The Complete Guide
Since 2009, cryptocurrency and blockchain technology have been disrupting and rewriting the rules of the financial industry. Today there is a range of new and exciting trends taking hold of crypto enthusiasts everywhere, one of the most significant being crypto lending.
Although the technology is still in its infancy, crypto lending presents a groundbreaking opportunity for crypto currency investors to source fiat money (USD, Euros, etc.) on demand. But first, let's sink our teeth into the basics: what exactly is crypto lending?
Understanding Crypto Loans
if you follow finance, the core of crypto lending is actually quite simple.
Crypto borrowers are now able to use their crypto assets as collateral to obtain different loans while lenders provide the assets required for the loan at an agreed-upon interest rate.
Crypto lending emerged as an alternative for hodlers (someone who prefers to hoard cryptocurrency rather than sell it) to increase their assets' productivity. With crypto lending, the old rules of assets no longer apply. By using blockchain in this economic system, the new rules are shaped by smart contracts and algorithms to ensure the transactions remain autonomous and decentralized.
However, for many, the idea of crypto lending still seems too new, too risky, and in some ways, too good to be true. If you fall into this camp, keep reading for everything you need to know about crypto loans.
How Do Crypto Loans Work?
Crypto lending is the act of lending through crypto exchanges or other lending platforms.
Like traditional loans, interest will be incurred at a settled rate over the course of the loan. In a nutshell, crypto lending is a type of crowdfunding where individual investors (lenders) are connected with borrowers through a third party. In the case of crypto loans, this trusted intermediary is a crypto lending platform.
For crypto lending to happen, you need these three players:
The Lender
These are the individual investors who provide the fund. These could be hodlers (any crypto head intent on holding their cryptocurrencies until the value appreciates) or other crypto traders who need a way to grow their assets' productivity.
The Platform
This one's pretty obvious: to do any sort of crypto lending, you'll need an online platform that manages the transaction. There are now many different iterations of crypto lending platforms. Some are entirely autonomous and decentralized (DeFi), while others are centralized with a company or group handing all the behind the scenes operations (CeFi).
Confused? Don't worry–we'll break it down later.
The Borrower
Lending is a two-way street, and crypto loans are no exception. With every lender must come a borrower. This could be an individual or a start-up business who are looking for funding. These people will usually have ample crypto assets to use as collateral to guarantee the borrowed funds.
Who Should Use Crypto Loans?
If you're in the cryptocurrency space, crypto loans are a cost-effective and pain-free way to manage your cryptocurrencies and finance purchases big and small.
People commission crypto loans for everything from buying a home to refinancing debt. However, you don't need to have a big purchase on the horizon to take advantage of crypto loans. Many crypto enthusiasts have great success diversifying their portfolios with crypto loans.
If you're interested in exploring your crypto lending options, there are many great platforms to use. But be warned that not all crypto lending platforms are created equal. For a head start, reference our comprehensive review about major crypto lending players BlockFi and Nexo.
The Benefits of Crypto Lending for Borrowers
Crypto lending has several advantages. It is more accessible, flexible, and faster than bank loans making it an enticing trend for all sorts of financial transactions.
Traditional loans, such as bank lending, require going through bureaucracies and lengthy verification processes such as reviewing your credit score. Since credit scores take forever to build and only one bout of bad luck to break, this can inhibit many deserving people from securing a loan.
Alternately, this process moves quite efficiently in the crypto lending space. With no award-winning credit score (or any cited credit score for that matter) needed to access your crypto loan, this is the fastest loans process available.
What's more, crypto lending is worlds more accessible than traditional loans that make banks set the interest rates, loan amount, and loan period. With crypto lending, the people have all the power, and you can tailor your loan according to your unique obstacles and advantages.
The Benefits of Crypto Lending for Lenders
Borrowing from crypto lending platforms can also be extremely beneficial to lenders because the collateral is more liquid than bank lending. Generally, borrowers must collateralize over 100% or more of the amount they want to borrow. The high loan ratio is due to the volatility of cryptocurrencies.
