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What Is Crypto Lending and How Does It Work?


10 Nov 2022

#Aave

Many cryptocurrency enthusiasts believe that they can profit by buying, holding, and selling cryptocurrencies. However, many people are unaware that they can use their crypto holdings to obtain loans or even lend out cryptos for additional profit. For cryptocurrency users who aren't concerned with short-term volatility because they're in it for the long haul, their digital assets are now being used as collateral for loans. Here's what you should know about crypto lending, as well as some advantages and disadvantages to consider.

What Is the Difference Between Crypto Lending and Borrowing?

Crypto lending allows cryptocurrency owners to lend their coins to borrowers. They will gain some profit as a result of this. It's more like putting money in a savings account that earns interest. A cryptocurrency loan can be given or received through a cryptocurrency exchange or decentralized finance (DeFi) lending platform. Interest rates and terms of lending differ from one crypto lending platform to the next.

How to Borrow or Lend Cryptocurrencies

Three parties are involved in the lending of cryptocurrencies: the lender, the receiver, and the decentralized exchange (DEX) or centralized crypto exchange (CEX) that provides the service. The lender is the person who makes the crypto loans; the receiver is the borrower; and the exchange is the platform that makes the transaction possible. 

We'll take a quick look at how these parties interact throughout the process. To obtain a crypto loan, the receiver (borrower) must deposit funds that will serve as collateral for the loan. The user would then apply for a loan through the crypto lending platform. The lending platform connects the lender and the borrower once the terms are met using smart contracts. 

The lender will then begin to receive interest on the loan from time to time. However, the borrower will not be able to access the amount used as collateral until the loan is completely paid off. Using the example of a borrower who wants to trade Ether (ETH) but lacks the necessary funds, if he also has an investment in, say, MBG tokens, he could use the MBG token position as collateral to obtain a loan to invest in ETH. He won't be able to access his MBG tokens until he repays the borrowed loan. Also, keep in mind that the borrower is free to use the borrowed loan as he sees fit, including withdrawing it for use outside of the platform from which he borrowed it.

The collateral that the borrower deposits is usually greater than the loan charge. You may be wondering why you should take out a loan if you have to provide collateral worth more than the loan amount. Most people who take out crypto loans do so to add to a specific position they have been holding, to meet expenses without affecting their current trading positions, or to make new investments.

The expected annual yield for cryptocurrency lending varies by platform, but it is typically between 3% and 15% per year. The rate is also determined by the digital asset you are lending. In addition, the lending platform usually adds information about the expected yield per coin. Not all platforms have cryptocurrencies available for lending; you must conduct research to determine whether your desired cryptocurrency is available and the expected annual return. Liquidation can also occur when the borrower's collateral can no longer cover the loan value—if the collateral loses value or the amount borrowed gains value against the collateral. To keep a borrowed loan active, the loan amount must always be less than the collateral value. Borrowers must ensure this by increasing their collateral or repaying a portion of their loan when it decreases.

Types of Crypto Loans

There are two kinds of crypto loans: flash loans and collateralized loans.

Crypto-Lending Platforms

There are several cryptocurrency lending platforms. Some of these will be discussed further below.

Advantages of Crypto Lending and Borrowing

Now that you understand what crypto lending and borrowing are, you should be aware of some of their advantages. The following are some of the benefits of crypto lending and borrowing.

Disadvantages of Crypto Lending and Borrowing

Even though crypto lending can be a profitable activity, there are some drawbacks to consider. We'll go over a few of them below.


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