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As the world of crypto becomes more mainstream and less fringe, the available services and options are growing.
For example, crypto borrowing and lending are becoming more popular. Platforms like Nexo support crypto borrowing and lending, and on the lending side of things, it creates an opportunity to earn passive income.
So what exactly is crypto lending, and how does it work?
The Basics of Crypto Lending
Cryptocurrencies like Ether and bitcoin are digital assets with many uses. Of those uses is securing a loan.
If you get a crypto loan, you’re pledging part of your crypto holdings as collateral for what you borrow.
Like a traditional secured loan, such as a mortgage, you maintain ownership of your cryptocurrencies while you’re paying down the loan. If you don’t pay down the loan as you agree to, then you could lose your collateral.
You can usually borrow up to 50% of your digital asset balance, but some platforms will let you borrow up to 90% of the value of your portfolio.
There are restrictions on what you can do with the assets, and if you default on your debt or the price of your crypto goes down significantly, you could end up defaulting on the loan and losing your assets.
You might be able to get your loan funded in U.S. dollars or in certain cryptocurrencies depending on the platform.
The types of cryptocurrencies you can use to secure your loan are limited.
For a borrower, the benefits of a loan backed by crypto include low interest rates since they’re secured by an asset. The ownership element can be a good thing too. You can get money if you need it, but you’re not forced to sell your holdings to do so.
The funding can be quick—once you’re approved, you might get funding within a few hours, and there’s usually not a credit check.
The downsides include high minimum borrowing requirements and short repayment terms.
Platforms vary, but you may not have enough holdings to get the minimum loan amount a lender offers. On BlockFi, to provide an example, the minimum loan amount is $10,000. If there’s a 50% maximum loan-to-value ratio, you’d need at least $20,000 in holdings for approval.
As far as the short repayment terms, crypto loans usually have terms of no longer than 12 months. You don’t have much time to repay the loan as a result.
Margin calls are also a big threat. A margin call is what happens when the value of your collateral drops below a threshold the lender sets. So, if your crypto asset value goes down by a lot which often happens because of the volatility, you might have to deposit more money into your account to retain your assets. If you don’t, the platform could sell your holdings.
While your loan is outstanding, you can’t use or trade your assets.
What Should Investors Know?
If you’re a crypto investor, you can get involved with lending as a way to get immediate returns without selling anything.
If you’re willing to lend out your crypto, you can earn annual percentage rates that are in the double-digits.
Not all crypto exchanges allow for lending it out, and every exchange is different, with a lot of variance in interest rates depending on the type of coin you loan out and the type of loan.
If you lend coins like bitcoin, they’re very volatile. The amount you earn in interest can be unpredictable as a result. If there’s a change in the price of crypto, it’s going to affect your income.
If you’re an investor who wants to use fixed lending services, prepare yourself for sudden value changes. You won’t be able to trade coins tied up for set time periods.
Stablecoins currently offers among the highest interest rates, ranging from 5-25% on most exchanges. The rates for bitcoin and Ethereum can be significantly lower.
What Are the Risks of Lending Crypto?
If you’re an investor, your returns are never guaranteed, and you’re not going to have the same protections on a crypto exchange as you do with an FDIC-insured bank, for example.
There are some exchanges, including Gemini, that vet borrowers through a rigorous risk management process, but others don’t.
Some exchanges do claim lenders can get full repayment through the insurance funds they offer if a borrower defaults.
Exchanges can and do fail, though, and coins can pump and dump. High returns that can come with investing through lending crypto mean high risk.
You shouldn’t invest money that you need in the short-term and can’t afford to lose in this way.
Be mindful of fees as well. Most exchanges will charge a fee for buying, selling, and withdrawing crypto, so these can take a portion of your earnings.
How Do You Lend Your Crypto?
For someone interested in crypto lending, known as Decentralized Finance, you go through a thirdparty connecting you with borrowers. The lenders are the first part of crypto lending. The second party is the platform where the transactions happen. The borrowers are the third party in the process, and they’re the ones who receive the funding.
The borrower goes to the platform to request a loan. The borrower stakes the crypto collateral once their request is accepted by a platform. Then, the borrower can’t get back the stakes until the loan can be fully funded back.
Lenders automatically fund the loan on the platform, which you can’t see as an investor. Then, you receive regular interest as payment.
Once the borrower pays off the entire loan, they get back the crypto collateral.
The biggest thing to do if you want to lend your crypto is to find a reputable platform and think of the exchange you want and the coins you want to lend. The coins you want to lend will be based on the market conditions, your risk tolerance, and the returns you’re hoping to get.
If you have crypto sitting in a wallet that you don’t plan to sell, lending is a way to put it to work and get some value over time.
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.