What is Crypto Lending? In short, when you lend your cryptocurrency funds to borrowers in exchange for interest payments, this is known as “crypto lending.”While buying and holding cryptocurrency is the most common way to invest, there are often passive income opportunities that can boost your returns, with crypto lending being one of the most common. It allows you to earn high-interest rates on your investments, but it comes with certain risks. Discover what crypto lending is, how it works, crypto lending risks, and much more!
What is Crypto lending?
Crypto lending is the process of depositing cryptocurrency and lending it to borrowers in exchange for regular interest payments. These payments are compounded on a daily, weekly, or monthly basis.
Crypto lending works in the same way that traditional lending does, such as when someone needs more cash than they have on hand and a traditional entity, such as a bank, lends them the money while charging interest.
Crypto lending can be obtained through crypto exchanges that provide lending programs and decentralized crypto lending protocols. Both offer competitive interest rates ranging from 3% to 10% APY (annual percentage yield), and both typically require borrowers to deposit collateral in order to obtain a crypto loan.
Why Crypto Lending
The process has exploded in recent years, as have the DeFi (decentralized finance) systems in place to promote crypto lending and other crypto-related systems that allow users to circumvent traditional financial institutions. These platforms are more accessible than traditional banks because they require less paperwork during the lending and borrowing process.
Furthermore, the use of a formal intermediary to manage a typical crypto loan is not required. Smart contracts, on the other hand, automate the entire process, including the agreed-upon repayment schedule and costs. Another difference is that lending your cryptocurrency does not require you to register with any regulator or government agency. This enables you to lend to or borrow from anyone who has a Web3 wallet, regardless of where they are.
Crypto Lending was created to provide investors with the ability to borrow against deposited crypto assets as well as lend out crypto to earn interest in the form of crypto rewards.
How Crypto lending Works
Crypto lending typically involves three parties: the lender, the borrower, and a DeFi platform or crypto exchange. Borrowers are usually required to put up collateral before borrowing any cryptocurrency. Let’s look at how crypto lending works for crypto exchanges and DeFi platforms.
How Crypto lending works for Crypto Exchanges
To begin, open an account with your preferred exchange that provides crypto lending services, such as Coinbase, Binance, or others. You’ll also need to go through the KYC verification process, which includes submitting identity documents and taking a selfie.
You can interact with the platform and find the platform’s crypto lending rates by navigating to the lending area once you have an active exchange account. If you want to borrow, you can usually find out how much collateral you’d need to put up and the interest rates you’d have to pay by editing the input fields.
The repayment rates will vary depending on the length of your loan, the cryptocurrency you borrow, and the amount of collateral you put up. If the loan term meets your needs, you can make a request to the platform, which will then verify your collateral. Your borrowed funds will be deposited into your account as soon as the exchange approves the loan.
Lending through cryptocurrency exchanges makes use of liquidity pools to lend your money to multiple users at the same time. You won’t know to who you’re lending money, but you can rest assured that your funds are secure.
How Crypto lending works for DeFi Lending Protocols
Decentralized lending is available through a variety of DeFi platforms, including AAVE, Compound, and others. There is no third party actively managing the lending process when using DeFi; only smart contracts that automatically pay out loans and liquidate collateral.
This means you retain control of your tokens at all times, which some argue is safer than entrusting them to a cryptocurrency exchange. The majority of DeFi lending protocols require borrowers to overcollateralize by at least 110%, and their interest rates are almost always determined by supply and demand.
There are a few exceptions, one of which is MakerDAO, whose members vote on borrowing rates using MKR tokens.
DeFi lending is completely trustless, which means there is no KYC verification required to lend or borrow cryptocurrency. This makes DeFi protocols more open than crypto exchanges, as anyone with an internet connection can participate.
Lending Cryptocurrency Platforms
Crypto lending platforms have a total market cap of over $3 billion USD. The following are some of the best cryptocurrency lending platforms with high yields.
Our take: Coin Rabbit is the best cryptocurrency lending platform for altcoin, as users can get loans from over 130 cryptocurrencies. However, the APR rate for borrowers on CoinRabbit is relatively high.
CoinRabbit, based in London, is quickly becoming a popular choice for crypto traders due to its diverse crypto offerings. There is no KYC or credit check, and you can even get a $100 loan.
Lenders can earn a ten percent interest rate on five popular coins: USDT, USDC, BSC, USD Coin, and Binance USD. CoinRabbit has no platform fees, and funds are never locked. Borrowers have more options, as they can use the top 70 coins listed on their website as collateral. Almost every coin has an APR between 12% and 16%.
Our take: Compound is one of the best cryptocurrency lending platforms that is reliable for obtaining loans. If you’re looking for compound loans, keep an eye out for rate changes.
Compound Finance is well-known in the industry due to its innovative DeFi model and community-governed decentralized autonomous organization, which was founded in California (DAO).
Because of its yield farming model, the platform’s lending and borrowing rates continue to fluctuate. Lenders, on the other hand, can expect to earn market-rate interest rates. Current rates can also be found on their website under the Markets tab.
Similarly, their lending terms are extremely adaptable. The APR for BTC can range between 0.04% and 6.5% depending on the current market. The USDC rate fluctuates between 0.15% and 10% depending on market conditions.
Our take: Aave is one of the best crypto lending platforms, but the platform’s fluctuating interest rates make it difficult to plan for a large investment.
Aave, a Swiss-based technology firm founded in 2017, is a liquidity protocol based on seven networks and thirteen markets.
