Cryptocurrency lending allows investors to generate passive income on their crypto holdings at comparatively high interest rates. Continue reading to find out how crypto lending works and what are some of the different types of crypto loans.
What Is Crypto Lending?
Cryptocurrency lending refers to the process of temporarily transferring ownership of a crypto asset to a borrower in exchange for interest payments. Cryptocurrency lending is most commonly performed through crypto lending platforms — centralized or decentralized intermediaries that connect borrowers and lenders.
Cryptocurrency lending enables lenders to monetize their savings and borrowers to unlock the value of their digital assets by using them as collateral for a loan.
How Does Crypto Lending Work?
Both centralized and decentralized cryptocurrency lending are similar in nature to lending in traditional finance.
A borrower deposits collateral, receives funds from a lender, uses these funds at their discretion, and then repays the loan plus interest until the end of the repayment term. In case the borrower defaults on the loan or the value of the collateral falls below a predefined requirement, the lender can seize the collateral and sell it to recoup their losses or, in other words, “liquidate.”
While centralized cryptocurrency lending involves trusting a centralized third party to control and facilitate the movement of money between borrowers and lenders, decentralized lending platforms rely on smart contracts to do so.
Centralized lending platforms provide their users with a more regulated environment compared to decentralized ones. However, Defi platforms are often able to offer higher yields, faster approvals, and greater transparency than centralized platforms.
Both centralized and decentralized crypto lending platforms offer access to comparatively high interest rates, sometimes up to 20% annual percentage yield (APY).
Well-known Crypto Lending Platforms
Centralized platforms
Nexo
Launched in 2018, Nexo is a crypto lending platform that enables users to borrow against their holdings, earn interest on deposits as well as trade and convert cryptocurrency. The Nexo ecosystem is powered by its proprietary token NEXO, an ERC-20 token on the Ethereum blockchain. In 2022 Nexo launched the Nexo Card, a “first-of-its-kind crypto-backed Mastercard card.”
Blockfi
BlockFi is a US-based crypto finance company founded in 2017 that provides financial services for both private and institutional clients. Same as Nexo, it offers interest-earning accounts, crypto-backed loans, and trading services.
Binance Earn
Binance Earn is a crypto lending platform created by the world’s largest cryptocurrency exchange Binance. Binance Earn allows users to earn interest on their holdings by lending them to margin traders on Binance. “Locked products” on Binance Earn lock users’ funds for a specific period of time, while “flexible products” offer the flexibility to redeem the funds at any time. As one could expect, locked products provide higher interest rates than flexible products.
Decentralized platforms
Aave
Aave is an open-source decentralized finance protocol that allows users to borrow and lend cryptocurrencies through non-custodial liquidity markets. Aave works by creating liquidity pools, where lenders deposit their funds to earn interest, and borrowers can take out loans. To govern its operation, Aave has created a decentralized autonomous organization (DAO), where holders of the Aave governance token AAVE can propose and vote on changes to the protocol. Aave became the first ever Defi lending protocol when its mainnet was launched as ETHLend in 2017 on the Ethereum blockchain.
Compound
Founded in 2017, the Compound decentralized crypto lending platform works similar to Aave. It also uses liquidity pools to allow users to borrow and lend cryptocurrency and earn interest on their holdings. Compound’s native token, COMP, is used to govern the platform and is an ERC-20 standard token on the Ethereum blockchain.
dYdX
dYdX is a decentralized non-custodial cryptocurrency exchange focused on bringing advanced financial products to the DeFi space. dYdX supports spot, margin, options and perpetuals trading as well as lending and borrowing for a variety of assets. The platform is deployed on the Ethereum blockchain.
Types of Loans in Crypto
Collateralized loans
As mentioned above, in collateralized crypto lending borrowers are required to pledge their existing crypto assets as collateral to receive a loan. Collateralized loans are much less risky for lenders than unsecured ones and therefore offer cheaper rates for borrowers.
Most crypto lending platforms require loans to be over-collateralized, i.e. backed by a greater value than the value of the loan. With collateralized loans, users are typically allowed to borrow up to 90% of the collateral provided. The metric used to express the ratio of a loan to the value of the collateral is commonly called loan-to-value or LTV.
