Crypto lending has emerged as a unicorn in the financially-troubled times we live in. With the pandemic out of control, many traditional p2p lending platforms have shut down due to their failure to secure investors’ assets. Such a predicament was bound to happen since traditional p2p lending platforms offer a majority of their loans without collateral.
However, the silver lining has been the remarkable growth of crypto lending amidst the current financial market slowdown.
What is Crypto Lending?
Crypto lending is a type of Decentralized Finance (DeFi) where investors lend cryptocurrencies or fiat money such as USD, GBP, AUD, CAD, EUR, JPY to borrowers. In exchange, investors receive interest payments also known as crypto dividends. It is somewhat similar to p2p lending in that it involves primarily three parties: the lending platform, lender, and the borrower.
Much like its offshoot DeFi lending, crypto lending involves a collateral in the form of cryptocurrency pledged by the borrower as security until the loan is repaid. If the borrower defaults on the loan payment, the investor can simply sell the mortgaged cryptocurrency assets to recover their losses.
How does Crypto Lending work?
An online crypto-lending platform acts as an intermediary between lenders and borrowers for smooth facilitation of the lending process. There are 3 major stakeholders in the lending process, namely:
- The lender (professional investor, crypto enthusiast) who lends some amount of their crypto holdings.
- The borrower, an individual or business, who wants to obtain funds for whatever reason. They are required to mortgage their crypto or fiat assets as collateral until the loan is repaid.
- The crypto lending platform which oversees the transaction between the lender and borrower. There are 3 types of lending platforms: decentralized, centralized and autonomous platforms.
When the loan is repaid in full, the lenders are eligible to receive their cryptocurrencies. However, in a stark contrast to p2p lending, all loans on the lending platform are granted on two conditions. Either by keeping virtual assets such as cryptocurrencies or real-world assets such as real estate as collateral.
Interestingly, the lending platform usually relies on smart contracts (built on the Ethereum blockchain) to enforce the terms and make the whole process of lending and borrowing seamless.
A smart contract is a self-binding contract with terms and conditions laid out in the form of lines of code for all the parties involved. The code and terms and conditions of the smart contract exist across a decentralized and distributed blockchain network.
Crypto Lending: Pros
- Crypto lending is quite accessible to all stratas of the society. You don’t need to open a bank account, assess your credit score ratings, or even factor in your income.
- It is an automated process that doesn’t require any effort. Especially on automated lending platforms, you can earn lending dividends without doing anything.
- Crypto lending is safer than p2p lending Since the loans are backed up by crypto assets as collateral, Crypto lending is considered to be much safer and liquid than P2P lending.
Crypto Lending: Cons
- Crypto assets are known to be very volatile. Hence, the lender and borrower need to be very careful in their risk assessment.
- With a spate of hacking attacks and cases of crypto theft, the state of security in crypto lending platforms is constantly under scrutiny.
Crypto Lending: Market size and Growth Forecast
A recent report published by the Global Market Insights estimates that the burgeoning crypto lending market is expected to bloom in the post-pandemic era once the current global economic disruption is history. As more and more crypto holders realize the immense potential of their holdings as a lucrative collateral with guaranteed ROI, the crypto lending market size could climb new highs in the next 2-3 years.
Most savvy crypto holders do want access to native fiat currency while still holding onto their virtual crypto assets. Hence, they can allocate their crypto supply and easily collateralize fiat loans on the go.
How to Invest in Crypto Lending?
Before you embark on lending your first crypto asset, it is pertinent to choose a reliable and trustworthy lending platform. Crypto-lending platforms such as Youhodler are usually of three types: centralized, automated or decentralized.
Centralized platforms allow both the lender and borrower to agree on the important details of the terms of the loan. However, centralized platforms also handle the management and transfer of the loans. The interest rate on lending on such platforms varies between 2% to 8%.
Decentralized platforms, on the other hand, eliminate the dependance on intermediaries in the handling of the loan.
Crypto Lending Investment
As you may be aware, cryptocurrencies are super volatile. There can be world of difference in the value of your digital assets when you are buying and cashing out. Hence, you need to exercise due caution and conduct thorough market research to assuage the risk of capital loss. First and foremost, as an investor you need to suss out the collaterals offered against the loan. Usually, when there is a smart contract enforcing the lending, the collateral is worth more than the value of the loan.
As we mentioned earlier, the collateral can be in the form of a cryptocurrency such as Bitcoin, Ethereum, Litecoin, Monero, Cardano, etc. or even real-world asset such as real estate.
Most crypto lending platforms in their smart contracts enforce a maximum LTV (loan-to-value) ratio of up to 60%. So, borrowers receives a loan that is 60% or less than that of the collateral asset’s value that they have mortgaged.
However, please note that cryptocurrency collaterals may change in value at point in time due to their volatile nature. Henceforth, to circumvent loss of investment, lender must factor in this aspect and assess risks involved carefully.