Blockchain has been actively disrupting and revolutionizing the traditional finance ecosystem right from payment transactions and even the investment behaviors. Especially with De-Fi (an acronym for decentralized finance) platforms offering at least 10x more interest rates than the traditional banking systems, has resulted in the spurt of institutional interest in the cryptocurrency lending ecosystem.
Crypto lending has massed a lot of attention over the last couple of years, propelling beyond the praise of niche Bitcoin fanatics and is now becoming the mainstream conversation for banking experts and institutional investors.
Let’s dive in, to understand the crypto lending ecosystem to its core
Growth Of Cryptoassets — the emerging asset class
Cryptoassets or as commonly referred a cryptocurrency was born in the year 2008 by mysterious Satoshi Nakamoto with the invention of Bitcoin attracting hardcore technologist to expand the idea. With the inception, innovation got new horizons, and new cryptocurrencies were created like Namecoin and Litecoin with Bitcoin continuing gaining popularity and recognition.
Going with the numbers, in the year 2017 Bitcoin value was US$1,000, but by the end of the year, it was worth ~ US$20,000. Stories were floating about individuals selling their houses/availing debt to buy Bitcoin and get rich. But in early 2018, we saw a decline and as I write this Bitcoin value is $10,326.73 [September 9, 2019].
Some fun facts about crypto assets
Decentralized Finance [DeFi] — A need to manage crypto assets
The idea seeded by Satoshi was accepted and applauded by brands, governments, and MNC’s and each of them started to use it to build a use case offering advantages of blockchain technology to the users. However, the bitter truth is that entire financial infrastructure hinges on the existence of an intermediary, that means everyone started building their own private distributed ledgers that take away the concept of complete decentralization.
This is where DeFi[Decentralized Finance] comes into the picture.
In an attempt to offer an independent and open financial system, in 2018, a network of 15 Ethereum based project came together. It included projects like MakerDAO, Origin Protocol, and Paradigm, followed by others like Compound and the Kyber Network. The network works of laying down guidelines for DeFi members and also started working on the project to build a service for a decentralized blockchain within the financial sector. They made sure to be aligned to core principles of Blockchain, i.e. Permissionless, Decentralized, Trustless, Transparent, Censorship Resistant, Programmable.
As of now, many projects in different form like exchanges, prediction markets, wallets, stable coins, and liquidity protocols are part of this initiative.
The DeFi space is growing with investors locking their crypto assets as collateral and taking loans, creating liquidity in the market, or mint a new asset. This has helped in measuring the value locked in the DeFi applications called as total Locked Value [TVL]. As the below graph depicts ~2.5M ether is locked in DeFi applications and investors are enjoying the new open financial products they could use to manage their crypto assets.
Firms from the globe are working on providing a platform that helps investors in managing their crypto assets. The below table shows some of the key players offering a DeFi platform and their quick comparison.
Lending — A throwback
As the market for crypto assets increases, a new financial world in need of fresh financial services were in demand. The services included payment systems, exchanges, crypto-based lending, and financing. While the integration of exchanges and payment systems is evolving and will continue to mature, lending services are allowing holders of crypto assets to generate interest income.
A unique service, which allows individuals/users[lender] to fund in multiple currencies to traders[the borrower]. The interest rate, the duration could all be decided by the individual who is funding it. In such a case, a user could earn a passive income by lending USD/cryptocurrency depending upon the trade volume and price at a given time. However, these loans are mostly self-contained on a centralized platform, making it hard for the borrowed funds to leave the platform.
Nuo.Network offers margin trade in two-simple steps with upto 3x leverage.
The arrangement works for people who have spare crypto and are not using at any time. Just lend your Bitcoin or Ether, or Altcoins agree to the smart contract and earn an interest rate for a given period. It helps users or businesses to earn extra cryptos just by lending it.
Nuo.Network, offers lending in 12 different tokens, you do not need to limit yourself to ETH or BTC, a user could use any of the 12 tokens available.
