Crypto lending has made it possible for many people to take affordable loans at a low-interest rate which they can return at flexible terms. This is way simpler and quicker when compared to traditional bank loans.
Crypto lending is one of the biggest breakthroughs in the decentralized finance industry. Assets that were illiquid can now be used by lenders to generate passive income quickly. On the other hand, people can easily borrow more cryptocurrency with their existing cryptocurrency in the form of loans without going through many extra steps.
With the invention of crypto lending, cryptocurrencies can now enjoy better functionality and liquidity.
Understanding Crypto Lending
Crypto lending works exactly like any other type of lending. The lender lends his cryptocurrency to the borrower in exchange for a specified interest. If a person needs more money than they have in their hand, they can ask a lender to give them the money.
The lender will then impose an interest on the money and charge the borrower a specific percentage according to the specified terms in the deal. However, there are certain key differences between lending money and lending cryptocurrency.
When you have to apply for a cryptocurrency loan, you do not have to visit a bank. Borrowing cryptocurrency is an automated process that is carried out by certain protocols like the DeFi protocol AAVE or CeFi protocols.
The interest rate on your cryptocurrency loan will depend on the type of protocol you use when borrowing the cryptocurrency and the terms and conditions of the cryptocurrency exchange you are borrowing from. On average, there is about 1 to 10% interest on cryptocurrency loans.
No Intermediaries
One of the biggest differences between cryptocurrency loans and regular loans is that crypto loans don’t involve any intermediaries, such as banks.
In crypto loans, smart contracts are used to set the terms of the loan, set the repayment timescale, and fix the amount of interest as well. This filters out the need to involve any regulator or a third party as well. All you need is a Web3 wallet, and you can use it to easily access the loan.
Collateral Requirements
Crypto loans have different terms and conditions when it comes to collateral requirements.
In the case of a cryptocurrency loan, the borrower has to put up a way bigger collateral as compared to a regular loan.
This is primarily because the lender doesn’t have to go through the whole Know Your Customer (KYC) process in order to get access to the borrowed crypto.
Since you don’t need any permissions to apply for a crypto loan, lenders have to take your collateral as a guarantee that you won’t run away without paying the loan back.
This brings us to a big question. Why would someone with more cryptocurrency take out a small amount as a loan? In some cases, even accounts with higher amounts can get rejected for a loan. So, what’s the benefit of crypto lending?
One of the key benefits of crypto lending is that cryptocurrency owners can earn very high interest on their stagnant crypto assets. Depending on the type of crypto a lender has and various other factors, they can earn interest ranging from 1% all the way up to 20%.
These interest rates are very high when compared to normal interest rates offered by banks around the globe. These interest rates start at just 0.1% per annum.
However, there might be various reasons for a person to lend cryptocurrency.
Releasing Liquidity
Releasing liquidity is one of the biggest reasons why people borrow lots of cryptocurrencies. If a person has lots of cryptocurrency in his crypto wallet, they can benefit from booming crypto markets. While they can continue benefiting in the form of cryptocurrency, as soon as they sell anything, they will have to pay taxes.
However, if the same person uses their cryptocurrency as collateral on a new crypto loan, they can easily have cash in their pocket without paying any taxes and without giving up on any future price hikes for their cryptocurrency.
After taking the loan, if the cryptocurrency market goes down, the borrower can let their cryptocurrency liquidate without repaying the loan. On the other hand, if the crypto market rises after the borrower takes out the loan, they can buy their cryptocurrency back at a price lower than the current market price and resell it to make more profit.
Margin Trading
Whenever you have to trade cryptocurrency, you can choose the margin trading option to borrow cryptocurrency from the exchange instead of using your own cryptocurrency.
In order to make this work, you will have to use your cryptocurrency as collateral to take out a loan, then use that loan to buy more collateral and add it to the loan.
You can continue doing this until there is no more cryptocurrency for you to borrow. This way, you can temporarily increase your portfolio and hugely benefit from the rapidly appreciating crypto market.
