Defi Crypto lending is a Defi service that allows crypto owners and investors to lend their cryptocurrencies in return for interest, also known as crypto dividends.

Lending and borrowing are one of the most elements of any financial system. Most people and organizations, at some point, are exposed to borrowing, usually by taking a student loan, car loan or mortgage.

In conventional financial systems, the process is quite simple. Lenders, aka depositors, provide funds to financial institutions that, in turn, lend out the money to borrowers in return for interest on their final payment. 

In such a case, borrowers or loan takers are willing to pay additional interest on the amount they borrowed in exchange for having a lump sum of money available to them immediately. In conventional financial systems, institutions such as banks facilitate the borrowing and lending process.

However, in a Decentralized Finance ecosystem, the process is very different. Unlike banks, DeFi facilitates peer-to-peer lending and borrowing among network users. 

In this article, we will explore crypto lending and how you can lend or borrow crypto assets. 

What is crypto lending?

To lend out, their crypto investors have to deposit their assets in a pool of cryptocurrencies and stablecoins, often referred to as a market maker. The market maker then determines the demand and supply of crypto assets for loans to compute the crypto lending interest rates.

It is already known that cryptocurrencies are becoming more and more popular as a payment method. Furthermore, most investors also view them as a great investment opportunity as such investors are more willing to hold on to their assets rather than sell them. Crypto lending offers investors more liquidity without selling their crypto assets. 

With crypto lending, borrowers also have the chance to stake their cryptocurrency as collateral for a loan. In most crypto lending platforms, loans issued to borrowers are usually over-collateralized. This means that the amount allocated as a loan is always less than the collateral a borrower has put up. Most platforms allow borrowers to take out about 50 – 75% of their collateral as a loan. 

The two types of crypto loans

Cryptocurrency loans can be divided into two broad categories:

1 – Custodial crypto loans

Custodial crypto loans are governed by a central authority controlling the collateral. Moreover, the lending terms are governed by a central authority that holds the private keys to the collateralized assets. As such, they have total control of the assets and have the power to confiscate assets or even halt withdrawals. An excellent example of such a case is the recent meltdown of the Celsius Lending platform

Currently, more than 80% of crypto lending platforms are custodial. 

2 – Non-custodial loans

Non-custodial loans, on the other hand, are issued by decentralized platforms governed by smart contracts. The smart contract includes all the lending terms, crypto lending interest rates, and rules. Plus, the smart contract is governed by the network users, not a central authority. 

How does Defi Crypto Lending cryptocurrency lending work?

The crypto lending ecosystem is comprised of three main parties. The lenders represent the first party and could be investors wanting to grow their crypto assets or crypto hodlers waiting for a value boost to sell their crypto.

The second party in the crypto lending platform is the lending platform or smart contract, which facilitates the lending process. Lastly, we have the borrowers who could be individuals or businesses seeking funding. 

The crypto lending process is quite simple and happens in the following steps.

  1. The borrower joins a crypto lending platform (centralized or decentralized)
  2. As soon as the borrower’s loan request is approved, the borrower stakes the specific crypto collateral required to take out the loan.
  3. Through the lending platform, the lender automatically funds the loan. This is an automatic matching process that happens in the background.
  4. Investors, or lenders, will start receiving regular interest payments.
  5. When the borrower manages clear the loan, the collateral is released, and the borrower can choose to withdraw it or take out another loan. 

Every platform and smart contract has its way of doing things. However, this is how the general process unfolds. 

What are the rates for crypto lending & borrowing?

DeFi Crypto Lending Work

Like conventional banks, different crypto lending platforms offer different rates. So the return you get for lending out your crypto assets depends on the platform you choose. 

In crypto lending, there is usually an average yearly yield to be expected. For crypto assets, the interest rate can be 3% to 8%, while for stablecoins, it can be from 10% to 18%.

The interest rates are also different according to the lending period. Furthermore, each lending platform offers an interest rate that correlates to the risks involved. Therefore, doing your research before committing to one platform is essential.

How to lend your crypto assets

Lending your crypto assets is relatively straightforward. All you need is a digital wallet or crypto exchange account, crypto assets and a reliable crypto lending platform. Unlike the conventional banking system, you do not have to provide a credit score or personal information. Your name, address, occupation, and telephone number will suffice.

When you have all the above, you must decide the exchange rate you want for your crypto assets, whether you want to make a fixed rate that stays constant during the loan period or a flexible rate that is subject to change depending on how the market moves, then determine the crypto coin you want to lend. Once you issue a crypto loan, you can sit back and watch your crypto balance grow as interests are deposited into your account. 

One thing to note is that you can think of crypto lending is opening a savings account. However, in this case, the interest rates are much higher, and instead of FIAT, you deposit crypto assets.  

How to borrow cryptocurrency

Like lending cryptocurrency, you also have to be extremely careful when taking out crypto loans. You have to ensure that you choose a trustworthy platform that has been tested and approved by the crypto community.

Once you find a reliable platform, you must confirm that they lend out the crypto coin you wish to borrow. Also, go through the annual interests of the crypto you want to borrow. This can help you save your funds in terms of the interest you pay for the loan.

Finally, it would be best if you considered the loan-to-value ratio. Different platforms have different ratios. Some platforms allow you to take out only 50% of your collateral, while others allow you to take out up to 75% worth of your collateral.

It would help also to consider the volatility associated with the crypto coin you want to borrow to prevent immediate liquidation. Once you have everything figured out, you can then deposit the collateral and take out the crypto loan.

Can you crypto without collateral?

Although not popular, crypto users can acquire uncollateralized loans through DeFi flash loans. Flash loans are a relatively new concept that allows traders and users on some DeFi protocols to access loans without putting up any collateral or going through any intermediaries. 

When a flash loan is issued, its rules and terms are encoded in a smart contract to ensure the borrower pays back the loan before the transaction is finalized. If the conditions are not met, the smart contract reverses the transaction to a state that it’s like it never happened. 

Is crypto lending safe?

If we consider loans in traditional financial institutions, there is always federal insurance for every loan issued. However, there is no federal insurance on any crypto assets in the crypto space. Moreover, although crypto loans are over-collateralized, there is always the risk of a crash and liquidation. 

There are two primary risks involved with crypto lending and borrowing:

1 – Technical risk

Everything in crypto trading and transactions happens in the digital world. As such, there is always a considerable risk that the smart contract may run into technical problems or become compromised by attackers. Because of this, investors stand a chance of losing their crypto assets.

2 – Forced liquidations

The crypto market is very volatile, and crypto prices can fall by more than 50% in hours. Suppose a scenario when a crypto’s price falls to a certain point that the loan-to-value ratio is too high for the lending platform to maintain.

In that case, the lending platform ends up with two options — ask the borrower to increase collateral or liquidate the borrower. This is risky for both the trader and borrower as the price might fall below the loan-to-value ratio.

The bottom line

Cryptocurrency lending is among the best ways to earn passive income for crypto holders without selling their assets. This way, your crypto assets can offer you more value in return.

However, it’s crucial to remember that the crypto lending interest, the crypto lending platform and the volatility of your crypto assets play a major role in determining your crypto dividends.

Therefore, before committing your crypto assets as a loan, do your due diligence and research.