Crypto Lending Explained
Cryptocurrency enthusiasts are often encouraged to “HODL” their assets — keeping them safe in a wallet until the price of their chosen currency rises to the price they want. But just as you would be uncomfortable letting your cash sit in a bank with low-interest rates, a corresponding question is this: how can you increase the value of your digital currency?
This is where Crypto Lending comes in. Not only can it allow those who have the coins and lend to receive interest on their Bitcoin stock, but it also allows borrowers to use the value of their digital assets, using them as collateral for a loan, without having to sell them.
Analysis of Crypto Lending
During any investment, one of the biggest challenges can be cash flow — and there is nothing worse than having to use the capital you have committed to investments for short-term costs and due to a lack of liquidity.
Let’s say Steve has 2 BTC. He does not want to sell any of them because he is sure that their price will rise significantly. Steve is also concerned that if he ends up selling his BTC, he risks ending up with fewer Bitcoins when he buys back later.
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Crypto Lending platforms can help here. Usually, Steve will have the opportunity to use his Bitcoin as collateral — and get a loan in some stablecoin. Due to the volatility of digital currencies, it will normally have to “overcollateralize”, meaning it will have to lock up more BTC than the total value of the money it will receive.
Once he pays back his loan, plus interest, his cryptocurrency will be returned in full — and he’ll also make a nice profit if BTC ends up rising in price as he predicted. His cryptocurrency would only be at risk if he defaulted on the terms of the loan or if the value of the Bitcoin he had put up as collateral fell below the value of the loan he received.
Changing Entrepreneurship and Decentralized Investing
Crypto Lending started to gain popularity right when the economies came to a standstill in 2020 due to the pandemic. This resulted in interest rates falling and subprime lending declining. Many people have been looking for other ways to make their assets work for them and bring them profits. Crypto loans have become a quick and easy way to access fiat currencies almost instantly without having to sell your crypto.
Unlike personal loans or credit cards, secured loans are much safer for the lender, which allows the borrower to take advantage of cheap interest rates.
Cryptocurrencies can fluctuate widely in their prices, which is why these loans are almost always overcollateralized. This provides security for the lender in case the price of the cryptocurrency falls. However, this can negatively affect the borrower — especially if the platform they use requires them to always maintain their loan-to-value (LTV) ratio.
One of the major bonuses that many people see in a cryptocurrency loan is that, unlike traditional banking, it will not be subject to an assessment of your credit profile. That means lending is more accessible to people with no financial history, unbanked consumers and self-employed workers who struggle to get a loan because their fluctuating earnings don’t meet a bank’s strict lending criteria. Repayments can also be more flexible.
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And while loans can take several days to clear in the traditional financial world, cryptocurrency loans can be practically instant. Users can also switch between cryptocurrencies, so you can for example deposit Ethereum and borrow Tether, all on the same platform.
How to get a cryptocurrency loan?
If you like the idea of a cryptocurrency loan but aren’t sure where to start, you have two main options — centralized and decentralized lending platforms.
Centralized ecosystems such as BlockFi, Nexo, Coinbase and Binance must follow certain rules and procedures to be compliant with the legal and regulatory framework. You should create an account on your chosen platform and follow the “Know Your Customer (KYC)” procedures in place to prevent fraud and money laundering.
These platforms usually have protocols in place to ensure your collateral is safe. Some protect your cryptocurrencies with insurance or keep most of them in cold storage, which means that where they are stored there is no internet connection.
Centralized cryptocurrency lending platforms will still record all your deposits and withdrawals using blockchain technology, which is visible to everyone, and offer a great way to earn interest on Bitcoin or many other cryptocurrencies or even stablecoins like USDC, USDT and DAI. To be more precise, the best interest rates on a savings account for the dollar are just over 1% APY (Annual Percentage Yield, or simply annual interest rate), but many platforms offer up to 8% APY on interest rates of cryptocurrencies. It pays to do your research to find the best deal — and avoid paying more than usual.
There is more bureaucracy and more paperwork required to get a loan through a CeFi platform, but the fact that there is a regulated environment — and a customer service representative who is just a click or phone call away — could make these platforms more attractive to traditional investors.
The second option for crypto lending would be to use a decentralized platform, known as DeFi for short.
Cryptocurrency loans without collateral
Unsecured crypto loans, also known as crypto loans without collateral, are innovative new financial services that provide short-term liquidity and can be repaid in fiat or cryptocurrencies. The idea is to borrow funds directly from a lender using cryptocurrency as collateral instead of traditional assets like real estate and gold. If you are interested in an unsecured cryptocurrency loan or an unsecured cryptocurrency loan, there are several platforms that make it possible. For example, flash loans are a popular example of an unsecured cryptocurrency loan, but they require a high level of cryptocurrency knowledge to explore this space.
Before you go ahead with any unsecured cryptocurrency loans, make sure you do your own research and make sure the platform you want to use is legitimate.
What is DeFi Lending?
DeFi Lending platforms are completely decentralized and transactions are managed by the code and not by some people. In services such as Aave, Compound, and dYdX, smart contracts use algorithms and protocols to automate loan payments.
Anyone can access the protocols on a decentralized funding platform, which makes them completely transparent, as nothing can be hidden on the blockchain. Unlike CeFi platforms, there is no middleman or financial regulator, which means you don’t need to go through a verification process like KYC to use the platform. However, DeFi interest rates for a cryptocurrency loan are often less compared to what centralized platforms can provide.
Getting a BTC or ETH loan — or any other type of cryptocurrency loan on a DeFi platform — is very quick, as you won’t have to go through any kind of screening. Thanks to smart contracts, all a user needs to do is apply for the loan and then send the cryptocurrency they want to use as collateral to a specific wallet associated with the lending platform.
Users of decentralized lending platforms can apply for a loan of any size without having to confirm their identity to a third party. Loans can be made in stablecoins such as USDC or USDT, in fiat currencies or in cryptocurrencies such as Ethereum or Bitcoin.
Conclusion
In many centralized and decentralized lending platforms, you will have the option to open a savings account using your cryptocurrencies, as well as trade tokens or even get a loan.
With both (Centralized and Decentralized) of these types of lending platforms still in their early stages, it’s clear that this is an exciting space that will be our focus in the future. There is a lot of room for growth and the ability to access lending without the usual processes could be a huge change, a game changer, both for people and the financial services industry.
Do you need help about crypto lending? Contact Enkronos team today.
