What Is Crypto Lending?

As the name implies, crypto lending is a financial service that involves lending cryptocurrencies to earn interest. Through lending, you generate passive income on your cryptocurrencies rather than leaving them to collect dust.

Depending on where your interests lie, you can lend your cryptocurrencies on a CeFi or DeFi platform. Thanks to the low barrier to entry and the high interest rates, crypto lending is going mainstream. 

Summary of Important Points

• Crypto lending refers to depositing cryptocurrency savings on a DeFi or CeFi platform to earn interest.
• In CeFi lending, a centralized platform like Binance Earn or BlockFi mediates the transactions. 
• DeFi lending is overseen by smart contracts, facilitating peer-to-peer crypto lending. Some popular DeFi lending platforms are Aave and Compound.
• Over-collateralization, market fluctuations, lock-up period, and the lack of regulations are some of the disadvantages of crypto lending. 
• On the bright side, there is no documentation or KYC requirements. Crypto lending is open to all.

How Does Crypto Lending Work

There are no fixed rules as to how crypto lending should work. Being a relatively new service, it is still undergoing experiments. Centralized and decentralized platforms offer crypto lending programs with different working mechanisms, features, and interest rates.

CeFi Lending 

Binance Earn and BlockFi are some of the most credible bitcoin lending sites. If you have idle cryptocurrencies in your wallet, you can lock them up on these platforms for a fixed or flexible period of time to generate interest. 

While Binance lends your funds to margin traders, BlockFi grants loans to crypto businesses to fund their operations. BlockFi also offers bitcoin-backed loans without prepayment penalties or fees. KuCoin exchange has relatively higher crypto lending rates for fixed-term deposits. In addition to margin traders, the funds are lent for personal use. It’s interesting to note that platforms like Nexo offer daily compounded interest to lenders. Nexo too grants collateral-backed loans to individuals and institutions. 

If borrowers fail to pay back the money, their collaterals are liquidated to pay interests to lenders. The key to sustainability in crypto lending is over-collateralization.

DeFi Lending 

DeFi lending platforms like Aave and Compound host money markets for different tokens. You can add your idle tokens to these pools and generate passive income. These are transferred to smart contracts, which will then unlock them for borrowers. 

For example, you are lending some ETH on Compound. In return, Compound sends CTokens to you (CETHs).  The number of CTokens you receive depends on the exchange rate specific to each token. These ERC-20 tokens accumulate interest over time and can be used on compatible platforms. But bear in mind, you need them to redeem your deposited assets. You could say they act as your lending key. When it comes to Aave, ATokens are pegged to the value of the deposited tokens at an equal ratio. 

In DeFi too, loans are overcollateralized to eliminate chances of failure. However, flash loans are unsecured crypto loans designed for developers. They let you borrow without any hassle, given that you return the liquidity within one transaction block.

Pros and Cons of Crypto Lending

Pros

• One of the main reasons why people opt for blockchain lending despite over-collateralization is to avoid selling their cryptocurrencies.
• There is little to no paperwork involved. 
• Your credit score is not a parameter on most crypto lending platforms. 
• The high interest rates, while a turn-off for borrowers, work in favor of lenders. 

Cons

• The erratic fluctuations in the crypto market can sabotage your calculations, whether you are a borrower or a lender. 
• Fixed-term deposits won’t let you seize spontaneous market opportunities.
• More importantly, crypto-backed loans aren't insured. In the event of a security breach, you are on your own. 

Legal Considerations of Crypto Lending 

Regulations concerning crypto lending can vary across different jurisdictions. Make sure you have a good grasp of the rules before lending or borrowing crypto assets. Keep track of the taxation rules to avoid last-minute dilemmas. 

Since there is little clarity on crypto regulations and governments are still figuring out the market, due diligence can go a long way in securing your assets.