- 2020 stands as a year that changed the global financial landscape, leading to the emergence of decentralized finance (DeFi)
- DeFi is a collection of financial applications built on the blockchain. With the World Bank estimating that 1.7 billion people across the globe remain unbanked, DeFi aims to promote financial unity, ensuring that everyone gets access to financial services – from remittances to loans.
- Crypto has remained a buzzword for quite some time, but only in the last few years have crypto holders been able to put their crypto to work and access financial services. Just like instances where traditional financial institutions offer loans to customers capable of depositing collateral, the cryptocurrency industry is not left out. Borrowers can simply sign up on any of the numerous lending protocols to access a loan, providing collateral in the form of crypto.
- This article explores cryptocurrency lending and the top lending platforms in this ecosystem.
What is Crypto Lending?
Crypto lending is the process where investors deposit cryptocurrency into a protocol to be lent out to borrowers in return for yield. Interest rates are often compounded weekly, monthly or yearly and designated in annual percentage yield (APY). Interest can depend on the lending protocols, as well as the asset in question. It is not rare for interest to be as high as 20% APY.
There are two major components associated with crypto lending. These are deposits that earn interest and crypto loans. Crypto deposits work in a similar way to those of financial institutions where users deposit cryptocurrency and the lending protocol pays them an interest in APY. The deposited crypto is often loaned out to borrowers to be used for other forms of investment.
On the other hand, crypto loans are often collateralized and users are required to deposit at least 100% in crypto collateral to borrow digital assets.
Crypto loans are of four types and each comes with its own risk.
Types of Crypto Loans
There are four types of crypto and they include:
- Collateralized loans: These are the most popular types of loans and work such that deposited cryptocurrency is used as collateral for the loan. In some protocols, over-collateralization is required so that borrowers can access only a specific percentage of the deposited collateral, usually below 90% of the loan-to-value.
- Crypto line of credit: Some crypto platforms now offer a cryptocurrency line of credit, rather than following the traditional loan pathway. The crypto line of credit is a collateralized loan where users borrow up to a certain percentage of deposited collateral. These loans come with a set of repayment terms and users only pay interest on funds withdrawn.
- Uncollateralized loans: Though not popular, uncollateralized loans operate the same way as personal loans. To qualify, borrowers must fill out a loan application form, verify their identity and complete their creditworthiness review. These loans pose a great risk to lending institutions because the borrowers do not provide collateral that can be liquidated if the borrower defaults.
- Flash loans: Flash loans are common in most cryptocurrency exchanges because these loans are borrowed and repaid in the same transaction. These loans are extremely risky and often used to take advantage of arbitrage opportunities in the market, such that a user can buy crypto at a lower price in one market and instantly sell at a higher price in another.
Some of the risks associated with crypto lending include margin calls, liquidity, non-regulation, and high interest rates.
How Does Crypto Lending Work?
To understand how crypto lending works, it is important to note that there are three parties involved – the lender, the borrower, and the DeFi protocol, which acts as the set of rules and logic that govern the transaction. The borrower must deposit some supported cryptocurrency which ultimately serves as collateral before borrowing any crypto. In some cases, interest rates may be paid in kind or with the native token of the platform. In situations where interests are paid in kind, there may also be bonus payments.
The safety of crypto lending is not always clear. In instances where the loans are collateralized and the borrower defaults in repaying the loan, the lender can get back their money by liquidating the borrower’s collateral. Interest rates are often much higher compared to those of traditional financial institutions.
In other instances, borrowers may suffer some risks because the collateral can lose some percentage of its value and be liquidated. When users deposit crypto in a lending protocol, they earn a significant amount of yield which is often much more compared to traditional financial institutions.
Top Crypto Lending Platforms
Crypto lending platforms are divided into two major types – centralized and decentralized. Each of these platforms has its own mode of operation and characteristics.
Centralized Crypto Lending Platforms
Centralized finance (CeFi) platforms simply refer to trading platforms that are controlled by a specific group of individuals who manage the platform and take decisions regarding the protocol at any time. Exchanges such as Coinbase, Binance, and Crypto.com are examples of these exchanges and offer more user-friendly options. These platforms operate just like traditional institutions and offer a perfect set-up for new crypto investors because they are not just easy to navigate but also present simple interfaces and streamline the process of buying and selling crypto coins.