Lenders can benefit from interest rates that are accrued and compounded in real time. It is difficult to obtain an exact APY due to Aave’s incentivization protocol. However, for the native token, you can expect 0% to APY and up to 18% on USDT and BUSD.
Borrowers are in good company, with APRs as low as 0.1% for MKR, 0.5% for AAVE, and 1.3% for BUSD. Unfortunately, stablecoin interest rates are on the high side.
Crypto Lending vs Staking
Crypto lending and crypto staking are sometimes confused because they both involve earning money with your cryptocurrency funds.
Staking is the process of locking up your cryptocurrency to help secure the blockchain network. It is an option for blockchains that validate transactions using the proof-of-stake system. A blockchain network in this system requires users who want to validate transactions to stake their crypto, which means they put it up as collateral.
The network selects a validator from among the users who staked their cryptocurrency. When a validator confirms the correctness of a block of transactions and adds it to the blockchain, they are rewarded in that cryptocurrency.
You earn interest with crypto lending, whereas you earn rewards with crypto staking. Both produce similar results because you typically earn a percentage of what you deposit.
Cryptocurrency Lending risks
When something promises extremely high rates of return, there is usually a catch, as with most things in the financial world. Crypto lending is no different.
Risk of Impermanent loss
Impermanent loss occurs when you provide liquidity to a liquidity pool and the price of your deposited assets changes from when you deposited them. The greater the magnitude of the change, the more vulnerable you are to temporary loss. In this case, the loss equates to less dollar value at the time of withdrawal than at the time of deposit.
It’s called impermanent loss because the losses are only realized when you withdraw your coins from the liquidity pool. However, at that point, the losses will almost certainly be permanent. The fees you earn may be able to compensate for those losses, like at Uniswap, which charges a flat trading fee of 0.3%, which is distributed to liquidity providers (LPs).
Mitigating the risk: The best way to mitigate impermanent losses is to provide liquidity to pools containing less volatile assets, such as Stablecoins. Impermanent loss should not be a deterrent to crypto lending, but rather a calculated risk to be aware of before lending your assets.
Smart Contract risk
Smart contracts are blockchain-based programs that govern the execution of actions when certain conditions are met.
Smart contracts are also used to automate the lending process for cryptocurrencies. Smart contracts are also used to automate the cryptocurrency lending process. They govern what happens to your cryptocurrencies when certain actions are performed, such as interest payments or collateral liquidations. Because these software codes are created by developers, they may contain security or functionality flaws that affect investors.
DeFi crypto lending protocols such as Compound and Aave are more resistant to smart contract risk. Unlike crypto exchange lending platforms, where customer support may be able to assist with such errors. On DeFi lending platforms, there is no such control because everything is automated by smart contracts.
Mitigating the risk: The smart contracts on the majority of DeFi platforms are open source. You can study the protocols if you have the technical knowledge. If not, conduct research by interacting with their community to assess its trust in their smart contracts before investing.
Risk of rug pulls
In the absence of traditional forms of regulation in the DeFi lending space, users must develop a level of trust with the platforms to which they are willing to lend their assets or purchase tokens. Unfortunately, rug pulls are a common breach of trust.
Rug pulls are a type of exit scam used by DeFi developers to drain a pool of assets’ liquidity. DeFi developers create a new token, pair it with a leading cryptocurrency such as Ether (ETH) or Tether (USDT), and set up a liquidity pool to accomplish this.
They use marketing to entice people to deposit money into the pool, often promising extremely high returns. Once the pool has amassed a significant amount of the leading cryptocurrencies, the DeFi developers mint millions of new coins using back doors purposefully coded into the token’s smart contract. They exchange these for popular cryptocurrencies, leaving millions of worthless coins in the pool. The founders then vanish into thin air.
Mitigating the risk: Rug pulls risk entails conducting extensive research into the pools you want to lend your crypto to, how long they have been in operation, reaching out to their community if it has one, and determining whether there has been a record of a rug pull in the past.
Flash Loan risk
Flash loans are distinct loan products in the DeFi market. Flash loans are unsecured loans in which the borrower receives the loan without putting up any collateral. Instead, they have a shorter time (usually a few seconds) to repay the entire amount in the same transaction in which the loan was disbursed.
Because there is no risk in issuing these loans, there are no limits to how much a person can borrow. Furthermore, there are no credit checks or other screenings required to obtain flash loans.
Because of their ease of access, flash loans are attractive to criminals. These attackers use flash loans to borrow large sums of money, which they then use to manipulate the market or exploit vulnerable DeFi protocols.
C.R.E.A.M. Finance is an example of this, as it has been attacked several times in 2021. One of the largest heists cost $130 million. The perpetrators stole CREAM liquidity tokens worth millions of dollars over an unspecified period of time. All of the losses are visible on-chain, and the perpetrators have yet to be apprehended.
Mitigating the risk: Because most flash loan attacks rely on price manipulation, decentralized pricing oracles such as Chainlink and Band Protocol are required to counteract this approach. Also, Defender Sentinels provide ongoing protection from flash loan attacks. Developers can use the tool to automate their defense strategies, pausing entire systems and deploying fixes in a matter of seconds.
Both the borrower and the lender benefit from cryptocurrency lending platforms. Investors can now unlock the potential of their funds by using them as collateral, allowing hodlers to earn passive income in a new way.
If you’re thinking about lending or borrowing cryptocurrency, you should be aware of the vulnerabilities associated with the platform.
You should also be aware of the specifics of your lending account or loan terms, as well as the general risks associated with the volatile and illiquid cryptocurrency market.