The borrower and the lender are two different actors in cryptocurrency lending transactions. A borrower must deposit cryptocurrencies as collateral to secure a loan from a lender.
The COVID-19 pandemic has adversely impacted returns on traditional investment vehicles such as stocks, gold, and real estate, driving hordes of investors to cryptocurrencies. Individual and institutional investors alike tried their luck in the sector, which delivered decent returns even during the global economic crisis that horrified many investors.
Despite an intense debate surrounding cryptocurrency, which offers a huge window for enthusiastic wealth creation and its extremely volatile forms, there is no denying the fact that the industry has grown rapidly in recent years. Stay innovative, try different ideas and break more barriers along the way. One such area is cryptocurrency lending.
What is cryptocurrency lending?
Cryptocurrency lending is an ingenious tool to get the money you need quickly as it allows you to use your cryptocurrency holdings as collateral to get secure loans. If you are wondering how to borrow cryptocurrencies, secured cryptocurrency lending is a viable solution. It allows borrowers to use their crypto assets as collateral to get a fiat loan or stablecoin.
This allows you to receive the money without having to sell your coins, use the money to achieve your goals, and then pay to take back control of your wealth. Crypto lending allows you to use digital assets you own to generate dividends by lending some or all of your holdings.
Cryptocurrency lending platforms play a key role in providing these loans. You can generally borrow up to 50% of the value of your digital assets, although some platforms allow you to borrow even more. Crypto loans generally do not have a concept like EMI and borrowers can repay if they can before the fixed term ends. As for interest rates, Celsius Network is around 4% in popular non-stablecoin cryptocurrencies.
The question of whether cryptocurrency lending is profitable depends on a number of factors. If you don’t pay your debts, you end up losing your wealth. Integral inconsistencies in crypto assets have drawn more borrowers to stablecoin loans. On Celcius Network and Nexo, stablecoin lenders can earn 8%, while on Compound Finance – a decentralized cryptocurrency lending platform – the annual lending percentage (APR) for Dai (DAI) and USD Coin (USDC) is 12% and 9%, respectively.
How does stablecoin lending work?
When it comes to interest rates, peer-to-peer (P2P) lending and lending models are heavily influenced by the supply and demand landscape. A high volume of loans coupled with a low supply of lenders means high returns for lenders. However, if the demand for crypto lending is low and the supply from lenders is high, then the interest rate for borrowers will be low to attract borrowers.
If you’re thinking about why stablecoins have high yields, this section might seem quite informative. The basic idea of supply and demand leads to the stablecoin award, which delivers double-digit annual returns. Stablecoins are still a growing industry, accounting for only 2-3% of the total cryptocurrency market cap.
On lending platforms, a significant portion of the lending supply comes from stablecoins. Many buy these coins just to lend them out on these platforms, but it’s alarmingly low compared to the supply of major cryptocurrencies. Take the case of Compound Finance, where Ether (ETH) has 50% more gross supply than DAI and USDC combined.
Compare that to demand and you’ll see that the numbers are impressive. In Compound Finance, the demand for DAI exceeds that for ETH by almost 40 times. Behind the huge demand for DAI are large institutional merchants and cryptocurrency payment processors. Institutional traders include hedge funds and market makers that use crypto lending for speculative purposes.
READ MORE: Top 10 Best Metaverse Crypto To Invest In
How does cryptocurrency lending work?
Just like a bond-based loan, a cryptocurrency-backed loan backs the digital currency. Basically, it is similar to a mortgage loan. You release your crypto assets to receive the loan and repay it in a pre-determined time. These types of loans can be obtained through a cryptocurrency lending platform or cryptocurrency exchange. While you retain ownership of the secured cryptocurrency, you waive the right to conduct digital currency transactions.
Crypto lending appears to be a viable option due to several advantages such as low-interest rates, choice of lending currency, no credit checks, fast funding, and the ability to earn passive income from your otherwise idle cryptocurrency. Also, you can borrow your own digital currencies and get high APY (over 10%) on various crypto platforms.
All cryptocurrency lending transactions have two distinct parties: the borrower and the lender. It is the borrower’s responsibility to post crypto assets as collateral to secure the loan with the lender. The arrangement works to their mutual benefit as the borrower receives an instant loan in exchange for their crypto assets, while the lenders earn interest on the amount released as a loan. If the borrower defaults, they discard the underlying crypto assets to realize their funds.
Steps of cryptocurrency lending explained
Whether you want to borrow cryptocurrency on Binance, Coinbase, or another platform, the basics remain the same.
Borrowers need to go through the following steps
- Register on the platform and apply for the amount you need
- Depending on their crypto lending rates, the platform will automatically calculate the amount of crypto needed as collateral
- Borrowers need to deposit the collateral on the platform and the apply for the loan
- The platform receives and confirms the borrower’s collateral
- When the lender approves the loan, the sum is deposited in the account of the borrower
For lenders, the steps for the loan are provided below
- Register on the platform and select a specific interest rate
- The lender offers liquid crypto funds to borrowers and receives bonds in return, which is of equal value to the loan released to the borrower
- On repayment of interest, lenders will receive additional bonds
- Upon the agreed-upon time of repayment, the lender can send back all the bonds to recover the funds
- Smart contracts facilitate the sending back of bonds and receiving crypto in exchange
Things you should know before you start cryptocurrency lending and borrowing
Cryptocurrency lending is a replication of secured fiat currency lending. When dealing with cryptocurrencies, you need to pay attention to a few factors.
- Lack of access to collateralized assets: The borrower cannot access the collateral he deposited during the period of repayment
- Margin calls: If the value of collateral drops below a certain threshold, the borrower is required to increase the holdings to access the loan
- Loan-to-value ratio: There are cases where the lender sells a part of the collateralized assets to cut the loan-to-value ratio
- Shorter repayment plans: The borrower usually has less than a year to pay back the borrowed sum
Should you borrow cryptocurrencies?
You may want to know if cryptocurrency lending is safe. Before you become active as a lender on a crypto platform, you should be well versed in the details. If you move your cryptocurrency to any lending platform, they have access to the cryptocurrency keys – not you. You only have the security issued by the smart contract. View smart contract audit standards and project history, and your team can help you make decisions.
If you start borrowing money with your eyes closed, don’t be surprised if your cryptocurrency disappears. QuadrigaCX, for example, is nothing short of a horror story. A Netflix documentary discussed the suspicious death of Gerald Cotton, founder of QuadrigaCX, the Canadian cryptocurrency exchange, and how he embezzled funds from customers. About $190 million worth of digital assets held on the exchange were lost.
In summary, you need to do your due diligence before making a call on the platform you would use to rent and borrow. Regardless of the lending platform, knowing your game and its limitations is extremely important when it comes to successful participation. A mistake can be costly, so it’s best to make the most of your exploration skills.