The crypto lending industry has become increasingly adopted by traders and investors. There is a push for more legislation and regulation in the space, however.
The Securities and Exchange Commission (SEC) held a meeting on April 4, 2022, where it was noted that many of the assets traded in the crypto markets currently could be considered securities. The implication is that traders of crypto should have protections similar to investors who trade traditional securities.
With the push for more regulation is the idea that crypto trading and lending could become seen as increasingly mainstream. Part of this includes crypto lending.
With that in mind, the following is a guide to everything to know about crypto lending and its implications.
What is Crypto Lending?
In November of last year, cryptocurrency market capitalization went beyond $3 trillion. Around 16% of Americans reportedly invest in, use or trade cryptocurrencies, meaning around 40 million people just in the U.S.
Digital currencies are extremely volatile, and the past couple of weeks have been evidence of that. For example, in 2021, Bitcoin doubled its value, and then just within the first month of 2022, it lost nearly all those gains.
Cryptocurrencies, despite their volatility, do have benefits for long-term holders. Holders are now using their digital assets to provide collateral for loans.
The following are some of the most popular cryptocurrencies right now:
- Bitcoin was the first and remains the most well-known cryptocurrency. It trades as BTC, and around 114 million worldwide accounts held Bitcoin as of 2021.
- Ethereum is an open-source and decentralized blockchain using Ether or ETH as the native cryptocurrency. Ethereum, by market capitalization, is the second-largest blockchain.
- Tether was first known as Realcoin, and it’s considered a stablecoin. When a digital currency is characterized as a stablecoin, that’ means it has a direct link to another asset.
- XRP is the digital currency for Ripple, which is a payment network and settlement system.
- Terra is also a stablecoin pegged to key currencies. For example, TerraUSD is tied to the US dollar. Luna is the native token for Terra, but unfortunately, Luna has recently grabbed headlines for all the wrong reasons. Luna collapsed, falling from a price of $116 in April to having virtually no value.
A crypto loan is a secured loan with some similarities to traditional products like a car loan. With crypto lending, you pledge an asset to get financing.
In the case of crypto lending, the asset offered to a lender in exchange for cash is cryptocurrency. You’ll be required to pay the loan back in installments, and if you don’t, then the lender can liquidate the cryptocurrency.
Digital currency can be called collateral. You can get a crypto loan through a crypto lending platform or a crypto exchange.
You keep the crypto you use as collateral, but you also give up some rights in exchange. For example, you aren’t able to use it for transactions or trade it while it’s collateral.
If the value of your digital assets goes down significantly, which has happened over the past few weeks, you could owe more than you borrowed if you default on your loan.
You can get money without having to sell your digital coins and then use the cash to do whatever it is you need to achieve at the time. You repay your loan, and you regain the full hold on your assets.
Crypto lending platforms usually allow you to borrow up to 50% of the value of your assets. Some platforms might allow for more. You can repay when you can, even before the end of your fixed term.
On lending platforms, a lot of the lending supply comes from stablecoins. It’s somewhat common for people to buy stablecoins so they can lend them specifically.
Crypto Staking
Another compelling part of the world of earning passive income from crypto is what’s known as staking. Crypto staking involves you locking up your crypto for a period of time. In doing so, you can generate passive income as more crypto. It’s somewhat like a certificate of deposit. You can’t use the crypto while you’re staking it, but you’re earning interest.
CDs contrast from staking because they’re considered long-term while staking usually comes in intervals of around 30 days.
You’re rewarded with passive income because you’re dedicating your crypto to support the blockchain for a period of time.
Not all cryptos can be staked, but if you are interested, you find a platform supporting it, choose how much you’re interested in staking, and for how long.
Crypto lending is different than staking in some key ways, despite the similarities.
The biggest key differentiator is how the crypto is used. When you lend crypto, you’re allowing the platform you use to lease it to borrowers. The borrowers pay interest, and the platform splits the interest with you as earnings.
Crypto loans use the borrower’s own digital assets as their collateral to secure the loan.
The second difference is that when you stake your crypto, it locks it up for whatever period of time it is that you agree to. Lending platforms will usually let you withdraw earnings whenever you want, on the other hand.
When you lend your crypto, you might earn massive interest rates compared to something like a savings account.
U.S. regulators tend to view staking and lending differently from one another. The SEC currently doesn’t appear to see staking as a big threat beyond how it already views crypto in general. Crypto lending, on the other hand, is drawing the attention of regulators in a big way.
The Cryptocurrencies You Can Stake or Lend
You can’t stake bitcoin because the transactions are verified with the proof of work process. You can only stake coins if they are proof of stake, which is a newer and more efficient method that uses coins rather than power.
Coins you can stake include Ethereum 2.0, Binance, and Cardano.
Lendable coins aren’t restricted by proof of stake or proof of work, so there’s no limit on the types of coins you can lend. The list isn’t huge right now, but it is growing.
The Benefits of Lending Cryptocurrency
Crypto loans can have unique benefits compared to traditional financing.
First, if you’re borrowing money through a crypto loan, the interest rates are going to be lower than what they are on things like credit cards or personal loans. The interest rates aren’t, however, as cheap as a mortgage or car loans. The rates are usually somewhere between personal and secured loans.
The loan amount is based on asset value, so you might be able to borrow an average of up to 50% of the value of your portfolio, but sometimes as much as 90%.
Depending on the platform you’re using, and what you need, you might be able to get your loan funds as U.S. dollars or the cryptocurrency you choose.
You’re usually not going to have to go through a credit check when you apply on crypto lending platforms, and the funding is fast. If you’re approved, loan funds might come through in just a few hours.
Are There Downsides?
There are some risks and downsides that come with crypto lending.
First, there’s the potential for margin calls. A margin call is when your collateral’s value goes below a threshold, and then, as a result of the drop, the lender would require you to increase holdings to keep up your loan. The lender could even require you to sell assets to reduce your loan-to-value ratio. Since cryptocurrencies are highly volatile, your chances of finding yourself in this situation are high.
When your loan has an outstanding balance, you can’t access holdings for transactions or trading, and the repayment terms vary. You might have a very short window of time—often less than a year—to repay what you borrow.
When the repayment terms are shorter, you need to make sure you can realistically manage the payments.
As mentioned above, not all digital assets are eligible, and interest account funds aren’t insured.
What If You Want a Crypto Loan?
If you’re interested in securing a crypto loan rather than earning passive income by lending your cryptocurrency, there are a lot of online platforms that will facilitate this.
Most loan platforms for crypto are classified as decentralized finance platforms or DeFi platforms. These platforms function as a connection between investors and borrowers.
Interest rates a lending platform will charge vary depending on a multitude of factors, including the specific type of crypto that’s collateral.
You may have to pay a commission to the platform as well as other fees.
To get a loan, once you’ve selected a platform, you create an account. You need to verify the collateral for the loan and your reliability and identity as a borrower. The platform gives you a trust score.
Then you choose the type of loan you need based on the collateral you’re putting up and the interest rate you’ll agree to pay. If you agree to a higher interest rate loan, you won’t have to put up as much collateral.
Finally, from there, you begin to receive loan offers which happen quickly. Borrowers will usually start getting loan offers a few hours after they submit their applications. Once you accept the loan terms, you get money instantly.
