- Crypto lending is the process of lending cryptocurrency to borrowers and making regular interest payments.
- Crypto lending is a risky process because of the volatility of crypto assets.
- The crypto lending industry also provides different types of loans to the borrower.
The crypto lending industry faced losses and downfall last year and the market is trying to rebuild. The process is not so unexpected and impossible as crypto assets are highly volatile and hence, crypto lending industries have to be aware of the future consequences. They need to follow some approaches, such as an increase in transparency, diversification of lending, etc., that can mitigate risks.
It is the process of lending cryptocurrency to borrowers to get regular interest payments in return. The payment is made in the form of cryptocurrency that is compounded on a daily, weekly, or monthly basis. There are two main types of crypto lending platforms; decentralized crypto lenders and centralized crypto lenders that offer access to high interest rates (sometimes up to 20% APY, or annual percentage yield).
In both cases, borrowers need to deposit collateral to access loans. The crypto lending process has two components; deposits that earn interest and cryptocurrency loans. This works similarly to a bank where users deposit cryptocurrency and the lending platform pays interest. There are different types of crypto loans; collateralized loans, crypto lines of credit, uncollateralized loans, flash loans, etc.
Challenges and Needs
There are a few risks and challenges to crypto lending; margin calls (it happens when a crypto loan drops below the agreed-upon rate), illiquidity (crypto assets are deposited and become illiquid that cannot be accessed quickly), unregulated (do not offer protection just like central banks), and high interest rates (some crypto loans offer low rates, but some charge more).
Crypto lending has both pros and cons, as most loans are collateralized so lenders can make up their losses via liquidation. The cons are that collateral can drop in value and be liquidated, selling their investment at very low prices. Crypto assets come with both advantages and disadvantages. These are ideal collateral because they can be liquidated at any time (unlike real estate).
However, they carry a high level of volatility. Loans with less than 100% collateral deposits are at much higher risk. In the case of a lower loan-to-value ratio (amount of collateral relative to the amount loaned), the collateral value can go below the loan value faster than it can be sold. The crypto lending industry faces challenges.
For example, Genesis went into financial trouble due to FTX’s collapse, which forced crypto exchange Gemini to terminate the lending product in which the company was a partner. The crypto lending industry can succeed in the future with the help of a few approaches, such as the implementation of the two-account system (two-wallet system), a big push for transparency, and smart and diversified lending.
Crypto lending industries function similarly to central banks in that they borrow money and pay interest on it. The only difference is that money is in cryptocurrency here and the platform is decentralized and blockchain-based. Borrowers and investors can lend their cryptocurrency as well and they can take different types of loans, such as collateralized loans. The crypto assets are highly volatile; hence, the crypto lending industry faces risks because of the volatility.
Hence, transparency, security, smart moves, and diversification should be increased in the crypto lending industries so that companies and organizations do not collapse and face losses in the millions of dollars, which can create problems for the borrowers and investors and eventually the crypto market.