APY Crypto Lending
What is Crypto Lending?
The advent of crypto lending was a crucial breakthrough in DeFi. Lenders could suddenly generate passive yields from formerly illiquid assets. Borrowers could immediately receive cash for their crypto without triggering any tax events.
As a result of crypto lending, almost every cryptocurrency now has far more utility, and therefore value, than it did before.
Crypto lending involves one party lending cryptocurrency to another party in exchange for interest payments. At its core, crypto lending works similarly to traditional lending: someone needs more cash than they have on hand, and someone else (usually a bank) lends them this money and charges interest. There are, however, a number of important differences.
For instance, crypto loans are not handled by banks. Instead, CeFi exchanges, like Binance, or decentralized finance (DeFi) protocols like APY let us borrow or lend out our crypto in return for interest. The interest rates typically range between 10–50% APY/APR and will vary according to whether you use a DeFi or CeFi platform.
Your typical crypto loan doesn’t require any formal intermediary to manage the loan. Instead, smart contracts automate the entire process, including the repayment timescale and costs, both of which are agreed upon in advance. Another difference is that lending your crypto doesn’t require registration with any regulator or government agency. This lets you lend to, or borrow from, anyone with a Web3 wallet regardless of where they live.
What’s the point of Crypto Lending?
The underlying value of crypto assets may increase or decrease, but sitting idle in wallets doesn’t accrue any interest. Just holding a particular cryptocurrency won’t make any earning. It is the situation where Defi loans come into the picture. Defi loans enable users to lend their crypto to someone else and earn interest on the loan. Banks always have been utilizing this service to the fullest. Now, in the world of Defi, anyone can become a lender. A lender can loan their assets to others and will be able to generate interests on that loan. This process can be done through lending pools, the loan offices of traditional banks.
Users can pool their assets and distribute them to borrowers using smart contracts. There are various ways to distribute interests to investors; hence it is recommended and worth investing some time to research to identify your interest type. The same goes for borrowers, as each pool will have a different approach on how to borrow.
While taking a loan from a bank, collateral is required that is associated with that loan. For example, for a car loan, the car itself is collateral. When the user stops paying the loan, the bank will seize the vehicle. The same goes with the decentralized system; only the difference is that the system is anonymous and doesn’t involve any physical property used as collateral. To get a loan, the borrower needs to offer something more valuable than the loan amount. Smart contracts are used to deposit this amount of currency of at least equal value to the loan amount. Collaterals are available in wide varieties; any crypto token can be used to exchange borrowed cryptocurrency. For example, if a user needs to borrow one bitcoin, he’d need to deposit the price of one bitcoin in DAI.
Furthermore, the prices of Bitcoins keep swinging wildly. A case may arise when the cost of collateral drops below the price of the loan. Now, here the question arises, How to deal with this situation? An example could explain it better. Let’s say a user wants to borrow 100 DAI. MakerDAO requires borrowers to collateralize their loans at a minimum of 150% of the loan value. This straight away means that the borrower needs to collateralize the loan with $150 in ETH. And when the value of collateral reduces below $150 ETH, it becomes subject to a liquidation penalty.
How does Decentralized Crypto Lending Work?
Decentralized lending is available through numerous DeFi platforms. When using DeFi, there’s no third party actively managing the lending process; only smart contracts that pay out loans and liquidate collateral automatically. This means you keep custody of your tokens at all times, which some argue is safer than handing them over to a CeFi exchange. Smart contracts also approve or deny loans near-instantly as well, as there’s no need for a human to rubber stamp loans one by one.
DeFi lending is entirely permissionless (unlike CeFi lending) which means there’s no KYC verification to lend or borrow crypto. This makes DeFi protocols comparatively more open than their CeFi counterparts, as anyone with an internet connection can partake. They’re also trustless, in that you don’t need to trust people to run the service as expected; you (or a knowledgeable expert) can manually audit its code before you commit any funds.
What are the benefits that Defi Lending provides to its users?
- Improved loan origination speed
Digitally-enabled lending processes have the most significant advantage of fast processing speed. Defi lending platforms are backed by cloud-based services, analytics for fraud identification and detection and machine learning calculations for optimum loan terms and risk factors. All these technologies eventually help to speed up the process. As soon as the loan is approved, lenders send offers via e-contracts. - Greater consistency in lending decisions
Rules describing credit policies guarantee consistency in lending decisions. Variations in evaluating applicant attributes and structuring deals by underwriters are eliminated. - Compliance with Federal, State and Local regulations
Decision rules provide a record of who, when and where the rules were used and which rules were in effect. It plays the role of evidence and ensures that the lender complies with federal, state and local regulations. - Analytics for process improvement and portfolio profitability
Analytics can help lenders and borrowers get the most out of the digital lending process. Monitoring loan applications over a particular duration (a week, month or year) can help lenders anticipate and allocate proper resources to accommodate seasonal demands. Analytics also provides insights into demographics, loan sources, credit tiers, etc. The portfolio can be improved by determining how borrower characteristics and credit policies affect loan performance. - Permissionless
Defi lending allows open, permissionless access, meaning anyone with a crypto wallet can access Defi applications built on Blockchain, regardless of their geographical location and without any minimum amount of funds required. - Transparency
The public Blockchain broadcasts every transaction on the network and is verified by every user on the network. This transparency level around transactions allows for rich data analysis and ensures verified access to every user on the network. - Immutability
Blockchain’s decentralized architecture ensures tamper-proof data co-ordination and increases security and auditability. - Programmability
Smart contracts are highly programmable, automate execution and enable the development of new digital assets and financial instruments. - Interoperability
The use of an interconnected software stack ensures that Defi protocols and applications integrate and complement one another. - Self-custody
The use of Web3 wallets ensures that Defi market participants keep strong custody of their assets and control their data.
Is Crypto Lending Safe?
For the most part, yes, crypto lending is safe because your money is lent out through smart contracts. These contracts are publicly auditable and verifiably secure; or at least as safe as the platform providing them. And whenever you lend out crypto, your funds are protected by the high collateral requirements.
Conclusion
This detailed discussion shows that Defi lending has a high potential to reshape the entire financial system. It attempts to decentralize the core traditional finance services like payments, trading, investments, insurance, lending and borrowing. Defi lending being involved with the intriguing technology truly has vast opportunities to revolutionize the global financial landscape.
