As an investor in crypto, crypto lending presents a way of earning returns without selling coins. Until recently, safe borrowing and lending were limited to traditional financial institutions like banks.
Recently, crypto lending has been fascinating to the crypto community and is propelling the decentralized financial (DeFi) ecosystem.
Not long ago, Bitcoin investors were limited to holding and waiting for it to appreciate. Alternatively, they could engage in a riskier option of trading on crypto market volatility.
Today; however, investors can earn passive income by lending Bitcoin. To safely do this, follow these bitcoin lending safety tips. This guide will cover how crypto lending works and it’s potential as well as associated risks.
What is crypto lending?
Crypto lending is an emerging trend that lets people lend through cryptocurrency exchanges or several lending platforms. It is a form of crowdfunding that allows lenders who are individual investors to connect with borrowers through an intermediary.
The intermediary is the crypto lending platform that acts as a trusted third party. Three agents must be present for crypto lending to happen.
First, an individual investor or lender who provides the funds. It could be anyone holding cryptocurrencies or a crypto enthusiast interested in increasing their asset’s productivity.
Second, an online platform managing the transaction. Different types of crypto lending platforms exist. Some are purely autonomous and decentralized while others are centralized with a group of people or companies operating behind the scene.
Third, borrowers could be individuals or businesses in search of funding with crypto or fiat assets as collateral to receive the borrowed funds.
Benefits of cryptocurrency lending
There are several things that make crypto lending more appealing to financial actors. While conventional bank lending includes bureaucracies and long verification processes, in crypto lending things move relatively fast.
Crypto lending does not require a credit score to give out a loan. This makes crypto loans more accessible compared to bank loans. Besides, crypto loans let you tailor them to your needs.
Often, crypto lending does not require elaborate paperwork or processing. All the activities are digital and can be done in minutes or hours making crypto lending appealing.
Regardless of the cryptocurrency, most crypto lending platforms allow users to switch between assets. For instance, a user can deposit using bitcoin and borrow different crypto within the same platform.
How crypto lending works
The lending process usually varies from one platform to another. However, receiving a crypto-backed loan usually involves the following steps for lenders and borrowers:
- Select interest rate
- Provide the borrower crypto assets and receive bonds as proof
- Get more bonds in terms of interest
- To get your money back, send the bonds you got via the smart contract.
- Earn profit
- Sign up on the crypto lending platform and show the loan you seek
- Automatically, the platform will calculate the amount of crypto necessary for collateral
- Borrower deposits collateral
- He/she applies for a loan then waits for approval
- Platform deposits funds in the borrower’s account
Why lend crypto on crypto lending platforms?
- Attractive interest rate
The biggest advantage for crypto lenders is the high-interest rate they get from crypto lending platforms. The opportunities on these platforms make it possible to earn more than the amount lent out.
So, you will be making a profit because you own crypto assets. Also, the interest rate is more than what you get in a savings account. Compared to banks that pay approximately 1% for your funds, crypto lending platforms can earn you approximately 10% to 12% of your capital. However, there are risks to crypto lending.
- Avoid crypto volatility
Ideally, you can lend any crypto. But, lending stablecoins is a new solution for crypto owners. When you lend stablecoins, which are digital assets pegged to real currency, you can grow your assets without the risks associated with crypto.
So, you can predict how much you are going to get before lending your crypto assets.
New opportunities in crypto lending
There are various crypto lending opportunities that capitalize on high liquidity which makes crypto great collateral and a source of remarkable yield for lenders. One simple option is for a trader to lend one crypto asset through one platform.
The rates vary depending on the coin and platform. On decentralized finance platforms, you can make approximately 12% on stablecoins compared to 1% on WBTC (wrapped bitcoin).
Also, you can earn approximately 4% of your Ethereum and Bitcoin on a centralized platform. As well, most crypto holders seize the opportunity to capitalize on DeFi protocols to liquidate their assets without paying tax.
Another opportunity is by increasing the availability of leverage through borrowing funds, buying extra capital, and increasing the loan size to the limit. So, if you provide Bitcoin as collateral and sell your dollar-pegged stablecoin for more Bitcoin. This way, you are going long on your collateral currency hoping to get a return once the value of bitcoin rises. It is a risky approach but the profit can be remarkable.
Flash loans are another potential source of revenue in crypto lending platforms. The approach lets you borrow the maximum free liquidity then using the unsecured loan to make an instant transaction that is going to earn profit. To be successful, the transaction must be able to repay the loan in full.
As well, you can earn revenue by serving as a DeFi liquidator. The option requires a level of technical understanding since you need to carry out several algorithms. The algorithms are to establish loans that fall below the collateral threshold before liquidating the collateral to give funds to the lender. The fees for such a service are substantial.
Risks of crypto lending
Compared to its conventional counterparts, cryptocurrency lending is less regulated. However, the main risk of borrowing is that the coin used as collateral can be liquidated if its value falls below a certain threshold. Thus, it can result in the total loss of a borrower’s capital. In a clear show of how risky it is to invest in DeFi, CNBC points out that even billionaires are not immune, citing Mark Cuban loss.
Also, security breaches are a major concern. Smart technology associated with the control of funds has some vulnerabilities that hackers can exploit. In 2020, several high-profile incidents led to the loss of millions of dollars.
Before you embark on crypto lending, make sure you understand the ramifications. Ensure you avoid shady crypto lending platforms and take time to understand the loan terms.