Crypto enthusiasts are often encouraged to “HODL” their assets — keeping them safe in a wallet until the price of their chosen currency appreciates. But just like you’d feel uneasy about leaving your cash sitting around in a bank with a low interest rates, a common question is this: how can you get your digital currency to grow?
This is where crypto lending comes in. Not only can it enable savers to receive interest on their stash of Bitcoin, but it enables borrowers to unlock the value of their digital assets by using it as collateral for a loan.
Crypto Lending Explained
When investing, one of the biggest challenges can be cashflow — and there’s nothing worse than having to raid the capital you’ve got tied up in assets for short-term costs and lack liquidity.
Let’s imagine that Steve has 2 BTC. He doesn’t want to sell any of it because he’s confident that prices are going to appreciate substantially. Steve’s also worried that, if he does end up offloading his crypto, there’ll be a risk that he ends up with less Bitcoin when he buys it back at a later date.
Crypto lending platforms can come to the rescue here. Typically, Steve will be given the opportunity to use his Bitcoin as collateral — and receive a loan in stablecoins. Owing to the volatility of digital assets, he’ll normally have to “overcollateralize,” meaning he’ll have to lock up more BTC than the overall value of the funds he’s receiving.
Once he’s repaid back the loan, plus interest, his crypto will be returned in full — and he’ll make a handsome profit if BTC ended up appreciating as he predicted. His crypto would only be at risk if he failed to keep up with the loan’s terms, or if the value of the Bitcoin held as collateral fell below the value of the loan he received.
So… when did crypto lending start to take off? Well, it was right around the time that economies came to a screeching halt in 2020 due to the pandemic. This saw the interest rates get slashed, and lending for big-ticket items take a nosedive. Many people were looking for other ways to make their assets work for them. Crypto loans became a quick and easy way to gain access to fiat currencies almost instantly, all without selling it. All of a sudden, the days of Bitcoin and Litecoin gathering dust in an exchange or cold storage were numbered.
Unlike personal loans or credit cards, collateralized loans are much more secure for the lender, which enables the borrower to take advantage of cheap interest rates.
Cryptocurrencies can be very volatile, which is why these loans are almost always overcollateralized. This provides insurance for the lender should the price of crypto plummet. However, this can negatively impact the borrower — especially if the platform they use requires them to always maintain their loan-to-value (LTV) ratio.
One of the major bonuses many see in a crypto loan is that, unlike traditional banking, you won’t be subject to your credit score being assessed. This means that lending is more accessible to people who don’t have a financial history, underbanked consumers who don’t have a bank account and self-employed workers who struggle to access credit because their fluctuating earnings don’t meet a bank’s strict lending criteria. Repayments can also be more flexible.
And whereas it can take several days for loans to clear in the old-fashioned financial world, BTC loans can be practically instant. You’ll also be able to make your assets liquid without triggering a taxable event — and you can adjust the loan to suit your needs. Users can also switch between crypto assets, so you could deposit Ether and borrow Tether, all on the same platform.
How to Get a Bitcoin Loan
If you like the sound of a BTC loan but you’re not sure where to begin, you have two main options — centralized and decentralized lending platforms.
Centralized ecosystems such as BlockFi, Nexo and Binance have to follow certain rules and procedures to be compliant. You’ll have to create an account by signing up for your chosen platform and go through Know Your Customer procedures that are in place to prevent fraud and money laundering.
These platforms typically have protocols in place to ensure that your collateral is safe. Some protect crypto assets via insurance or keep the majority of the digital assets in their custody in cold storage, meaning they’re away from an internet connection.
Centralized crypto lending platforms will still record all deposits and withdrawals using blockchain technology, visible to everyone, and offer a great way to earn interest on Bitcoin, alongside many other cryptocurrencies and stablecoins like USDC and DAI. To put it in perspective, the best USD savings account rates around barely scrape past the 1% APY mark, yet many platforms offer up to 8% on crypto interest rates. It’s worth doing your homework to get the best deal — and avoid paying above-average fees.
There’s more paperwork involved in getting a loan through a CeFi platform, but the fact that there’s a regulated environment — and a customer service representative who’s just a click or a phone call away — could make these platforms more appealing to traditional investors.
The second option for crypto lending would be to go via a decentralized platform, known as DeFi for short.
Crypto Loans Without Collateral
Unsecured crypto loans, also known as crypto loans without collateral, are innovative new financial services that provide short-term liquidity, and can be paid back in fiat or cryptocurrency. The idea is to borrow funds directly from a lender using a cryptocurrency as collateral instead of traditional assets such as property and gold. If you are interested in an unsecured crypto loan, or a crypto loan with no collateral, there are a number of platforms that make that possible. For example, flash loans are a popular example of crypto loans without collateral, but they do require a high level of crypto knowledge to navigate.
Before moving forward on any crypto loans without collateral, be sure to do your own research and make sure that the platform is legitimate.
What Is DeFi Lending?
DeFi lending platforms are completely decentralized, and transactions are handled by code rather than by people. On services such as Aave, Compound and dYdX, smart contracts use algorithms and protocols to automate loan payouts.
Anyone can access the protocols on a decentralized finance platform, which makes them completely transparent, as nothing can be hidden on the blockchain. Unlike CeFi platforms, there’s no middleman or financial regulator, which means you don’t have to go through a verification process like KYC. However, DeFi interest rates for crypto lending often pale in comparison to what centralized rivals can provide.
Getting a BTC or ETH loan — or any other type of crypto loans on a DeFi platform — is very quick as you won’t need to pass any kind of due diligence. Thanks to smart contracts, all a user will need to do is apply for the loan and then send the crypto they want to use as collateral to a specified wallet associated with the lending platform.
The users of decentralized lending platforms can apply for a loan of any size without having to confirm their identity to a third party. Loans can be supported in stablecoins such as USDC, fiat currencies, or cryptocurrencies such as Ethereum or BTC.
On many centralized and decentralized lending platforms, you’ll have the option to open up a savings account using your crypto, as well as trade tokens or take out loans.
With both types of lending platforms still in their early stages, it’s clear that this is an exciting space to watch. There’s a lot of room for growth, and the potential to access borrowing without the usual formalities could be a game changer for both the people and the financial services industry.