Cryptocurrency has seen an impressive growth over the past few years, becoming a trending topic in the world of finances. As more and more people start investing in different blockchain network’s coins and tokens, we are seeing investors starting to look for new ways to maximize their crypto earnings. Many choose to get started with crypto by buying assets and holding onto them with the hope that their value increases over time, however there are other highly lucrative strategies you can apply to earn significant yields, one of them being lending crypto.
If letting your crypto sit in your wallet doesn’t sound as appealing to you and you are wondering how DeFi crypto lending works, keep on reading. This guide will walk you through how crypto lending and borrowing works and outline its advantages and disadvantages to help you decide whether it is the right investment strategy for you.
How does Crypto Lending Work?
In reality, crypto lending works very similarly to how it does for fiat currencies. The lender provides the funds requested by the borrower, who can access the funding immediately with the obligation to pay the borrowed amount back and an agreed upon interest in a set amount of time.
In the same way, if you hold crypto and are looking to earn a yield from your assets, you can lend it out to a DeFi lending platform, eventually getting back your crypto and some interest in return. The rewards obtained from lending, also referred to as “crypto dividends”, can vary greatly between platforms and cryptocurrencies due to the different interest rates offered.
On the other side of the coin, crypto lending platforms have also given rise to crypto backed loans. Crypto investors can use their cryptocurrency coins or tokens as collateral to request a loan from a crypto lending platform. This is similar to using a house or property as collateral for a loan, since you retain ownership of your assets with the possibility of them being seized if you fail to make the timely payment. When your crypto is used as collateral for a loan, you will also be unable to use it for trading or to complete any other transaction. Only once the full loan, including interest is paid, will the borrower regain full rights over their crypto.
Let’s take a look at lending crypto from a practical standpoint. For example, if you own 3 bitcoins, you can lend them out by depositing them in a crypto lending platform. In return the platform will pay you interest, with a rate that currently ranges from 3%-7% (but can vary between platforms and can be higher for other coins). You’ll receive interest earnings weekly or monthly depending on the platform.
Looking to do the same and lend your digital assets to earn high yields in interest? Lending is available for a wide range of cryptos through several DeFi platforms. All you have to do to get started is to find a crypto lending platform that is secure, you can trust and offers you an interest rate you find convenient. Then, decide how much of your crypto you want to lend out and make the deposit.
When it comes to borrowing funds (in fiat currency) using crypto as a collateral there are several things you’ll want to keep in mind.
On the bright side, crypto loans have the advantage of not requiring a credit check, since loans are typically overcollateralized (meaning the value of your collateral must meet or surpass the borrowed amount). This is great news for anyone struggling to obtain a loan from a traditional financial institution due to a poor credit score or a lack of credit history.
There are also some downsides to crypto-backed loans though. Since cryptocurrencies are highly volatile, the assets you put up as collateral can experience importan price drops. This will require you to put up more crypto to meet the initial value of the agreed upon collateral or result in you owing back more than you initially borrowed. Due to their volatility, lending platforms will also typically require overcollateralization, where you have to match or surpass the amount you are borrowing with crypto. Crypto-backed loans also imply a risk since they are not federally insured.
Is Crypto Lending Safe?
You should keep in mind that lending your crypto also comes at some risk. Here are some of the risks you should keep in mind:
- Small contract flaws: Crypto lending platforms use smart contracts, which can contain errors or security vulnerabilities. There is always a risk for the technology to fail, placing your assets at risk.
- Lack of legal support: Crypto asset regulations are still in the process of being developed. With no firm legal framework in place, lenders and investors have little to back them up.
- Volatility: With crypto prone to quick and dramatic price drops, those using crypto as collateral for a loan must meet margin calls to maintain the value of their collateral or risk having their assets liquidated by the lending platform.
- Cyber-Attacks: Attacks on crypto exchanges are not the norm, but they are definitely not unheard of. This is why you should lend your crypto using safe, well-known platforms that store your crypto with as much security as possible.
- Insolvency: While lending platforms protect themselves from insolvency through overcollaterization, insolvency is a risk. If the platform were to become insolvent, it would be unable to return your deposited assets.
Lending Crypto: An Overview
Crypto lending platforms fund loans using the crypto collateral obtained from borrowers and the crypto assets provided by lenders, who can earn a high interest rate in return (when compared to investing through a banking institution) and generate passive income. This is an attractive alternative to those looking for an alternative to holding on to cryptocurrencies that will allow them to earn higher yields. However, before taking part in lending crypto you must weigh-out associated risks such as the significant volatility and price fluctuations of assets, the risk of the lending platform becoming insolvent, cyber-attacks and technical flaws in smart contracts.