Although margin trading can provide you with extra profit, it is still considered as one of the riskiest types of trading in the cryptocurrency world. Whenever the market goes down, your collateral is rapidly liquidated to save the lender from any loss. Because of the nature of margin trading, you will be left with nothing. So, do margin trading only if you can live without your cryptocurrency.
Flash Loans
Flash loans are another reason why people borrow cryptocurrency in huge amounts. Flash loans basically let you borrow a large amount of cryptocurrency without putting up any collateral, but the loan has to be within one block.
People mostly use flash loans to instantly avail arbitrage opportunities. These opportunities arise when different cryptocurrency exchanges have different prices for the same cryptocurrency.
However, if you take a flash loan and fail to repay it before the block is validated, the whole transaction will vanish from the blockchain as it never happened in the first place. Since taking out flash loans is a very technical and lengthy process, and arbitrage opportunities do not arise every day, many people never even feel the need to take out flash loans.
So, despite the high collateral requirement in cryptocurrency loans, there are various reasons why people feel the need to take out these loans.
Moreover, you should understand how DeFi and CeFi platforms are very different from each other, although they aim for the same results. You should develop a thorough understanding of the whole process, no matter whether you are a borrower or a lender.
Crypto Lending through CeFi Platforms
In general, CeFi lending platforms require you to satisfy some additional requirements which are not needed by DeFi platforms.
If you want to take out a cryptocurrency loan through a centralized finance lending platform, you will first have to create an account with a cryptocurrency exchange that offers crypto lending services. After that, you will have to go through the KYC or Know Your Customer verification process. You’ll have to submit your personal details just like you would when taking out a regular loan through a bank.
After creating your account with the respective CeFi platform, you can go to their crypto lending page to explore the rates they offer. The name of the crypto lending page can vary depending on the platform you use.
For example, in the case of Binance, the crypto lending page is named “Crypto Loans.”
For Borrowers
If you are interested in borrowing some cryptocurrency from your cryptocurrency exchange, you can use the input fields to learn how much collateral you will need for the amount of cryptocurrency you want to borrow and the interest rate applicable on that loan.
Depending on the amount of collateral you put up and the repayment time frame, the interest rate will vary.
If you consider yourself eligible for the loan, you can request the loan, and the platform will review your application before letting you borrow the desired amount. Once the platform verifies your collateral and approves the loan, the borrowed cryptocurrency will be available in your crypto wallet.
For Lenders
If you are a lender, you will have to go through a different process when lending your money through centralized finance platforms. You cannot choose whom you want to lend your money.
Rather, the platform will divide your cryptocurrency into various small parts and lend it out to different individuals. This way, you might not know anything about the people borrowing your money, but your cryptocurrency will be in safe hands.
You can bond from your platform, which mentions the total amount of cryptocurrency you’ve lent them. Once the loan period expires, you can take out the cryptocurrency along with interest.
Crypto Lending through DeFi Platforms
There are lots of decentralized finance platforms available for cryptocurrency lending. These platforms include AAVE and MakerDAO, among others.
No Third Party
In decentralized finance, there is no third party involved in the cryptocurrency lending process. Rather, there are only smart contracts that fix the rules for crypto lending, provide the borrowers with interest rates, and liquidate the collateral.
So, the cryptocurrency you use as collateral remains in your cryptocurrency wallet rather than getting transferred to a third party, just like in the case of CeFi platforms. With the help of smart contracts, these platforms can easily approve or deny loans within the blink of an eye, and there is no need for a human to evaluate the loan application.
When it comes to calculating the collateral in DeFi platforms, it comes out to be around 110%. Moreover, the interest rate on any DeFi cryptocurrency loan depends entirely on the supply and demand of cryptocurrency in the market.
MakerDAO is an exception to the rule, as the platform lets it’s investors decide the interest rate on crypto lending with their votes.
