In this guide to crypto lending, we will cover the advantages and disadvantages of this form of investing, looking at the types of lending platform, the risks and the developing opportunities. Firstly though, we need to define what cryptocurrency lending is and how it works. What a cryptocurrency lending platform is Crypto lending is a […]
In this guide to crypto lending, we will cover the advantages and disadvantages of this form of investing, looking at the types of lending platform, the risks and the developing opportunities. Firstly though, we need to define what cryptocurrency lending is and how it works.
Crypto lending is a recent trend that has taken hold of the crypto community and grown the decentralized financial (DeFi) ecosystem significantly in the last couple of years, with billions in locked value. In simple terms, it is a system of collateralized loans that provides unprecedented permissionless access to financial services.
The idea is that if you hold crypto assets, or fiat currencies you can use them as collateral to obtain a loan. Alternatively, as a lender, you can provide the fiat, stablecoins or other crypto assets needed for the loan at a pre-determined interest rate. Borrowers gain access to capital and lenders yield a profit from the interest they earn.
There are various types of cryptocurrency lending platform, but the main distinction is between those that are centralized and decentralized. Centralized lending platforms follow KYC/AML procedures, have custodial protocols for asset protection as well as loan agreements with businesses and financial institutions. Also, the interest rates are determined by the company and can end up being higher than for decentralized applications.
Decentralized cryptocurrency p2p lending protocols, such as Compound and dydX rely on smart contracts for the automation of crypto loan distribution and interest rate payments. They are non-custodial, and can be accessed by anyone, with no ID verification. Also, interest rates tend to fluctuate, sometimes quite dramatically, based on the supply and demand for a given asset.
In the past, the options available to Bitcoin investors have been mostly limited to HODLing, where your crypto just sits idle why you wait for it to appreciate, or the far riskier but undoubtedly potentially more lucrative option of trading on crypto market volatility.
Today, for investors wondering how to make money lending Bitcoin, crypto-asset lending offers an attractive option, creating a source of passive income with high yields. So, how much money can be made lending Bitcoin? Compared to a bank that will pay around 1% interest for your funds, you can make around 10%-12% on your capital with crypto lending platforms. However, while the rewards are significantly higher, so are the risks.
There are a wide variety of crypto lending opportunities, which take advantage of the high liquidity that makes crypto such great collateral and such a great yield source for lenders.
The simplest option for traders is to lend a single crypto asset, via just one platform. Rates differ across applications and for different coins. For example, on a DeFi platform you can make around 12% on stablecoins and only 1% on ETH or WBTC (Wrapped Bitcoin), whereas your Bitcoin and Ethereum can earn around 4% on a centralized platform.
Things become slightly more complicated with rate arbitrage, a strategy that involves borrowing an asset on one platform where the value is lower and then lending it on another platform, where the value is higher, netting a profit from the difference in price. However, there is inherent risk in this approach since variable rate fluctuations could wipe out your gains and even lead to a loss.
Many crypto holders also seize the opportunity to use DeFi protocols to liquidate their crypto without it being a taxable event. This is done by using the cryptocurrency as collateral to borrow currency pegged to the dollar without having to pay tax on the loan.
Another opportunity, opened up by the growing popularity of lending cryptocurrency coins, is the increasing availability of leverage through the process of borrowing funds, buying additional capital and increasing the size of the loan until you reach the available limit. So, let’s say you offer BTC as collateral and then sell your borrowed dollar-pegged stablecoin for additional BTC. You are basically going long on your collateral currency with the aim of making a return when BTC rises in value. You make a nice profit and still only need to return the original dollar sum to the protocol. While risky, since a drop in the price of BTC could lead to liquidation of your capital, the profits can be generous.
Flash loans are another potential source of revenue from crypto lending protocols. The way it works is that you can borrow the maximum of free liquidity and then use the unsecured loan to execute an instant transaction that will generate profits. The loan must be repaid within the same transaction chain so if you can’t pay back the full amount of the loan, then no part of the transaction will be executed.
A final revenue generating option is to serve as a DeFi liquidator. To take this route requires a degree of technical know-how, as you need to run a series of algorithms that identify which loans have fallen below the collateralization threshold and liquidate the collateral to return the funds to the lender. Setting up the bots can take time but the fees that you can charge for this service are substantial.
The world of cryptocurrency lending is less regulated than its traditional counterparts, so oversight is minimal. However, one of the major risks comes with borrowing. If the value of the coin being used as collateral falls in value to below a required threshold, this can lead to the liquidation and loss of all the borrower’s capital.
Another factor that needs to be considered before placing funds in the hands of a cryptocurrency p2p lending platform is the danger of security breaches. Smart contract technology that governs the flow of funds through the application has certain vulnerabilities that can be exploited by hackers and 2020 saw numerous high-profile incidents of this kind that led to millions in losses.
There is also an element of risk that comes from low liquidity, if there is a large sell off, leading to a major change in the interest rates being offered.
Finally, due to the under-regulated nature of the crypto arena, which is still developing and only gradually being legislated in different jurisdictions, the tax ramifications of lending cryptocurrency coins is uncertain and future financial repercussions are up in the air.
One of the best ways of avoiding the risks of crypto lending is to put your capital to work on a hybrid platform that offers the security of a centralized platform but will generate the high rates of return previously only offered on DeFi lending protocols.
Here at ArbiSmart, our FIU licensed automated crypto arbitrage platform, offers unparalleled, guaranteed returns of up to 45% a year at close to zero risk. Also, as an EU regulated platform we have strict data security protocols and KYC/AML procedures as well as client capital insurance coverage.
Crypto arbitrage generates profits by taking advantage of price inefficiencies across cryptocurrency exchanges, meaning that your capital is not vulnerable to the extreme volatility of the crypto markets. The ArbiSmart platform does all the work for you. It scans 35 exchanges at once, 24/7, to find instances where a cryptocurrency is temporarily available at different prices at the same time. It automatically buys the currency where the price is lowest and then instantly sells it on the exchange where the price is highest, before the market has the chance to adjust and the price discrepancy is resolved. The profits are exceptional, account integrity is guaranteed and no effort or prior market knowledge is required.
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