Crypto investors are increasingly discovering crypto lending as an attractive way to generate additional returns. But how do you actually lend cryptocurrencies, and what risks are involved?
Crypto lending is a crypto-based loan, with the lending transaction usually being processed through special lending platforms that bring lenders and borrowers together. Unlike traditional lending marketplaces, lenders cannot choose who they lend their money to. Instead, with crypto lending, they make their coins available to an exchange, which then lends them to other users of the respective platform. The lender therefore has no insight into a loan project or the borrower’s background.
Such crypto loans are usually overcollateralized, meaning the borrower must deposit a larger portion of the cryptocurrency than they are allowed to borrow. But why would they borrow a cryptocurrency if they already own it? The answer to this question is that such a loan allows them to leverage price gains (but also price losses).
The parties agree in advance on the number of coins to be loaned and the duration of the loan. Depending on the chosen exchange, flexible periods are possible, but also terms ranging from seven days to several years.
Attractive Return
The interest rate is also determined, with this percentage depending on the demand for crypto loans, the platform used, the cryptocurrency being lent, and the number of coins provided. According to “Coinratgeber,” returns in the mid-single-digit percentage range are not uncommon for the lender. This is significantly higher than with an overnight deposit at a traditional bank. Even double-digit returns are possible.
After the loan period expires, the lender receives their coins back plus the contractually agreed interest. The technical platform receives a small portion of this interest.
Numerous Risks
As with loans in traditional fiat currencies, the borrower’s credit risk must be considered. To mitigate this risk, borrowers must deposit their own assets as collateral when using crypto lending. If they are unable to repay a loan, these so-called securities can be liquidated to reduce or, in the best case, offset the lender’s loss.
However, other cryptocurrencies usually serve as collateral, and their value can fluctuate significantly. This poses a risk for the lender, but for the borrower, it has the advantage of not having to sell their own coins and thus continuing to benefit from any price fluctuations.
Additionally, crypto lending poses additional risks. Given the high volatility of the crypto market, coins can suffer significant price losses in a very short period of time, meaning that the investment may even be worthless by the time it is repaid.
A total loss can also occur if the exchange used is hacked or goes bankrupt. According to the saying “Not your keys, not your coins,” even storing your own coins on a centralized crypto lending platform poses a risk because the coins are then no longer under your control.
