Volatile prices and hectic marketplaces may come to our mind when considering crypto gains and losses. However, that is not the only way to make money from the blockchain. Crypto lending is an easy solution that allows you to lend your money with little risk.
Apart from that, you can easily obtain borrowed digital assets at low interest rates. Taking out and giving loans is typically simpler, more efficient, and less expensive with crypto, making it a viable alternative for both sides of a loan. As a result, getting knowledge of what crypto lending is and how it works became crucial for lenders. So, let’s get started!
Crypto Lending Explained
Crypto lending works by taking cryptocurrency from one user and lending it to another for a fee. The exact manner of managing the debt varies for each platform. Although crypto lending services are available on both centralized and decentralized platforms, the fundamental concepts remain the same.
You don’t even have to be a borrower. You can make an income and earn interest by putting your cryptocurrency in a pool that manages your funds. There is usually little chance of losing your funds, depending on the stability of the smart contract you utilize. This could be because the borrower put up collateral, or because the loan is managed by a CeFi (centralized finance) platform.
Crypto Lending Working
A cryptocurrency-backed loan, like a securities-based loan, uses digital currency as collateral. It is similar to a mortgage loan in many ways. You use your crypto assets to obtain the loan and repay it over a fixed period of time. These loans are available through a crypto lending platform or a crypto exchange. Though you retain possession of the collateralized crypto, you lose the ability to conduct transactions with digital coins.
Crypto loans appear to be a viable option due to various benefits such as cheap interest rates, loan currency selection, no credit check, quick funding, and the potential to make passive income on your crypto that would otherwise be idle. Furthermore, on numerous crypto platforms, you can lend your own digital currencies and earn a high APY (more than 10%).
All crypto lending transactions include two different parties: the borrower and the lender. The borrower must deposit crypto assets as collateral to secure the lender’s loan. The arrangement benefits both parties because the borrower obtains a quick loan in exchange for their crypto assets, while the lenders gain interest on the loan amount. If the borrower defaults, the underlying crypto assets are sold to recover their money.
Types of Crypto Loans
There are several types of crypto loans available in the cryptocurrency market. Some common ones include:
◾Collateralized Loans: Collateralized loans are the most common and involve the deposit of cryptocurrency as collateral for the loan. Most platforms demand over-collateralization, which means borrowers can only access a portion of the provided collateral (usually less than 90% loan-to-value). The lower the loan-to-value (LTV), the lower the interest rate and the lesser the risk of margin call.
◾Crypto Line of Credit: Instead of an ordinary loan with a set time period, certain platforms provide a cryptocurrency line of credit. This is a sort of collateralized loan in which users can borrow up to a defined percentage of their submitted collateral, but there are no predetermined repayment conditions and they are only charged interest on funds taken.
◾Uncollateralized Loans: Uncollateralized loans are less common, but they operate similarly to personal loans. Borrowers must complete a loan application, identity verification, and a creditworthiness review in order to be authorized. Because there is no collateral to liquidate in the case of a loan default, lenders face a higher chance of loss.
◾Flash Loans: Flash loans are instant loans that are acquired and repaid in the same transaction and are often available on cryptocurrency exchanges. These are very high-risk loans that are generally utilized to take advantage of market arbitrage possibilities, such as purchasing bitcoin at a cheaper price in one market and immediately selling it at a higher price in another, all within the same transaction.
Pros & Cons of Crypto Lending
Crypto loans have long been a staple in the world of DeFi, but they come with both benefits and drawbacks. It’s essential to consider both sides before diving into lending or borrowing:
◾Convenient access to capital: Crypto loans are available to anyone who can offer collateral or repay through a flash loan, making them more accessible than traditional financial institution loans, with no credit checks required.
◾Efficient management with smart contracts: Smart contracts automate the lending and borrowing processes, enhancing efficiency and scalability.
◾Effortless passive income: Crypto HODLers can stow their assets in a vault and start earning APY without actively overseeing the loan.
◾Liquidation risk tied to collateral: Even if loans are well over-collateralized, sudden crypto price drops can result in liquidation.
◾Vulnerabilities in smart contracts: Poorly written code and potential backdoor exploits can jeopardize your borrowed funds or collateral.
◾Increased portfolio risk: While diversification is advisable, using loans to achieve it introduces additional risks to your portfolio.
Is Crypto Lending Safe?
To maximize your chances of success with crypto loans, it’s crucial to use a reputable lending platform and employ stable assets as collateral. However, exercise caution and consider the following tips before diving into lending or borrowing:
◾Be aware of the risks associated with relinquishing custody of your crypto assets. Once your coins are no longer in your wallet, you must trust someone else or a smart contract to manage them. Projects can become targets for hacks and scams, and in certain instances, your coins may not be immediately accessible for withdrawal.
◾Evaluate the prevailing market conditions before committing to lending your crypto. Keep in mind that your assets may be locked up for a specified duration, limiting your ability to react to fluctuations in the crypto market. Engaging in lending or borrowing with a new platform carries inherent risks, so it might be wiser to wait until it establishes a stronger reputation.
◾Carefully review the terms and conditions of the loan. There’s a wide array of options for obtaining loans, so it’s advisable to seek better interest rates and favorable terms and conditions when selecting a lending source.
When used effectively, crypto lending services benefit both the borrower and the lender. Investors can now harness the potential of their assets by using them as collateral, giving HODLers another way to make passive income.
Understand the conditions involved and prioritize utilizing a reputable platform whether you choose a DeFi or CeFi project to manage your debts. Blockchain technology has made it easier to obtain and provide credit than ever before, making crypto loans a strong tool for individuals who are interested.
To learn more about Crypto Lending, go check out SunCrypto Academy.
Disclaimer: Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. All content provided is for informational purposes only, and shall not be relied upon as financial/investment advice. Opinions shared, if any, are only shared for information and education purposes. Although the best efforts have been made to ensure all information is accurate and up to date, occasionally unintended errors or misprints may occur. We recommend you please do your own research or consult an expert before making any investment decision. You may write to us at [email protected].