What Is Crypto Lending and How Does It Work?
Crypto traders, enthusiasts, and investors often hold onto their digital assets until their prices increase so that they can sell and make a profit. Even if this is your case, it is not always better to accumulate digital currencies in your wallet. That is because their market value could fall. Therefore, consider earning interest on your investment by lending it to those who urgently need it. Did you just ask what crypto lending is and how it works? Read on to find out in this article.
What Is the Meaning of Crypto Lending?
The act of depositing Bitcoin, Ether, or any other cryptocurrency for it to be lent to borrowers in exchange for regular interest payments is what so-called crypto lending. The interest may be compounded hourly, daily, weekly, or monthly. However, what you stand to benefit from engaging in crypto lending is strongly influenced by your blockchain-based platform.
The two primary categories of cryptocurrency lending platforms are decentralised and centralised. Both of them allow users to access high-interest rates, sometimes as high as 20% annual percentage yield (APY) and often demand that borrowers place collateral before being granted access to a cryptocurrency loan. Nevertheless, it is possible to get a crypto loan without collateral.
How Does Crypto Lending Work?
Lending in cryptocurrency is carried out through platforms or exchanges that act as middlemen between lenders and borrowers. Borrowers obtain loans through the lending platform after lenders deposit their cryptocurrency into high-interest lending accounts. They set different interest rates for crypto lending and borrowing. While they can charge a fee for their services, lenders who agree to lock up their cryptocurrency for a set period of time can expect to be given better terms and conditions.
Crypto lending can be centralised or decentralised. Centralised crypto lending involves putting your faith in a company or blockchain platform to manage and streamline the loan and borrowing process. You will need to register an account with the service provider to lend and borrow crypto loans.
On the other hand, a decentralised crypto lending platform uses smart contracts to automate transactions and allows lenders and borrowers to connect their cryptocurrency wallets and do business with ease.
What are the Types of Crypto Loans?
There are basically four types of crypto loans. They are collateralised loans, uncollateralized loans, credit lines, and flash loans.
Collateralised crypto loans
Collateralized loans are the most popular type of cryptocurrency loan. They want you to deposit bitcoin that will serve as collateral for the loan. The majority of platforms demand over-collateralization, which limits how much of the deposited collateral borrowers can access (usually below a 90% loan-to-value). The interest rate and the likelihood of having your margin called are both lower when the loan-to-value (LTV) ratio goes low.
Uncollaterised crypto loans
Although less common, uncollateralized loans operate in a manner comparable to personal loans. For this type of loan to be approved, borrowers must submit a loan application, pass identity verification, and undergo a creditworthiness assessment. But since there is no collateral that may be sold off in the case of a loan default, these loans carry a more significant risk of loss for the lenders.
Crypto credit line
Similar to a conventional credit card, some services provide a cryptocurrency credit line rather than a standard loan with a defined term and duration. Users can borrow up to a specific amount of the deposited collateral using this kind of collateralized loan. However, the terms and conditions for repayment are not specified. So, users only pay interest on the money they withdraw.
Flash loans are instant loans that are acquired and returned in the same transaction, and they are frequently offered on cryptocurrency exchanges. These are very risky loans that are used mostly to benefit from market arbitrage, such as buying cryptocurrency at a cheaper price in one market and immediately selling it at a higher price in another.
How Can I Get a Crypto Loan?
You must register with a centralised lending site or link your digital wallet to a decentralised lending platform in order to apply for a cryptocurrency loan. Next, you will choose the type of loan you need, enter the amount you want to borrow, and provide the collateral that will be submitted. Then, place the required collateral in the platform's digital wallet to complete the transaction.
When all of the above has been done, the borrowed money will be sent immediately to your account or digital wallet. Note that a smart contract is typically used to lock in loan conditions, and most loans give fast approval.
Are you interested in becoming a crypto lender? Then, you must register with a lending platform, choose a compatible cryptocurrency to deposit, and fund your account. That’s all.
Interest on a centralised crypto lending platform could be paid in kind or with the platform’s token. On a decentralised exchange, bonuses are possible in addition to interest payments being made in kind.
The safety of your crypto loans depends on the lending platform you select. Compared to a conventional bank or online lender, crypto lenders provide less security against your collateral due to a lack of government regulation and control. They frequently employ private insurance, which is limited to certain types of risks.
To make money from lending your cryptocurrencies and earning high interest on your deposit, you need to go to a crypto exchange or digital platform that has a relevant lending programme. Create an account and choose a listed cryptocurrency to deposit. Then fund the account and join the lending programme. Pay attention to the terms and conditions as well as the interest rate before you sign up on the platform.
If you fail to pay a cryptocurrency loan, the lender will liquidate (or cash out) the crypto, and you will lose your collateral.
Yes, it is possible to lose your digital assets or cryptocurrency through lending. That is because most crypto lending accounts are uninsured and the market is unregulated. You could lose your deposit if the platform fails or goes bankrupt.
The sum of money you can earn from lending crypto depends on the interest rate offered by the exchange and your amount of deposit. Some lenders earn up to 25% interest on their loans.
Staking and lending are two of the various ways to make money off of cryptocurrency. But the difference between them is that staking allows you to earn rewards for pledging your crypto to a network to support their transaction verification efforts, while you can earn interest from borrowers by lending your crypto.
Crypto lending rates are very high because demand for some coins is higher than supply. Hence, lenders are charging high-interest rates to make more money from the scarcity of certain coins.
No! Crypto loans generally do not affect a borrower’s credit score. Besides, your credit report does not cover crypto transactions.
