In a universe with over 1.7 billion unbanked people, crypto arose to offer a seamless, more user-friendly way of banking. Cryptocurrency lending has emerged as a significant component of the decentralized finance (DeFi) ecosystem. As of September 2023, the total crypto lending market size is estimated at around $40-50 billion, showcasing its substantial role in the broader cryptocurrency landscape. But what is crypto lending?
What is Cryptocurrency Lending?
Crypto lending involves the lending of virtual assets. It is a child of the DeFI universe, where investors borrow and lend their crypto assets. Here, participants borrow and lend using digital currencies.
In essence, crypto lending echoes the tenets of traditional lending, where lenders loan out their assets and earn interest in the process. This concept takes two main shapes:
- Crypto asset deposits
- Cryptocurrency loans
Crypto asset deposits take the shape of a savings account in a bank. Here, the lender is depositing assets into the crypto lending platform. The assets help enhance the platform’s lending, borrowing, and other investments. On the contrary, Crypto loans demand the borrower to deposit some collateral, 100% or more, before accessing the loan. It leverages a principle called over-collateralization.
In 2021, average crypto lending interest rates were around 8-10% APY for major coins like Bitcoin and Ethereum. However, as of 2023, rates have generally lowered to 3-6% APY, reflecting the market’s maturation and increased competition.
Like traditional loans, interests vary depending on the platform used. But, in general, crypto loans are short-term.
How Does Crypto Lending Work?
Unquestionably, the mechanism of crypto lending blends traditional banking fundamentals with new blockchain tech. The lending platforms act like banks/intermediaries, connecting borrowers and lenders.
This procedure encompasses the following stages:
- A lender begins by depositing their assets into a lending account. The drive? Good interests.
- Meanwhile, a prospective borrower adds collateral, calculated on a Loan-to-Value (LTV) ratio.
- The lender gives out the loan through the smart contract-based platform.
- The borrower received the loan.
- Repayment occurs, with the borrower paying the loan amount plus interest.
- If the borrower fails to repay, they lose collateral, whose value is typically higher.
In essence, the backbone of crypto lending is smart contracts. These contracts automate lending and borrowing while bolstering trust and security. Other platforms entice lenders to lock their crypto assets for some time with higher rates. This not only incentivizes long-term investment but also ensures a steady supply of assets available for lending.
Loan-to-value ratios for crypto-backed loans typically range from 25-50%, requiring significant over-collateralization. This practice helps mitigate risks associated with the volatile nature of cryptocurrency values.
Types of Crypto Loans
There are several types of crypto loans today. Among them include:
- Collateralized loans — In the financial world, Collateralized loans are most popular. The borrower adds some collateral for the borrowed amounts.
- Uncollateralized loans — Loans with zero collateral. However, they require more KYC to protect the lenders
- Crypto line of Credit — A crypto line of credit is a type of loan where a user can borrow a certain amount of already deposited collateral.
- Flash loans are instant, short-term loans whose borrowing and repayment both occur in one transaction.
Is Crypto Lending Safe?
Safety is always a key consideration when making any financial decision. While crypto platforms have been implementing proper security measures in modern years, there are still risks associated with these platforms.
If there’s one thing we learned from crypto in 2022, it is that there are still huge risks. The crypto world is very far from attaining true safety.
Even crypto lending possesses some risks to its users and entities in general. Among them include:
- Lacking legal clarity — There’s still a large lack of regulatory clarity surrounding crypto and lending platforms. Even worse, FTX’s fall in 2022 led to an even deeper regulatory attack on crypto platforms.
- Insolvency risk – The demise of Celsius and BlockFi after the death of FTX exposed another risk investors need to know: insolvency. If the lending platform goes bankrupt, there is a high chance that you will lose funds
- Volatility risk – The realm of cryptocurrency is known by one key feature: volatility. This volatility means the cryptos used as collateral can lose value, leading to margin risks.
What Are The Benefits of Crypto Lending?
Despite the large risk count associated with lending cryptocurrencies, crypto lending has some major benefits. What are they?
Passive Income Earning
The dawn of crypto brought with it a world of income-earning opportunities. By depositing your cryptos in a lending network, you take advantage of the passive income in the form of interest.
Flexible Loan Terms
In traditional lending, the loan terms are always pre-determined by the institution. All borrowers must adhere to the interest rates and loan repayment system. In this ultra-modern blockchain universe, loan terms vary depending on the platform and agreements between borrowers and lenders.
Competitive rates
Lenders stand a good opportunity to make money in the vast world of crypto, which offers highly competitive rates for users. In some accounts, the lenders can earn interest, hitting highs of 14% APY.
Low Entry Barriers
Borrowing in traditional systems requires a lot of investment, time and even paperwork. Everything can be completed in minutes with a few clicks of buttons in crypto lending.
More Private
Traditional lending mostly involves going to long queues in banking institutions, exposed to everyone. What if you can just do that with your phone? That’s the perk of crypto lending.
Is There a Future for Crypto Lending
Although the crypto lending realm seems fraught with risks, the benefits outweigh the risks. The setbacks encountered in 2022 are mere hurdles in the long-distance race that is crypto.
The crypto universe is growing at an exponential rate. Yet, even with the growth, there’s still a lot of market to cover. Billions of people are yet to invest in crypto. This means the market is ripe for the taking. As such, the future remains bright for crypto lending.
Lending and borrowing in crypto involves users loaning out their cryptocurrency to earn interest, while others borrow crypto assets by providing collateral. This process is typically facilitated through decentralized finance (DeFi) platforms, allowing for peer-to-peer transactions without traditional intermediaries.
Crypto lending works by allowing users to deposit their cryptocurrency into a lending platform. The platform then lends out these funds to borrowers, who provide collateral. Lenders earn interest on their deposited crypto, while borrowers gain access to funds without selling their assets.
To borrow crypto on lending platforms, first choose a platform and create an account. Then, deposit collateral (usually another cryptocurrency) and select the amount you wish to borrow. Review the terms, including interest rate and repayment period, before confirming the transaction to receive your borrowed funds.