Cryptocurrency lending: What is it and why is it important?

Last Updated on 19 mins by Jordan

As geopolitical tensions rock the financial world and the global economy is once again pushed to the forefront of uncertainty, alternative investments and moneylending have come back to the fore. With the growing acceptance and fascination of decentralized finance (DeFi), crypto lending could be the secret weapon of funding without inflated interest rates amid economic uncertainty. In it, we explore what crypto lending is.

What exactly is crypto lending?

It may sound too simplistic, but at the core of cryptocurrency lending are lenders who are able to provide assets to borrowers such as fiat or stablecoins using their crypto assets as collateral, or vice versa where lenders provide crypto assets to borrowers who post fiat as collateral.

These are not dissimilar to secured loans, but based on blockchain. Instead of lending giants and financial firms providing lending, the peer-to-peer nature of blockchain-based assets means that any user with assets can lend and any user who needs can borrow. This opens up access to credit and credit to a much wider audience without the financial red tape found at banks and traditional financial firms.

The benefits of crypto lending

Crypto lending creates a significant opportunity for cryptocurrency markets and users to transact and leverage the currency beyond investing (or HODLing) and trading. This means the alternative asset class can be used by lenders to find a way to use their wealth as something that offers a passive way to profit beyond investing – by charging an agreed-upon interest rate, the lender makes money on the side its lending. Most cryptocurrency lending platforms offer large rewards to lenders for providing liquidity to the platform, offering up to 8% for lending stablecoins. In contrast, savings accounts in the United States generally offer less than a 1% return for keeping money in the bank.

In addition, it allows more people to borrow money without having to take out high-interest loans and locking themselves into a system designed to create debt. If you are a borrower in the crypto lending process, use some type of asset as collateral that protects you from suffering the pitfalls of the credit system.

The Risks of Crypto Lending

In a burgeoning industry, not all things can be positive for users. There are still inherent risks in cryptocurrency lending that are worth knowing about.

Ultimately, when you are a cryptocurrency borrower, you assume the risk of providing liquidity if the value of your collateral falls below the required price. This means that it is important to monitor the collateral ratio to keep it in a safe range and not lose out on the investment.

While smart contracts are intelligent at their core, they also pose a technological problem when there is a crack in the code that could lead a hacker to exploit. While blockchain-based transactions are secure and immutable once signed, if a hacker manages to attack a platform or contract before it is signed, the outcome would be unfavorable for both parties.

With decentralized platforms, discussed below, there is also the possibility that low liquidity can have a large impact on interest rates. When liquidity is provided, the credit system remains stable, however, should it fall, the platform and users are likely to face credit swings.

Using a cryptocurrency lending platform

There are two different types of cryptocurrency lending platforms:

  • Centralized lending platforms and
  • Decentralized lending platforms.

Centralized lending platforms

These work a little more like traditional fintech companies offering cryptocurrency. They tend to follow the regulations necessary for operation, such as B. Know Your Customer (KYC) protocols, and have a custody system in place. Centralized lending platforms generally offer interest rates set by the platform, which may be dictated by partners working with them, and offer higher returns to lenders of higher-performing and dominant crypto-assets like Bitcoin and Ethereum.

Decentralized lending platforms

On the other hand, decentralized platforms work with systems that work without KYC and custody services. Unlike their centralized counterparts, decentralized lending platforms tend to have fluctuating interest rates that change based on the supply and demand for assets on the platform. Users who are able to lend low-supply but high-demand assets could enjoy the gains from massive interest rates, while borrowers would suffer from more expensive fees on the borrowed asset.

Cryptocurrency Lending: What Is It and Why Is It Important? appeared first on Coin Insider.

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