choose the currency in which you wish to receive the crypto loan.
3. No KYC in the case of DeFi loans
While CeFi loans may require you to provide data on KYC, DeFi loans are completely permissionless. You get the loan approval and disbursal within minutes. There is no need for a credit check, and there are no biases based on gender, race, religion, etc., to opt for a loan.
What Are the Risks of Crypto Lending?
With an array of advantages, you need to be aware of the risks involved in crypto lending.
1. Higher collateral requirement
This is a bummer for many borrowers as the collateral requirements are very high in crypto lending to protect the interest of lenders. In many cases, it is more than 100% of the borrowed value.
2. Fund disbursal depends on the crypto platform
With crypto lending, disbursals of funds are almost immediate; however, the ultimate discretion over providing access to use funds is with the crypto platform you are using. There are chances that you may not get the money as expected, and that can impact your staked capital as you can’t complete a trade on time and withdraw it as per your schedule.
3. The legitimacy of crypto platforms
This is a major risk of crypto lending. If the platform you have borrowed money from is not legitimate, you may fall into the traps of Ponzi schemes. If you are a lender, you will lose money, and if you are a borrower, you will lose your collateral.
4. Prone to hacking
Crypto lending is done entirely online, and the data and cash are also transferred virtually, which makes it prone to hacking. Thus, it is a must that you check that the crypto platform you choose is renowned to at least reduce the chances of spurious activities.
How Can I Get Started with Crypto Lending?
If you want to get a crypto loan, here is what you can do.
- Select a platform of your choice. Make sure it is credible.
- Check the available cryptos for borrowing and whether your choice of crypto is available or not.
- Check for the annual returns and interest rates.
- Gauge the idea of how much collateral you will have to put.
- Check the LTV ratio and whether it is reasonable or not.
- Fill in your details and opt for a crypto loan.
That’s all you need to do to get started with crypto lending.
If you want to lend your crypto, you need to open an account with a platform that enables that and deposit the cryptos and additional funds. Once approved, you will start receiving interest payments. It is similar to depositing money in a bank savings account and earning interest.
What Are the Different Types of Crypto Lending Platforms?
There are two types of crypto lending platforms.
1. CeFi lending platforms
These platforms are secure compared to DeFi platforms as they have KYC requirements. You provide collateral to borrow cryptos on this platform. BlockFi and Coinbase are CeFi crypto lending platforms.
2. DeFi lending platforms
These lending platforms are completely permissionless. There is no need for KYC. However, you have to overcollateralize your assets here to get a loan. AAVE and MakerDAO are examples of DeFi lending platforms.
What Are the Different Ways to Make Money with Crypto Lending?
If you are lending your cryptos, you make money in terms of interest payments. The interest rate can be up to 17-18% which is relatively higher compared to banks and other financial institutions. Additionally, you can reinvest your interest income in other assets to make more money out of it.
What Are the Interest Rates on Crypto Loans?
The interest rates on crypto loans vary based on the lending platform. You may get around 3 to 8% interest on crypto coins like Ethereum or Bitcoin, while interest on Stablecoins like Tether or USDCoin can be around 10-18%. The ultimate rate depends on which cryptocurrency you are borrowing and from which platform.
What Are the Terms of Crypto Loans?
Again, the terms of a crypto loan depend on the platform you have selected. Some of the standard terms can be 7, 14, 30, 90, and 180 days.
Crypto lending is a great way to make use of your investments and earn some additional cash. It helps lenders and borrowers to match and satisfy their requirements of interest income and funds, respectively. However, you should note that the cryptocurrency space is not as regulated as equity or fixed income markets. Thus, you should research well before lending or borrowing money on any platform to avoid falling for scams. Other than that, crypto lending is truly a great innovation in the digital asset lending industry, which is likely to go a long way in the coming years.
1. Is crypto lending profitable?
Yes, crypto lending can be profitable as you earn interest income for lending cryptos. However, the rate of profit depends on which crypto you have lent on which platform. For example, leading stablecoins in Mudrex Vault can earn you up to 10%, while the same earns you 9.25% on BlockFi.
2. What happens if you don’t pay back a crypto loan?
In case you fail to pay back your crypto loan, the collateral you have pledged would be debited from your wallet to compensate the lender for their losses. This is not an ideal situation to be in, so do not miss out on your repayments.
3. Can I get a crypto loan without collateral?
Yes, you can get a loan without collateral via uncollateralized crypto loans. However, these loans are not very favorable as you have to give documents to verify your identity, go through a credit check, and meet other requirements. Uncollateralized loans are similar to personal loans and thus do not benefit much.
4. What is the difference between lending and staking?
Crypto lending refers to lending cryptos to borrowers and earning interest income on the same. While crypto staking is a mechanism used by blockchain networks to select a validator based on their stake in the network and reward them for verifying transactions.