Crypto enthusiasts understand that to HODL (hold on for dear life) to an asset is usually a solid way of making a profit from it. However, you might be tempted to sell if you urgently need capital. But, what do you do if your crypto assets are in the red? Rather than taking a loss by selling during a bear market, why not consider crypto lending and borrowing.
You can be an investor with crypto deposits or you can borrow using your asset as collateral. Whatever the case may be, benefitting from crypto lending requires a solid understanding of how it works.
Crypto Lending Explained
Crypto lending is similar to a traditional bank loan in that they both require collateral from the borrower in case of default. However, the hassle involved in borrowing from the bank from things like credit background checks and verification is absent in crypto lending. In fact, borrowing crypto is instant.
Crypto lending is a process where cryptocurrency investors lend crypto to borrowers in exchange for crypto dividends or interest. The crypto investor, in this case, earns passive income with their assets while the crypto borrowers use their assets as collateral to get cash or stable coins.
What Is Crypto Lending Arbitrage?
The price of a cryptocurrency like Bitcoin (BTC), Ethereum (ETH), or Ripple (XRP) can vary from platform to platform. Crypto lending arbitrage is the process of taking out a crypto loan in one platform and lending it out on another platform. The forces of supply and demand affect the price of crypto prices on different platforms. The higher the demand for a particular asset the higher the price and vice versa.
For instance, if there is an enormous dump of XRP on Binance, the price will fall drastically but if there is a low supply of an asset on the platform, it will push the price upward. This circumstance may not be true on other crypto platforms trading XRP. Therefore, to take advantage of the discrepancies in prices by instantly borrowing where the interest is low and lending out in a platform that offers a high rate of interest on the asset is what crypto lending arbitrage is, and why it is valuable.
Although the price of cryptocurrency is mostly coordinated in different networks, the general trade volume and general activities of buyers and sellers toward a particular asset in a platform play crucial roles in the price of the asset. In addition, crypto lending arbitrage can offer a high return and low risk if you understand the market and can move cryptocurrency from one service to another before the price change. Similarly, to maximize your earning, take into account the difference in the price of the cryptocurrency. The rate must be low where you wish to borrow and high where you are lending.
How Does Crypto Lending Work?
Crypto lending is similar to lending from a bank where you need collateral before you are qualified for a loan. Also, the collateral will be worth more than the amount of loan you are taking. Unlike a bank loan, however, you are not using your house or your car as collateral but your crypto asset.
For example, if you own 2 BTCs that you are holding to sell when the price rises, you can use it as collateral to borrow some stable coins, like Tether (USDT) to use in the real world. The moment you pay off your debt with interest, you get your BTCs back.
Note that the amount of Tether you will be getting will be worth a lot less than the value of your BTC during the period. This means that your loan to value ratio must correspond. Loan to Value or LTV is the amount of loan divided by the collateral amount expressed as a percentage. In this case, if the price of your BTC falls significantly less than Tether, the platform may demand that you repay the loan instantly or add to your collateral.
What Are the Benefits of Crypto Lending?
There are three parties involved in Crypto lending and borrowing, they are:
Lender
A crypto lender is also known as an investor. Due to the high volatility of the cryptocurrency market, you can loan out your crypto to avoid the risk of taking a loss while waiting for it to bull. A crypto investor earns passive income on the crypto lent. Furthermore, there is little to no risk in lending out your crypto as the loan to value ratio is usually low. So, if the borrower defaults, the collateral can be liquidated by the platform. According to Celsius, you can earn as high as 17% on your crypto investment. Other crypto platforms like YouHodler give investors 12% APY on stable coins.
Borrower
A borrower of crypto will not be able to trade their asset while using it as collateral; however, their urgent need at the time will be fulfilled. In addition, due to the instant crypto lending process without the need to go through the rigorous process of verification, you can turn to crypto borrowing during an emergency.
In the same vein, a person can be both a borrower and a lender in different platforms through crypto lending arbitrage.
Lending Platforms
Crypto lending platforms vary and they each have diverse policies and agreements for both borrower and lender. Lending platforms can be divided into two types:
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- Centralized lending platforms: These networks work like a traditional bank in some sense. They accept deposits from an investor and lend out to institutions with interest. This way they act as an intermediary between the investor and the borrower and automate payment on deposit. Some popular centralized platforms include Gemini Trust Co, BlockFi Inc, and Celsius Network.
- Decentralized lending platforms: In a traditional bank, a person can secure a loan through the bank and pay the bank back at maturity. In this case, the bank serves as an intermediary who loans out deposits from other customers or sources for money from the central bank and pays the depositor a little amount of money as interest. However, the introduction of Decentralized Finance or DeFi allows both the lender and the borrower to interact directly on a lending platform without a middle man. Decentralized lending platforms utilize peer-to-peer (P2P) lending whereby the lender decides the rate, tenure, and in some cases, who they want to lend their crypto.
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Interest rates on centralized platforms are higher than that of a P2P and there is also the risk of loan fraud and loan default. However, some decentralized platforms, such as Nexo, insure investment. Similarly, just like in a centralized platform, P2P platforms hold collateral in a smart contract according to the terms of the agreement.
Final Thoughts
Finally, the question is: should you get or give a crypto loan? There are many advantages of a crypto loan to you as both an investor and a borrower. Many platforms will offer instant Bitcoin loans with no verification, allowing borrowers to cater to whatever their needs are without losing their assets. In any case, ensure you carry out your research and use a trustworthy service.
Featured Image: Megapixl