With most crypto platforms, the lengthy paperwork and long processing times associated with traditional bank loans are eliminated. Everything is digitized and can be streamlined to completion in just minutes to hours.
This a major part of its appeal. In 2020, there is now a wide variety of cryptocurrencies. To stay relevalent, many crypto lending platforms were prompted to to allow users to switch between assets. This allows a user to deposit in bitcoin and borrow another crypto all on the same platform.
Lending Platforms: CeFi vs. DeFi
Unless you've been living in Amish Country, you probably know about the great divide between cryptocurrency and traditional finance. However, there is another debate brewing within the cryptocurrency space: centralized finance (CeFi) and decentralized finance (DeFi).
Both CeFi and DeFi share the unified vision of creating a world where it is easy for people to use cryptocurrency for financial services. What they don't share is how they venture to accomplish this.
There are many subtle differences between centralized and decentralized finance. Still, the core of their divide is one of the great questions of the tech age: should users trust people or technology?
Centralized Lending Platforms
Centralized lending platforms behave as if a traditional fintech company happened to operate in the crypto space. They borrow their philosophies from traditional finance practices. Implementing Know Your Customer processes and custodial systems to protect your assets, they leave themselves the option to form traditional business partnerships with institutions, such as negotiating specific loan agreements.
CeFi platforms, such as Nebeus and Nexo, tend to offer interest rates determined by the company. This often includes higher returns for lenders of big-time crypto-assets like Ether (ETH) and Bitcoin (BTC) than their decentralized competitors.
Pros:
Potential for higher returns
Better customer experience
Cons:
Higher transaction fees
Third party involvement
Identifying information must be disclosed
Decentralized Lending Platforms
Decentralized lending platforms, including options like Compound and AAVE can be accessed by any individual at any time without KYC or custody. Except for Maker, whose decentralized governance system determines the interest rates, these decentralized platforms have variable interest rates determined by supply and demand for an asset on the forum.
Depending on the interest rate function, this can sometimes lead to large swings in interest rates, with dYdX at times spiking over 30% for lenders.
Pros:
No one has control over your assets
Improved accessibility and speed
Cons:
Unclear regulatory environment
Big swings in interest rates
CeFi vs. DeFi: The Verdict
Both financial philosophies allow the cryptocurrency movement to continue to evolve. CeFi and DeFi alike offer faster transactions, competitive yields, and infrastructure that promotes the secure future of finance.
Whether you decide CeFi or Defi is best for your crypto loan, you will experience better financial services and gain an edge over traditional bank loans. For more about the great CeFi vs. DeFi debate, check out some of our other posts.
The Risks of Crypto Lending
Though crypto loans continue to rise in popularity for their flexibility, speed, and accessibility, interested participants should still be aware of the risks. Yes, they have competitive advantages, but you must bear in mind that these are newer and more volatile than traditional regulated bank loans.
Borrowers take on the built-in risk of supplying liquidity if their collateral value drops below the required value to ensure that lenders are always whole. Because of this, borrowers must keep a careful eye on their collateral ratio to ensure it stays within a safe range.
As of this post, liquidation systems have proved to be sufficient, and lenders have not lost their investments. However, like with any system, this is not guaranteed to continue into the future.
Within the decentralized financial space, both borrowers and lenders take on a technological risk with smart contracts. As computer code governs financial flow within these systems, it is theoretically possible for a hacker to exploit the platform.
The Future of Crypto Loans
Cryptocurrencies such as Bitcoin and Ether continue to cement themselves as enduring and valuable financial assets. During this tumultuous year wrought with corporate corruption, a non-inflationary digital currency that's not governed by corporations or individuals just sounds better and better. Because of this, we believe crypto loans have the potential to take over the loans industry as we know it.
Where to Begin
If you're a keen investor who is unfamiliar with cryptocurrency and blockchain technology, choosing the right crypto lending platform for your financial needs can be intimidating. Navigating the obstacles and advantages of DeFi and CeFi platforms is no task for the uninformed. If you're still not feeling confident, feel free to check out our in-depth reviews of the most buzzworthy crypto lending spaces.
👋 Hey, I’m Dean.