Crypto to Fiat Lending
The model works with businesses/users who are holders of cryptocurrency and in need of Cash. So the cryptocurrency like Bitcoin, Ether or Altcoin work as collateral and the user gets the cash in hand. The cash amount is usually credited to the bank account linked, the borrower needs to make monthly payments, and once the amount is fully paid the collateral is reimbursed.
Certain kind of conditions are applicable in case of Crypto to cash lending like in case if the collateral price is dropped by a specific percentage say 25–30, the lending service platform can request for more capital.
Firm offering Crypto to Cash Lending — Unchained Capital, SALT Lending
Nuo.Network offers visualization of historic and forecasted data for users easy viewing.
Credit score lending
The lending works within a specific group of a trusted network. It is a manual service that involves high levels of disclosure of personal information, and are primarily focused on small scale consumer loans.
P2P Lending and Crypto Lending — The differences
Crypto Lending — Participants, roles and the workflow
Crypto lending platforms is an open platform for borrowing and exchanging crypto assets. Let’s look at the significant participants involved in availing the services –
Participants of Crypto Lending Platform
Advantages of Crypto Lending
Involving blockchain technology into lending could make the product offerings cheaper, faster, and much more transparent to borrowers and lenders. Transactions powered by Blockchain are instantaneous and indisputable, that also comes along with — no transaction fees clause. Fundamentally, leveraging blockchain technology with peer-to-peer lending offers the following benefits –
Negligible Transaction Fees
Under the P2P lending process, when a borrower initiates the loan request, it goes to a bank/financial institution’s that charge you fees for processing, documentation, or early payment charges, that was most applicable to the borrower. If we refer to Processing charges by Banks in India, it could go up to 20000 INR, on the other hand, crypto-backed loans do not have any processing or transaction charges. Only if you are using the platform [like Nexo, Nuo Bank, Ethlend, etc.], they might be charging you with a small amount. So crypto-backed loans come with a value of money when compared to P2P loans
No Paper Work or Need of Bank Accounts
While opting for Crypto-to-Cash loan, you may need a bank account, but otherwise, there is no need for any paperwork or bank account while picking a crypto-backed loan. It also helps in targeting the individuals at the lower level of the pyramid, which is unbanked and cannot provide the required KYC documents.
No Boundaries, Loans Diversified
P2P lending mostly works in restricted geographies’; however, crypto lending could open gateways to cross-border lending, offering diversification to both lenders and borrowers. Crypto-backed loans offer an opportunity to the lending community to diversify their portfolio across different continents and countries. While lenders can take advantage of cross-country diversification, borrowers get a global pool of lenders. A win-win for both.
Risks Associated with Crypto Lending
No technology or concept is fool-proof, so while there are many advantages associated with crypto lending, there are some risks associated with it, that could be mitigated if you are an informed person. Here are some of the risks of crypto lending –
There are two kinds of platforms that connect a borrower/lender in crypto lending. First being the firms offering their software solutions, connecting lenders/borrowers and charging a small fee for the platform. On such a platform, it is crucial to know about the security aspects followed by them. Has there been a past breach? If the data was hacked? Also, it would be good to see the kind of measures provided by the firm in case of hacking. Simply know all aspects of security measures and policies offered by the platform provider to safeguard your assets from being hacked.
The other entity is the online cryptocurrency community where borrowers/lenders interact directly with each other. In such cases, as it’s an independent contract executed by the borrower and lender, there are less/negligible chances of any assistance in case of disputes of defaults or scams.
Blame it to regulation or difficulty is repaying the loan, but crypto-backed loans come with a possibility of higher defaulters when compared to peer to peer loans.
Crypto market is up and running throughout the day, so while arbitragers try to make a profit out of it. The lenders/borrowers might suffer a set back if the money repaid/borrowed has dipped throughout the day. Many investors might see a possibility of seeing an assets’ value depreciated to a point where the debtor is better off defaulting than repaying the loan.