The cryptocurrency industry offers many investment options. Among them, one is crypto lending that has gained momentum these days. In crypto lending, the borrower puts collateral more than the value of the loan, and the lender earns interest up to 17%. What could be better than this!
In this article, we will discuss what crypto lending is and which parties play key roles in the entire crypto lending process. So, let’s get started.
What is crypto lending?
For having a general idea about how does crypto lending work firstly let’s understand what is crypto. Crypto lending is a type of Decentralized Finance in which investors lend their digital assets to different borrowers. In exchange they get interest payments, also called crypto dividends. However, they remain the owner of their assets.
Many platforms offer crypto lending services for cryptocurrencies as well as stablecoins.
Which parties play key roles in the crypto lending process?
Crypto lending involves three parties that play key roles in the entire process. The first party is the investor or lender. The second party is the borrower, and the third party is a crypto lending platform.
Let’s understand the role of each party in crypto lending to learn about the crypto lending process.
Crypto lending and investor/lender
An investor or lender is one who has cryptocurrencies and is willing to earn some interest on his assets without selling them.
Consider an example to understand his role.
Suppose James has 10 Bitcoin and is willing to generate a passive income with his Bitcoins. He goes to a crypto lending platform and deposits these Bitcoins in the wallet to make them available for lending purposes. He will start receiving interest from it on a weekly or monthly basis.
For Bitcoin lending, the interest rates are usually between 3% to 7%. However, if the investor deposits stablecoins such as Binance USD, USD Coin, etc., the interest rate can be as high as 17%.
Crypto lending and borrower
A borrower is the one who has cryptocurrency, and he needs funds/loans in fiat currency without requiring selling his digital assets in case of an emergency. A borrower’s role is more interesting than an investor’s. A borrower has to stake his cryptos as security of the loan repayment.
Now let’s take an example to understand his role.
Suppose Jonathon has 1 Bitcoin worth USD 25,000. He needs a loan of amount USD 15,000 against his crypto at an interest rate of 8% annually. While Edison has USD 15,000 stable coins and he wants to earn some passive income on his assets. He lends out his assets to Jonathon at an interest rate of 8% keeping Jonathon’s 1 Bitcoin as collateral. This loan will have an LTV (loan to value) of 33.33% i-e USD 15,000/25,000.
In crypto lending, the borrower has to stake more than the loan amount. So, in case, the borrower does not pay off the loan investor can sell it to cover the loss. In this case, this list of the top crypto exchanges may be helpful.
In the above example, Jonathon is depositing collateral of value more than the loan amount.
Crypto lending and lending platform
A crypto lending platform plays a very important role in crypto lending. It processes all the transactions involved in lending and borrowing. The crypto lending platform works online through its website accessible to everyone. Usually, there are two types of crypto lending platforms which are as follows:
- Decentralized lending platforms involve the use of smart contracts to undergo the lending process.
- A centralized lending platform depends on a third party to take care of transactions.
However, users have a further choice between lending platforms which can be manual or automated. In a manual lending platform, the user does everything on its own, manually, to earn interest. While an automated lending platform allows starting earning interest as soon as an investor deposits his cryptos.
The crypto lending platform provides security to borrowers and investors with their funds. It makes the entire process straightforward, effortless, and automated. It also backs up the investors in case of scams and hacks.
How does crypto lending work by considering the role of each party?
Let’s learn about the process of crypto lending keeping in mind the role of each party.
- A lender goes to a crypto lending platform and offers his cryptos for the lending purpose at a specified interest rate.
- A borrower requests a crypto loan through a lending platform offering his cryptos as collateral and choosing the currency he wants to get a loan.
- Once his request is approved, funds are automatically transferred to the borrower’s account replacing the collateral.
- The interest payment is also automatically transferred to the lender.
The borrower cannot use his collateral until he pays back the entire loan amount and the interest. If he fails to pay back, the lending platform backs the investor by selling out the collateral, paying back the investor’s investment.