Trustless and Permissionless
When you borrow cryptocurrency from a decentralized finance platform, you do not have to go through the KYC process. This means anyone with enough collateral and a strong internet connection can take part in the process and take out a crypto loan.
Moreover, since decentralized finance platforms are open source, you can audit their code before borrowing cryptocurrency. The whole process is trustless as well, as you don’t have to rely on a person to keep running the service as expected. On the other hand, if hackers successfully break the code of a DeFi platform, none of the developers is liable for your loss as the whole thing is open source.
Advantages and Disadvantages of Crypto Lending
When you take a detailed look at DeFi and CeFi crypto lending, you will find out that both of them have their own benefits and drawbacks. No method is inherently better than the other one, and there is a reason why people choose one over the other in certain cases.
So, the best type of cryptocurrency loan is the one which suits your needs and risk-taking abilities.
Let’s take a look at some of the advantages and disadvantages of cryptocurrency lending.
Advantages
In most cases, cryptocurrency loans have lower interest rates compared to some credit cards and personal loans. However, when compared to mortgage and car loans, the interest rate you get in cryptocurrency loans is higher.
Whenever you take out a cryptocurrency loan, you are provided with various currency options to withdraw your loan. You can skip your local currency and take out the loan in any currency you want.
In most cases, cryptocurrency loans taken from decentralized finance platforms arrive in your account within a few minutes. At most, you will have your loan amount sitting in your bank account within a few hours. This helps both lenders and borrowers equally.
Lenders can easily earn high-interest rates on stagnant crypto assets, while borrowers can easily access cryptocurrency loans.
Since the whole loan process takes place on the blockchain, the complete process is perfectly transparent, and anyone can see complete details. And this way, there are almost no regulatory compliance tasks you have to complete in order to avail of the loan amount.
If you have lots of cryptocurrency sitting around, you can lend it in order to earn high-interest rates in a short amount of time.
There are no credit checks you need to pass in order to get a decentralized cryptocurrency loan. Moreover, there is no KYC verification process needed beforehand.
You won’t have to face any bias when it comes to getting approved for the loan. Rather, you will get the loan approved purely on a financial basis. There are no politics at play, and you won’t get denied for the loan because of your race, religion, or gender.
CeFi loans require you to go through the KYC process and submit some personal documents to get the loan. On the other hand, DeFi loans do not need you to go through the same process, and you can get the loan much faster if you satisfy the criteria. So, you can choose the right type of loan according to your requirements.
Disadvantages
There are some platforms that might not let you manage your funds as quickly as the other platforms. Moreover, since your collateral will be locked away for the duration of your crypto loan, your assets will become illiquid, and it can present you with many troubles if you want to quickly access your funds.
After taking the loan, if your collateral falls in value beyond a certain level, you will get a margin call from the lender. When this happens, you have to deposit more collateral within the specified time frame, or your collateral will be liquidated. After this, you will definitely lose your collateral, but you get to keep the borrowed amount.
Both centralized and decentralized lending platforms work entirely online. This makes them the biggest targets for hackers around the globe. This way, your cryptocurrency is less secure than depositing your money in a bank since no one is responsible for your financial loss if the exchange gets hacked.
Since crypto lending is being decentralized process, if you become a victim of some Ponzi scheme or scam, there will be no regulator to help you recover your cryptocurrency.
Since the collateral requirement is very high, the chances of you defaulting on your cryptocurrency loan are very high.
These were the advantages and disadvantages of cryptocurrency lending, put in simple terms. If you want to take out a crypto loan, you should weigh both the pros and cons before taking any solid step.
If you are worried about the safety of the crypto lending process, you have nothing to worry about. The process is perfectly safe for the most part. However, taking out a crypto loan is an extremely risky process since it requires a lot of your collateral to be at stake.
So, we recommend taking a crypto loan only if you can bear losing your collateral if you fail to repay the loan. Now it is up to you to make the final decision.