These platforms are also unique because, in addition to providing buying and selling services, they offer crypto lending services, ensuring that their users have access to borrowing/lending facilities.
Features of CeFi Loans
Loans offered by centralized finance platforms tend to be unique due to the features they present. Below are some of them.
- Loans are often handled by the exchange: Lending transactions that involve centralized finance protocols are not handled in a peer-to-peer manner, rather the exchange itself acts like an escrow and streamlines the lending process. This gives users access to several lending options such as multiple liquid pools.
- Know-Your-Client (KYC) is needed: Before issuing any kind of loan, centralized exchanges are required to verify their users’ identities. As such, setting up an account takes a lot of time.
- Anonymity: Just as with decentralized platforms, CeFi loans are anonymous. However, this anonymity only applies to the borrower and not the exchange. Due to the verification process that is always completed by the borrower, the exchange can see what each user does at any time. This makes the process of crypto lending between two or more users easy.
- Interest payments: As CeFi platforms give out loans, it is important to understand that these loans do not come from their coffers, rather crypto holders take on the risk to earn yield by lending their tokens to others.
- Easy-to-use interface: CeFi platforms offer easy-to-use interfaces which make them a great starting point for new crypto lenders who are interested in understanding how the whole lending process works without learning a new process.
- Higher fee structure: It is important crypto users understand that they indirectly pay for using CeFi platforms in the form of higher fees. These fees are comparatively higher than those offered by DeFi platforms.
Popular CeFi Lending Platforms
Currently, there are several centralized exchanges that offer crypto loans. While the crypto crash that happened in the second quarter of May has disrupted some (for example Celsius), below are the some popular CeFi lending platforms:
- Block Fi
Binance is the world’s most popular cryptocurrency exchange and remains a solid choice for crypto lenders. This platform supports the lending of various crypto tokens including USDT and BUSD. Every registered Binance user is entitled to lending coins on the platform. The loan term usually varies between 7 and 180 days, and the platform calculates the interest hourly depending on the hours the coin was borrowed.
Lenders who plan to lend their tokens will have them stored in a timed deposit of 14 days and they would not be able to withdraw the tokens during that period. This time frame is shorter compared to other platforms. Lenders must also understand that the interest fees are either fixed or floating.
Some reasons why lenders choose Binance include:
- The Binance platform supports the lending of several cryptocurrencies.
- Security is Binance’s watchword. While its lending services are safer than most others, users must understand that the concept of ‘’not your keys, not your wallet’’ still applies to centralized exchanges.
- There are instances where interest rates are excellent on certain assets, giving lenders more rewards.
- When it comes to lending, the Binance interface is easy to navigate, making it a top choice for new crypto lenders.
Nexo remains a top choice for crypto lenders because, besides the simple user interface, the platform presents a loyalty program which lenders can benefit from. Nexo gives its users an opportunity to deposit stablecoins and other cryptocurrencies in return for yield.
Nexo lenders receive interest rates that are directly proportional to the loyalty level on a daily basis. Interest rates can be in the form of stablecoins or other cryptocurrencies that are supported by Nexo. Nexo also supports earning on fiat currency, and all interest rates are fixed.
Some reasons why lenders choose Nexo are outlined below.
- Lenders can earn up to 12% interest rates on stablecoins, giving them an opportunity to earn more interest on tokens deposited on the platform.
- In addition to stablecoins and other cryptocurrencies, users can also lend fiat money.
- Unlike other platforms, interest payments are done on a daily basis.
Gemini gives lenders the opportunity to earn up to 8% or more on crypto assets they lend to borrowers. Gemini does not only lend assets to borrowers but also to financial institutions. Interest rates are paid to Gemini users on a daily basis, giving them the opportunity to accumulate their interest in variable rates.
Below are reasons why lenders choose Gemini:
- Interest rates usually range from 8% and above.
- Gemini pays lenders interest daily.
- On the same day users deposit their tokens, they start accumulating interest at 4:00.p.m
- Both financial institutions and retail borrowers can access loans on Gemini.
BlockFi is a popular CeFi lending option as it remains the only independent lender with institutional backing that offers huge benefits to lenders. The interest rate offered by BlockFi depends on the type of token and the amount deposited. Users can earn interest on both stablecoins and other types of crypto, giving lenders an option to choose from. Usually, interest rates on BlockFi are fixed.
