How Does Crypto Lending Works?
Crypto Lending Explained
This article will explain the concept of Crypto Lending. What is Crypto lending and how does crypto lending works?
Crypto lending enables crypto asset holders to lend out their crypto or borrow against the crypto as collateral. The crypto lending industry is divided into Centralized Financing (CeFi) and Decentralized Financing (DeFi).
Let's take a look at What is Crypto Lending
What is Crypto Lending
Crypto borrowing and lending have become increasingly popular over the last few years. Just like traditional lending, you have the ability to loan out your digital assets in order to receive high interest from whoever is borrowing from you. There are many platforms that let you give out or take a loan with your crypto.
Crypto lending works the same as traditional banking, but for digital assets. Crypto lending refers to a type of Decentralized Finance that allows investors to lend their cryptocurrencies to different borrowers. This way, they will get interest payments in exchange, also called “crypto dividends”. Crypto lenders offer yields on crypto deposits, such as stablecoins, by lending them on interest. Many platforms that specialize in lending crypto also accept stablecoins, on top of cryptos.
When it comes to crypto lending, borrowers also have the chance to stake their cryptocurrency as guarantees of loan repayment or as security. Thus, the investors will be able to sell the crypto assets in case the borrower doesn’t pay off the loan anymore, meaning that they can recover the losses.
Example Of Crypto Lending
Let’s give an example. You may have 20 bitcoins. You plan to get a steady passive income with them, so you have the chance to deposit them into a crypto lending platform wallet. As such, every month or week, you will receive interest. The interest rates can differ. They can either go from 3% to 7%, or they can go quite higher, up to 17% in some cases.
Categories Of Crypto Lending
- Custodial (Centralized) Crypto Lending
- Non-custodial (Decentralized) Crypto Lending
1. Custodial (Centralized) Crypto Lending
Custodial crypto lending looks and feels like a bank for cryptocurrencies — without the same regulatory oversight and consumer protections. It manages all deposits and loans on a centralized platform and internal balance sheet. Anyone who wishes to earn interest on their crypto savings sends their tokens to a custodial wallet address where they lose direct control of the asset. In return, the platform invests the assets at their discretion — whether through lending at interest or alternative yield farming.
2. Non-custodial (Decentralized) Crypto Lending
A noncustodial lending platform enables decentralized peer-to-peer or peer-to-pool lending. Unlike its traditional counterpart, it allows depositors (lenders) to maintain ownership of their tokens — and the source of yield is clear. Lenders earn interest and borrowers pay interest. Platforms can automate functions traditionally managed by banks or custodians using blockchain smart contracts.
How Crypto Lending Works
This is how crypto lending works:
First Party — Lenders:
The lenders represent the first party involved in crypto lending. They might be crypto aficionados who want to grow the output of the assets or people who hold onto cryptocurrencies waiting for a value boost.
2nd Party — Lending Platform:
The 2nd party is the crypto lending platform, where the lending and borrowing transaction unfolds.
3rd Party — Borrowers:
Lastly, the borrowers represent the 3rd party of the process, and they are the ones who will get the funds. They could either be businesses that need funding or people who look for funding.
The crypto lending process happens in a few steps:
- The borrower goes to a platform and requests a crypto loan.
- The borrower stakes the crypto collateral as soon as the loan request is accepted by the platform. Until he is able to fund back the entire loan, the borrower will not have the opportunity to get back the stakes.
- Using the platform, the lenders will automatically fund the loan, which is a process that investors cannot see.
- Investors will receive regular interests as payments
- When the borrower manages to pay off the whole loan, he will get back the crypto collateral he wanted.
- The interest rate paid to the lender differs based on the coin and the terms of the deposit. It’s usually between 3% and 15%. The APY is determined by supply and demand. If the demand is high and supply is low, the APY is higher, and vice versa.
- The duration of the deposit may also determine the APY ( refers to the amount of interest earned on your savings). Usually, the longer the duration of lending, the higher the APY. Sometimes, the APY is variable, and keeps on changing with supply and demand. However, this isn’t the norm.
- Traditionally, the LTV (loan-to-value ratio) is 50%. As a borrower can get a loan of 50% on the total amount of collateral. For example, if the borrower deposits $10,000 in crypto as collateral, the loan would be $5,000. As soon as the loan is paid in full, he will get back the $10,000 he left as collateral.
Every platform comes with its own way of lending crypto, but overall, this is how the process unfolds.
Things You Should Keep In Mind
There are several crypto lending parameters that should be understood and constantly kept in mind:
- LTV (Loan-to-value) is a ratio of the loan to the ratio of the collateral. In terms of cryptocurrency lending loans are always overcollateralized which means you receive only a part of your collateral value;
- APR (Annual percentage rate) is the interest rate for the whole year applied on a cryptocurrency loan;
- Time frame defines how many times you have to pay off your cryptocurrency loan;
- Liquidation is a process of selling your collateral to cover the lender’s expenses;
- Liquidation price is a price when the collateral is being sold to cover the lender’s expenses. It is determined before taking the loan.
Types Of Crypto Lending Platforms
There are two types of crypto lending platforms:
- Centralized Finance Platforms (CeFi): The platforms that basically require you to submit your personal details. They hold your private keys and retain substantial control over your transactions.
- Decentralized Finance Platforms (DeFi): On the other hand, DeFi operate on a permission-less basis. You have full control over your account and execute processes using applications built on the blockchain. While DeFi platforms are liberal, CeFi offers you the benefit of regulatory oversight.
Top Crypto Lending Platforms
Now, let us have a look at some of the best crypto lending platforms.
CoinRabbit
BlockFi
AAVE
Nexo
Benefits of Crypto Lending
Crypto lending is beneficial for both lender and borrower. From a borrower’s perspective, the main advantages are:
- Accessible: Borrowing a crypto loan is much easier than borrowing from traditional banks. If you own crypto, you can get a loan without strict requirements or paperwork. This is unlike borrowing in traditional banking, where banks have to go through multiple tedious steps of verifying your credit score, employment history, bank balance and personal documents.
- Faster: Under normal circumstances, you can get a crypto loan within 24 hours. Some cryptocurrency platforms offer instant deposits to your account once you complete their requirements. Usually, collateral and a government-issued ID are all that is needed.
- Flexible: You can set your APR according to your desired value. As discussed previously, many crypto lending platforms allow the borrower to adjust APR based on the term of the loan, loan-to-value ratio, type of cryptocurrency and the amount of collateral.
Risks of Crypto Lending
There are several risks strictly connected with it:
- Your collateral always has a liquidation price. You should closely monitor cryptocurrency price fluctuations and be aware of them. It is the ONLY reason for losing your collateral within crypto lending services;
- Keep in mind the LTV ratio. For example, if LTV is 30% it means that the price of Bitcoin used as collateral should drop by 30% before being sold;
- Do your own research. As with any other financial activity crypto lending should be fully understood before being considered;
- Do not lend out cryptocurrency you plan to cash out soon. Cryptocurrency lending should be considered for a mid-term or long-term;
- Do not use highly volatile digital assets as collateral (SZC, XRUNE);
- Take everything moderately like any other financial activity. Use only those funds that are ok to potentially be lost.
Wrap Up
In this article, we explained Crypto Lending. What is crypto lending and how the crypto lending works? we have seen their advantages and risks and much more. Crypto lending is feasible for investors who wish to earn interest in their crypto holdings. One can earn a good return on crypto lending if the lending process is well researched and well planned. Continue reading for more stories. Follow me on LinkedIn to stay connected → https://www.linkedin.com/in/ishanshahzad/
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