Crypto Lending Guide – Forbes Advisor

Decentralization is a core virtue of cryptocurrency. In the crypto society, decentralized finance (DeFi) describes the growing market for financial products and services built on the blockchain.

Crypto lending has become one of the most successful and widely used DeFi services, and many crypto exchanges and other crypto platforms offer lending and lending services. Investors deposit cryptocurrencies, which the platform lends to borrowers in exchange for interest payments.

What are cryptocurrencies?

Crypto lending is a decentralized financial service that allows investors to lend their crypto holdings to borrowers. Lenders then receive regular crypto interest rates, similar to interest payments earned on a traditional savings account.

Crypto-lending platforms can be either centralized or decentralized, and lenders may be able to obtain extremely high interest rates – up annual percentage returns (APYs) of 15% or more – depending on the platform and other factors.

Borrowers can use cryptocurrency lending platforms to secure cash loans by using their cryptocurrency as collateral.

Cryptocurrencies can be an attractive option for both lenders and borrowers, but the recent turmoil in the cryptocurrency market underscores the enormous risk involved in the industry.

How do cryptocurrencies work?

Lending platforms for cryptocurrency are like intermediaries that connect lenders to borrowers. Lenders deposit crypto in high-interest lending accounts, and borrowers secure loans through the lending platform. These platforms then finance loans using the crypto that lenders have deposited.

The platform sets the interest rates for both lending and borrowing, so that it can control net interest margins.

Interest rates vary from platform to platform and from cryptocurrency to cryptocurrency. Platforms may also charge fees for their services or offer higher rates to lenders who are willing to unlock crypto for a certain period of time.

Centralized cryptocurrency lending involves relying on a company or other entity to monitor and simplify the lending and lending process. Borrowers and lenders register accounts, and borrowers can apply for loans.

Lenders and borrowers can link their crypto wallets to a decentralized crypto-lending protocol, which automatically facilitates the lending and lending processes using smart contracts.

A smart contract is a code block that runs automatically on block chain networks when certain conditions are met.

Crypto-lending platforms

Current rates on popular crypto-lending platforms suggest that lenders may have much higher annual percentages (APYs) than they can expect on most high-interest savings accounts. For example, Gemini announces that with Gemini Earn, users can receive up to 8.05% on more than 40 crypto.

Centralized platforms, such as BlockFi and Nexo, integrate Know Your Customer (KYC) and regulatory protocols against money laundering to limit risk.

However, not all crypto exchanges offer crypto lending, especially in the United States

Binance.US, for example, does not offer crypto lending services compared to its parent company Binance. U.S. regulators have thoroughly scrutinized crypto exchanges and lenders.

The US Securities and Exchange Commission (SEC) is working with crypto exchanges to develop a comprehensive set of regulations for the cryptocurrency market.

Popular decentralized crypto-lending platforms include Aave, Compound, dYdX and Balancer. These platforms use smart contracts to automate loan payments and returns, and users can deposit collateral to receive a loan if they meet the relevant requirements automatically.

Advantages and disadvantages of crypto lending

Cryptocurrencies have several advantages over traditional bank loans. First, crypto borrowers can secure a loan without a credit check, and make loans available to borrowers who may not be eligible for a bank loan.

Borrowers can often secure a crypto-supported loan at a lower interest rate than a bank loan, another advantage of a crypto loan.

Crypto lenders can generate passive income on the crypto portfolio at rates that are generally much higher than the interest rates on savings accounts. It can also be a more flexible alternative to crypto staking, which involves unlocking the crypto and mortgaging it to a blockchain security protocol.

Unfortunately, Glenn Huybrecht, vice president of operations and chief operating officer of Cake DeFi, says that crypto borrowers must also understand the risk they are taking.

Institutional borrowers usually make an agreement on individual terms with the crypto loan companies. This is how it went south for Voyager Digital and BlockFi. These cryptocurrencies lent hundreds of millions of dollars in cash and Bitcoin (BTC) to the hedge fund Three Arrows Capital (3AC), and they were exposed when 3AC defaulted. 3AC filed for Chapter 15 bankruptcy on July 1st.

Voyager Digital, BlockFi and Celsius are just three examples of cryptocurrency borrowers struggling with serious liquidity crises. Voyager Digital recently filed for Chapter 11 bankruptcy protection. Celsius is facing insolvency. The Vermont Department of Financial Regulation said July 12 that they believe Celsius is “deeply insolvent” and has no liquidity to meet its obligations.

“Some lenders have been very generous with low security requirements, which then put them in hot water when one of their customers defaults,” says Huybrecht.

The Federal Deposit Insurance Corporation (FDIC) typically insures up to $ 250,000 per savings account per member bank. However, Jae Yang, founder of the cryptocurrency exchange Tacen, says that the decentralized nature of cryptocurrencies means that there is no government security network.

“Because crypto deposits are not insured by any federal insurance company, borrowers risk losing their money if the platform provider goes insolvent,” says Yang. “In recent weeks, we have seen this risk unfold in real time, with DeFi lending platforms such as Celsius, Babel and Vauld stopping withdrawals due to ‘extreme market conditions’ and leading to a cascade of downstream problems in the process. ”

Dikemba Balogu, a chartered financial analyst and financial adviser for Genius Yield and Genius X, says that crypto borrowers must also be prepared for a unique set of risks, including high liquidation risk.

“Decentralized lending with cryptocurrencies usually requires the borrower to deposit up to twice the value of the loan requested or have a loan-to-value ratio (LTV) of 50%,” says Balogu.

“Settlement triggers are built into the contract, for example an LTV greater than 75%, [which] would lead to the automatic liquidation of the borrower’s collateral to ensure that the lender gets the principal back. “

Things can get even more messy when sudden price falls and illiquidity in the market prevent the lending platform from selling the borrower’s collateral quickly enough and high enough to cover the lender’s principal, which could potentially lead to losses for both borrower and lender.

The bottom line

If you are considering lending or lending crypto, you should fully understand the vulnerabilities associated with their preferred crypto lending platform.

You should also understand the details of your lending account or loan terms and the general risks associated with the volatile and loosely regulated cryptocurrency market.