How Does Crypto Lending Work?

What is lending crypto?

The concept that underpins crypto loans is relatively easy to grasp. As the name suggests, it is possible to borrow or lend crypto these days. For several years, with many still implementing the practice, it has been believed that crypto should be stored up until a later date. The aim is to wait for a price surge, or simply an appreciation, that ultimately induces some sort of profit. While storing cryptocurrency, however, interest rates are usually very low. Thus, there is little financial gain in the interim. The ability to loan crypto has changed the crypto landscape dramatically.

A crypto lending platform and/or exchange enables you to make use of such transactions. Of course, there are a number of considerations to take into account. Not all third-party platforms that provide this service are trustworthy. For the remainder of our latest guide which delves into crypto lending explained, will bring your attention to all the important aspects that you need to take note of. But first, we’ve addressed ‘how does crypto lending work’ with a practical example.

How does crypto lending work? Step-by-step overview

For the purposes of this section, and absolute clarity, we are going to provide a simple example which outlines crypto lending explained. There are two parties involved (excluding the platform or exchange) that partake in crypto lending. Lenders and borrowers will be linked up with one another via a crypto lending platform. The ensuing transaction is facilitated by the underlying platform. The entire process, from start to finish, can be summarized as follows:

• A borrower will access a relevant platform. To get the ball rolling, it’s required of the borrower to request a loan.

• If the crypto loan is approved, then it is up to the individual to stake the required collateral amount. Bear in mind that the entirety of the loan must be paid back before the stake can be retrieved by the borrower.

• The platform will automatically facilitate the transaction from the lender’s point of view. The loan will be funded and lenders will receive subsequent interest payments in return.

• At the point in time when the entire loan has been repaid, the borrower is eligible to claim the collateral that was staked initially.

In essence, a borrower must offer crypto as collateral for the aforementioned loan. The borrower still ‘owns’ the underlying asset. However, certain rights will be relinquished as long as the loan is still in existence. This includes having access to the crypto collateral and being able to use it for payments. The standard crypto loan differs from zero collateral crypto loans but the latter is still in its infancy phase.

Secondly, if the value of the cryptocurrency in question drops, then your (assuming you are the borrower) outlook will worsen considerably. This can lead to an increased amount in arrears. At the end of the day, there is always the possibility that the borrower will end up paying back far more than the initial loan. With this in mind, let’s uncover the most important aspects that you need to consider when it comes to crypto lending in 2023.

Main types of crypto loans

There are two main types of loans associated with cryptocurrency, The first type of loan is known as a custodial CeFi crypto loan. These are known as centralized loans as there is a central authority. These authorities will oversee the entire process of crypto loans and implement procedures to ensure that there are minimal unknown variables.

Non-custodial DeFi crypto loans are loans which are facilitated by a third-party platform (as outlined in our example). Essentially, these are peer-to-peer loans between a lender and borrower. There is no central authority involved in these types of crypto loans. Knowing the differences will mean it’s easier to understand crypto lending explained.

Aspects to consider when engaging in crypto lending

Now that we have addressed ‘how does a crypto loan work’, it’s time to look at the different aspects relevant to this topic. Understanding what you should look out for, and take into consideration, will mitigate certain risks surrounding crypto loans.

Reputable third-party platforms

You might be asking yourself, “Is crypto lending safe?” There are always going to be those who are proponents of crypto loans and those who feel it’s too risky to undertake. One of the main aspects that you need to consider is whether the third-party platform you are using to obtain a loan is reliable. Certain platforms have a reputation of experiencing technical problems, scams, or worse. Always make sure that you are making use of a platform which is tried and tested in the process of offering reliable loans that are stored safely and securely.

Consider stablecoins

There are a number of reasons why you should consider using stablecoins. One of the main drawbacks, when looking at how a crypto loan works, is the fact that cryptocurrencies are volatile. Thus, crypto loans can prove to be very risky if the price of the respective digital coin suddenly drops. Stablcoins, as you would expect, are less volatile as these coins are pegged to a reserve asset. Thus, it is less likely that your crypto collateral will suddenly lose a significant amount of its value while you have an outstanding loan amount to repay.

Unable to access assets

Knowing how a crypto loan works is the first step to getting on top of this concept. In addition, it’s important to know that you cannot access your crypto assets when you are still repaying a loan amount. Any outstanding balance will hinder you from accessing your crypto collateral. This may prove to be an issue in the event that you need access to funds.