Some reasons why lenders choose BlockFi include:
- The average APY on tokens users lend to borrowers is 8.5%, depending on the type of token deposited.
- Tokens that users can lend to borrowers include Bitcoin, Ethereum, USDT, etc.
- Stablecoins can be used for lending on the platform, serving as an opportunity for users to earn diverse returns.
Decentralized Crypto Lending Platforms
Decentralized crypto platforms are those that are not controlled by a central authority, creating more room for decentralization and anonymity. When lenders offer their tokens for crypto loans, on these protocols, they interact directly with the borrower rather than waiting on the exchange to serve as a third party. This way, when a lender offers the tokens to borrowers, they retain custody of their coins. This is generally more reliable than handing custody of the tokens to a third-party platform.
Features of DeFi Lending platforms
There are some features that make DeFi lending platforms unique. They include:
- Peer-to-peer lending: Though DeFi lending takes place in a peer-to-peer manner, the transaction takes place over an exchange, prompting a secure and safe environment for users who lend their tokens to others.
- Anonymity: Because lending transactions take place on a decentralized exchange, users can easily interact to lend or borrow tokens without disclosing their identities to anyone.
- Interest payments: Users will receive interest for lending tokens to others. Even though the rates vary, users can still earn extra yield from their tokens while retaining custody.
- Borrowing pools: DeFi platforms often have liquidity pools where users can provide liquidity to decentralized exchanges (DEXs) and earn fees
- Non-custodial: Unlike centralized exchanges, users do not have to worry about transferring custody of their collateral to a third party.
- Security: Tokens deposited into the liquidity pool are backed by robust smart contracts and technological infrastructure.
Popular DeFi Lending Platforms
There are a lot of DeFi lending platforms in the cryptocurrency ecosystem. Some of them include Aave, MakerDAO, Compound, dYdX, Atomic, Uniswap, and PancakeSwap.
Aave is an open-source decentralized protocol that offers users access to liquidity pools where they can lend their tokens to others in return for interest. This platform offers varying interest rates for different yields and interest rates vary for each token.
The interest rates paid to lenders often range around 1% and 3%. While interest rates change regularly, some tokens are associated with much higher yields.
Some reasons to choose Aave include:
- Flexible interest options as the rates can be fixed or floating.
- Borrowing can somewhat be flexible as Aave also offers flash loans.
- Aave offers a risk framework (A+ to D-) that displays the rating for various assets on the platform.
- Nexus Mutual offers loan insurance on Aave.
Compound is another DeFi protocol with liquidity pools for different assets. When a user lends tokens, they go into the liquidity pools and are merged with other users’ tokens. Borrowers then assess the liquidity pools and later pay what was borrowed with interest rates.
Compound allows users to earn interest in the same token they provide to the lending pool. With interest rates being fixed or variable, earnings differ with tokens.
Below are some features of Compound:
- Lenders earn interest in the same token that was offered to the liquidity pool.
- Loans can be insured using Nexus Mutual.
With MakerDAO, borrowers and lenders combine to generate DAI, a stablecoin that is pegged to the U.S. dollar. The MakerDAO network is built on the Ethereum network and offers users flexible interest rates that range from 0% to 8.75%.
Below are some reasons why lenders choose MakeDAO.
- In the event of volatility, users can use asset management tools such as DeFi Saver to ensure vaults are sufficiently collateralized.
- MakerDAO vaults can be easily tracked because they are integrated into other asset management tools.
- Decentralized Governance: a community of MKR token holders govern the Maker Protocol
Frequently Asked Questions
What platforms offer crypto lending services?
There are several platforms that allow users to lend their tokens to borrowers in exchange for interest fees. These platforms are categorized into centralized and decentralized platforms. Popular examples include Nexo, Binance, Maker DAO, Aave, etc.
What do borrowers use crypto loans for?
Borrowers use borrowed tokens for a range of purposes such as collateralized debt positions, margin trading and so on.
Do crypto interest rates fluctuate?
Crypto lending interest rates change depending on a number of factors such as the utilization ratio of underlying capital pools. Also, the popularity of a liquidity pool will have an impact on rates.