What is crypto lending?
With crypto lending, a user can borrow or lend cryptocurrencies. These lending agreements will usually have a fixed payback term and come with a fee or interest.
There are different kinds of lending agreements (we'll cover them in more detail below), some of which can have you borrowing cryptocurrencies in as little as a few minutes.
There are a number of specific crypto lending platforms that specialize in this service, however, many of the better crypto exchanges also have some form of basic crypto lending available to their users.
How does crypto lending work?
Crypto lending generally requires three different parties.
- The lender
- The borrower
- The exchange
The exchange is usually a DeFi platform that allows P2P sharing and lending crypto.
As a generally rule, the borrower will have to provide some form of collateral before borrowing anything. This is to secure the lender in case the borrower defaults on their repayment.
The lender retains the ownership of the cryptocurrency they're lending. However, for the duration of the lending agreement, they won't have any rights to use that cryptocurrency as they've given that permissions to the borrower.
Types of crypto lending agreements
There are generally 2 forms of crypto lending agreements, flash loans and collateralized loans. Here's the difference.
Crypto Flash loans
Flash loans permit the borrowing of crypto without you having to put up collateral. They get their name because the entire process of getting and repaying the loan is handled in a single block.
If the loan cannot be repaid with the interest, the transaction is cancelled before it's written and validated in the block. Effectively making it so the loan never happened.
There's no human interaction with this kind of lending and all is handling by the smart contract that dictates the lending process.
So, if the flash loan is handled in a single block, what's the actual usage of this kind of crypto lending agreement?
It's generally used for quick trades that take advantage of price differences between two liquidity pools.
Imagine you're interested in token A.
In liquidity pool 1, that token is trading at $1.
However, in liquidity pool 2, it's trading at $1.20.
This is obviously a great opportunity for you to trade it and make a small profit on each token.
The problem you face is you have no available funds to make the initial trade. Rather than give up, you could use a flash loan to facilitate this trade and take advantage of this arbitrage opportunity.
Now let's imagine that you take out a flash loan for $10,000 USDT. You'd set up the flash loan along the below steps.
- You receive the funds to your crypto wallet
- You use them to purchase $10,000 of the token in LP 1
- You then sell those tokens on LP 2 for a total of $12,000
- You pay off the loan plus interest in the smart contract
Anything that's left of your $2000 profit after you've paid the flash loan fee is yours to keep.
If, for any reason, any of the steps cannot complete, then the flash loan is cancelled before it can be written to the block. Meaning there's no risk for you unless you get the math wrong and don't properly account for fees and exchanges.
Collateralized crypto loans
Collateralized crypto loans are similar to regular loans you may be familiar with. These still require the three parties, however, the borrower receives more time to use the funds but must provide some collateral.
Because of the very volatile nature of most cryptocurrencies, you'll likely have to provide a very low loan to value ration.
What this means is you'll have to provide a large percentage of the amount you're borrowing in collateral. Often around 50%.
What this means is that for a loan that equals $5,000 in value, you will have to provide $10,000 of an asset as collateral. You'll also need to keep an eye on price swings. If the value of your collateral drops below the agreed value, you'll need to top it up. And if it falls drastically, getting close to the borrowed value of assets, you may be forcefully liquidated so the lender doens't make a loss.
In the above example of you putting up $10,000 for a $5000 loan, you might be liquidated as soon as the value of your collateral hits $6000.
Can you borrow cryptocurrency without collateral?
As mentioned above, you can borrow cryptocurrency without collateral. however, you'll be limited to flash loans if this is your preferred method of lending crypto.
The positives of crypto lending
- Easily accessible capital - Pretty much anyone can get a crypto loan. All you need for a flash loan is to find an arbitrage opportunity and have the ability to set up the steps. For a collateralized crypto loan, you just need the ability to put up the collateral requested.
- Smart contract automation - For the majority of loans, a smart contract manages the whole process which makes the system far more scalable than doing things manually.
- Passive income with little work - In addition to staking your crypto., lending can be a great way to earn good interest completely passively.
- Low interest rates - Not as cheap as home mortgage or car loans, crypto loans can be cheaper than credit cards and personal loans.
- Based on asset value - You can often borrow value that's equivalent up to 50% of your portfolio. Some specific crypto exchanges offer higher than this though.
- No credit check- It can be difficult to get fiat loans thanks to credit checks. With crypto loans and lending, you're assessed solely on the value of your portfolio which can make things easier. Crypto lending platforms and exchanges typically won’t run a credit check when you apply, making it an incredibly attractive financing option for people with poor credit or no credit history.
The negatives of crypto lending
- High risk of liquidation - Crypto is so volatile that even over collateralized loans can find themselves liquidated unexpectedly.
- Smart contract weaknesses - One of the many attack vectors for hackers and scammers is smart contracts. If there are issues, loopholes,. or poorly written code, attackers can take advantage of the contract and cause real damage.
- Increased risk - Crypto lending is risky thanks to the volatile nature of crypto. By lending por borrowing you increase the risk of your portfolio.
- Locked assets - If you lend your crypto, or if your loan has an outstanding repayment balance, you won't be able to use it for anything. If prices then fluctuate, this could be a significant problem.
- Repayment terms - Loans usually are built around typical installment repayment structure. Different platforms will have different terms and lengths. You need to know what these terms are before taking out the loan.
- Insurance - If lending your own digital assets, any funds in a crypto interest account might not be insured. That means oif the exchange fails, you're going to lose your money. If this is how you operate, you might want to talk to a good crypto insurance company to see if they can help.
How to choose a great crypto lending platform
If you have the funds to spare, are happy with the risk, and know that you want to borrow cryptocurrency, you just need to look for the right crypto lending platform.
The above list will be a good starting point. however, in addition to our recommendations, you need to look at each one to see...
- If they support the currency you want to lend/borrow
- Have terms you're comfortable with
- Have fees you can afford
- Are a reliable and stable lending platform that's not likely to collapse
If you're happy with the lending platform, and happy with the risks, you should be good to go on your crypto lending adventure.