How collateralized loans work:
- A borrower deposits collateral into a lending protocol
- If the loan is approved, the funds are transferred to the borrower
- The borrower pays back the loan with interest until the end of the repayment term.
- The collateral is released to the borrower once the loan is paid off
Crypto line of credit
A crypto line of credit is a type of collateralized loan that allows users to borrow up to a certain percentage of the collateral deposited and pay interest only on the funds borrowed.
How a crypto line of credit works:
- A borrower deposits collateral into a lending protocol
- The protocol assesses the value of the collateral and sets the credit limit
- The borrower is able to withdraw funds up to the credit limit provided
- The borrower pays interest on the funds they’ve borrowed.
- The collateral is released to the borrower once the loan is paid off.
Uncollateralized loans
Uncollateralized crypto loans do not require borrowers to put up crypto assets as security for the loan. To receive this type of loan, borrowers typically need to fill out an application with a provider, pass identity verification, and complete creditworthiness. The advantages of such loans are that they make the crypto lending system accessible to the masses and enable more efficient use of value in the industry (since they avoid “locking up” capital in the form of collateral).
How uncollateralized loans work:
- A borrower submits their personal information to a lending protocol
- The protocol assesses the borrower's creditworthiness
- If the loan is approved, the funds are transferred to the borrower
- The borrower pays back the loan with interest
Flash loans
Flash loans are a type of uncollateralized crypto loans that are borrowed and repaid by the same blockchain transaction. They are usually facilitated by smart contracts — self-executing pieces of code, stored on the blockchain. Flash loans are often used for cryptocurrency arbitrage transactions among some other applications.
How flash loans work:
- A borrower builds a contract that requests a flash loan from a loan provider
- The contract executes the instructed steps, requesting and paying back the loan plus interest and fees within the same blockchain transaction.
Advantages and Disadvantages of Crypto Lending and Borrowing
Pros:
- Fast approval and funding. Lending and borrowing on cryptocurrency platforms takes significantly less time than at traditional financial institutions;
- No credit checks. A crypto loan can be issued without the platform running a credit check;
- Low interest rates. Borrowers can often get crypto loans at an interest rate below 10%;
- Higher yields for lenders. Compared to traditional savings accounts crypto lending platforms can offer considerably higher yields for lenders.
Cons:
- Volatility risk. Due to the volatile nature of the crypto markets, a lender’s deposit or a borrower’s collateral can significantly depreciate while locked up in a crypto lending platform.
- Technology risk. Crypto lending platforms can be prone to hacks and other online attacks, which lead to the loss of lent funds or collateral.
- Insolvency risk. While traditional banks are largely required by law to maintain a certain level of liquidity, cryptocurrency lending platforms are not. If a cryptocurrency platform goes bankrupt, in some cases its users may not receive compensation, and unfortunately, there is currently no legal framework in place to prevent this.
How to Get a Crypto Loan
To apply for a crypto loan users need to sign up for a centralized lending platform or connect their digital wallet to a decentralized lending protocol. Then they usually deposit collateral and select a type of loan by the LTV, loan amount, and repayment term they are comfortable with.
How to Lend Crypto
The process of crypto lending for an investor is relatively straightforward. They typically need to deposit funds to a crypto lending platform and choose one of the available investment products to start earning yields on their investment.
FAQ
What are some of the uses for crypto loans?
A crypto loan can be used at a borrower’s discretion, usually without any restrictions from the lender, similar to a personal loan.
How to secure a crypto loan?
To apply for a crypto loan a user needs to create an account on a centralized or a decentralized lending platform, where they will be offered to select a type of loan based on their preference for the amount, LTV, and the repayment period.
What are some of the popular crypto lending platforms?
Some of the best-known centralized lending platforms at the moment include Nexo, CoinLoan, and Lend. Aave, Compound, dYdX, and Balancer are among the most popular decentralized lending platforms.
What is the difference between centralized and decentralized lending platforms?
On centralized lending platforms, all the transactions and operations are controlled by a centralized entity, while decentralized lending platforms rely on smart contracts to facilitate the movement of money between borrowers and lenders.