Interest earned through crypto lending may be subject to capital gains tax, but this depends on the tax regime in your country. You might want to read our post about paying taxes on crypto and NFTs.
The market for lending cryptocurrency is mostly unregulated in different parts of the world. However, the United Kingdom and some other countries are working to regulate the crypto market and prevent money laundering and terrorism financing through it.
Understanding Decentralised Finance (DeFi) Lending
A decentralised finance (DeFi) lending platform provides borrowing and lending services that are controlled by smart contracts rather than being centralised. DeFi loans are instantaneous. To link a digital wallet with a DeFi platform, you must use a decentralised app (dApps). Then you will be able to provide collateral and quickly access funds.
In DeFi lending, interest is normally compounded every minute. It is common to find DeFi lending platforms that require borrowers to deposit 110% (or more) of the loan amount as additional security.
Popular Platforms for Crypto Lending and Borrowing
There are many online platforms that support crypto loans. But the most popular and highly trusted crypto lending and borrowing service providers are those we have listed below.
Binance is a world-leading crypto exchange that provides the freedom people need to earn money from trading and investing in cryptocurrencies. It allows them to hold, spend, earn, and share their money in a robust, safe, and secure blockchain ecosystem.
You can use the Crypto Loans product of Binance to borrow cryptocurrency for staking, margin, or future trading and repay it at any time. It offers many cryptocurrencies that can be used as loanable assets and collateral. They include Bitcoin (BTC) and Ether (ETH).
Binance offers partial liquidation, no transaction fee, and the opportunity to borrow BUSD with MDX at rates as low as 0.004% daily. The loan terms are 7, 14, 30, 90, and 180 days.
Crypto.com is a digital platform and exchange that allows lenders to earn up to 14.5% interest on their crypto and pays up to 8.5% interest for stablecoins. It enables users to gain credit directly in their crypto wallets and pay it back at any time.
In addition to the fact that no credit check is required to get crypto on this service, users are allowed to borrow up to 50% of their cryptocurrency collateral. They also use its non-custodial wallet and app to access DeFi services and explore famous DApps.
Coinbase is an online platform for trading and investing in cryptocurrencies. It also allows its account holders to use their Bitcoin as collateral for taking out cash loans, even without credit checks. They can borrow up to $1,000,000 against their Bitcoins at an annual interest rate of 8%. The money can be received through a PayPal account or a digital account with a traditional bank or neobank.
Nexo is one of the most trusted crypto lending platforms in the world. It provides instant funds to borrowers through a fast process that does not require credit checks. The repayment plan is flexible. You can use your fiat and crypto, or a combination of both, to pay back.
Borrowing crypto with Nexo is highly rewarding. It offers instant loan approval at market-leading interest rates, and funds are often sent within 24 hours. Users can borrow from $50 to $2 million at an APR that starts at 0% thanks to Nexo’s Instant Crypto Credit Lines.
- Easily accessible to anyone who has collateral or can pay it back in a flash loan
- Can be managed by smart contracts that automate transactions
- Provides high-interest rates for lenders to earn passive income
- Borrows get interest rates lower than most credit cards and personal loans
- Offers a wide range of digital currency options compared to fiat money
- Credit checks are generally not required to obtain a crypto loan
- Transactions are faster in crypto lending than in fiat money loans
- There is no discrimination by race, religion, gender, or any social status
- Transactions are securely and permanently recorded on a blockchain
- Crypto lending is mostly unregulated
- High liquidation risks as crypto can suddenly drop in value
- Smart contracts can fail sometimes due to attacks or badly written codes
- Portfolio risk is increased through crypto borrowing and lending
- CeFi crypto loans require KYC and account verification
- Usually requires high collateral
- Collateral can be liquidated by the lender when it drops in value
- DeFi and CeFi transactions are primary targets for hackers
What are the Risks of Crypto Lending?
Because deposits and loans are reliant on the constantly fluctuating cryptocurrency market, lending in the cryptocurrency space is inherently dangerous for both lenders and borrowers. For example, many crypto traders and investors were left saddened as the latest FTX collapse or Celsius bankruptcy scandal played out, seeing billions of dollars in deposits locked up overnight.
The common risks of crypto lending are the following:
- Unregulated transactions
Platforms for crypto lending are unregulated and do not provide the same level of safety that banks do. For example, a customer’s money is protected up to a certain amount should a bank go bankrupt. In the United States, bank deposits are insured for up to $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC). But there are no user protections for cryptocurrency lending platforms that have solvency problems, and money may be lost.
- Illiquidity problems
Crypto assets often become inaccessible and illiquid when they are put onto crypto loan services. While some cryptocurrency lending services let lenders access deposited funds pretty fast, others may need an extended waiting time.
- High-interest rates for borrowers
Borrowers may not always like crypto loans because of the costs involved. While some cryptocurrency loans have reasonable rates, the majority of them have APRs of above 5%, and some of them even have APRs of up to 13% or more.
- Margin calls
In crypto lending, a decrease in the value of the deposited collateral could cause the LTV of the crypto loan to fall below the agreed-upon point, and this might result in a margin call. When the lender makes this call, the borrower has two options: they can either add more collateral to fix the LTV or risk liquidation.
Crypto loans are advantageous for both lenders and borrowers since blockchain technology has made it simpler than ever to access and offer this type of credit. Investors can now unleash the potential of their money by using it as collateral, while lenders now have another way to make passive income from earning interest. Having shown you the best crypto lending platforms in this article, we leave it to you to make a wise decision with your cryptocurrency as soon as possible.