Make use of additional tools to analyze potential loans

How does a crypto loan work? In addition to our guide, it’s always good to make use of tools which outline the viability of a crypto loan. Make use of a crypto lending calculator so that you are able to analyze all financial aspects of a relevant loan. This is something that should be done regardless of whether you are a borrower or lender. In our guide to crypto lending explained, we have included a number of benefits and downfalls which will be addressed in the following two sections.

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Advantages of crypto lending

Our guide, which aims to cover crypto lending explained, has noted a number of advantages that come with crypto loans. Of course, there are always two sides to the coin. We’re going to look at the main advantages of these types of loans. It will be sure to shed light on why crypto loans are more in demand than ever.

Monetize passive assets

One of the main advantages for lenders is the interest that can be realized from lending crypto to a borrower. Traditionally, the mantra HODL (hold on for dear life) has been touted throughout the crypto scene. The downside of this is that the underlying crypto asset does not provide much of a return. The only way one profits is if the price of the cryptocurrency appreciates at some point or another. With the advent of crypto loans, lenders receive regular interest payments until the date of maturity. The ability to generate interest income is a major factor why lenders are ready to lend cryptocurrency these days.

Typically no KYC requirements

In traditional circles of finance, obtaining a loan can be cumbersome. At the very least, there are a number of requirements that any potential applicant must meet. For instance, Know Your Customer (KYC) processes must be undertaken. For the most part, individuals also need to have a decent credit score in order to receive a loan. These requirements, which can be a big hindrance to many, mean it’s not always possible to obtain traditional loans. Crypto loans don’t implement these types of requirements – making it much easier to access loans.

Realize funds quickly

Yet another advantage is the fact that crypto loans can be triggered in a short space of time. As outlined above, traditional loans come with plenty of paperwork. The process of obtaining a normal loan is not quick – not by any stretch of the imagination. Crypto loans can be obtained very quickly. Once the collateral for a loan is posted, and a third-party platform approves the loan, crypto funds are released. The ease of access enables borrowers to access additional funds, via a loan, in a short space of time. There is no doubt that this is a major motivator for individuals to opt for crypto loans.

Low interest repayments

Lastly, the interest repayments on crypto loans are usually low. Traditional financial institutions have the tendency to charge interest on loans which are certainly felt by the borrower. Interest on crypto loans can be as low as 3%. The fact that crypto loans only last a year, for the most part, also means that the overall interest repaid is a lot less than what you would pay when taking out a loan from a bank, for instance.

Disadvantages of crypto lending

Getting to know how a crypto loan works requires one to also assess the disadvantages. Below, we have outlined three distinct factors that must be considered before setting your mind on crypto loans.

Margin calls

Lenders are able to issue margin calls on loans. In order to keep a loan viable, a borrower will need to contribute more funds to the initial collateral. This can be in the form of additional crypto or even fiat currency. A lender also has the option to sell some of your collateral in order to equalize the loan-to-value ratio.

You can find out more about margin lending crypto right here at bitstacker.com. Our experts continue to bring you the latest guides on cryptocurrency topics. Stay on top of these developments and accumulate the knowledge required to make informative decisions about the world of decentralized finance.

Not all cryptocurrencies accepted as collateral

It has become clear, as crypto loans continue to come to the fore, that many cryptocurrencies are not accepted as collateral. What does this mean when it comes to how does a crypto loan work? In the event that your crypto holdings are not accepted, you’ll need to convert your cryptocurrency for a coin that is accepted. This means that you will need to part with your preferred cryptocurrency.

Not insured (unlike traditional assets/loans)

Unlike traditional loans, which are insured products, crypto loans are not necessarily insured. This poses a large risk when taking out a crypto loan. Many individuals have experienced issues with third-party platforms which prove to be unreliable. Loans that disappear will not be compensated for as there is no insurance on these loans. This extends to any problems that may arise with a lender or a simple security issue. Entering into loans that are not insured will mean that there is always a substantial amount of risk involved.

Conclusion – crypto lending explained

We hope that our latest guide has laid the foundation when it comes to getting on top of crypto lending explained. With the necessary insights, you will now be able to make use of instant crypto loans while making the most of the benefits that stem from crypto loans. Whether you are considering lending or borrowing, make sure that you find the right crypto platform to facilitate transactions.

At bitstacker.com, we bring you comprehensive coverage of all crypto-related topics. It’s our mission to ensure that you have ease-of-access to all the latest guides and reviews. Immerse yourself in the world of decentralized finance with the sound knowledge that we’ll always be here to lend a guiding hand.

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