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Crypto Lending 101: Is It Safe and How Does It Work?


Promo owners are frequently advised to hold their assets until price appreciation applies. However, leaving your currency unused in your wallet may not be the most productive thing, especially with low-interest rate. There are plenty of ways you can grow your digital currency, one of which is through crypto lending.

You may be worried or unsure whether this practice is safe or not. However, you don’t need to worry since crypto lending is completely safe! Let’s find out why!

 

Definition of Crypto Lending

Crypto Lending is a DeFi or Decentralized Finance type that allows crypto users to lend their cryptocurrencies to other users. This activity enables the lenders to earn interest payments called “crypto dividends”. 

 

How Does Crypto Lending Work?

To lend cryptocurrency, users need a third party connecting lenders and borrowers. Lenders referred to the first party involved in crypto lending. They are usually users who want their assets output to grow or who hold onto their crypto until there is an increase in value.

Then, there is a crypto lending platform, the second party in this process, where the lending and borrowing transaction process happens. Finally, there are borrowers, who are referred to as the third party. They are the people who will get the funds. Usually, these are businesses or people who need funding. 

With these three parties, the process will work this way:

  • - Borrowers log in to the crypto lending platform and apply for a crypto loan.
  • - When the loan request is accepted, the borrower will stake the crypto as collateral until the entire loan is returned.
  • - With the same platform, lenders can automatically fund the loan, and they will receive regular interest as a form of payment.
  • - As the borrower pays off the whole loan, he will receive the crypto he used as collateral.

While the different platforms may have their method, this is how the overall process works. 

 

Crypto Lending vs. Staking

Crypto lending and staking are often discussed as both methods to earn interest from idle cryptocurrency. However, lending and staking are two different things since staking is leasing crypto to the blockchain for token rewards, while lending is leasing crypto to a borrower to earn interests.

In staking, you will lock up your crypto for a certain amount of time to earn passive income. It is almost like a crypto certificate of deposit. Meanwhile, lending is when you pledge your crypto to a certain platform that will lease it out to borrowers.

The platform in crypto lending will charge the borrowers in the form of interest and split the earnings with lenders. You don’t need to worry about losing your crypto when lending them since the borrower’s crypto is used as collateral for security. 

 

Different Types of Crypto Loans

With a crypto loan, traders can receive liquid funds without having to sell their asset and use it as collateral instead. There are two types of crypto loans; here they are:

Custodial crypto loans

The first type is Custodial crypto or CeFi loans. In this type of loan, a central entity plays a role in taking custody of the collateral. A trader will not be able to access their collateralized assets because the lender has control of it. 

This type of loan is more affordable and on-hand than the traditional one. However, this system still needs a centralized lending provider to enforce the applicable terms. As of today, 80 percent of crypto loans are sheltered. However, the ratio is changing swiftly.

Non-custodial crypto loans

The second type is Decentralized Finance or DeFi loans. This type of loan doesn’t depend on a central organization to carry out the loan terms. Instead, it uses smart contracts. When users take out this type of loan, they will still have control of their assets’ key, except when there is a case of default on loan.

This platform doesn’t directly bestow fiat currency. Nevertheless, they receive stablecoins instead, which are exchangeable for cash. The interest of this type of crypto loan is usually higher than the custodial loan.

 

Pros and Cons of Crypto Lending

Like other types of investment, crypto lending has pros and cons. Therefore, it is essential to understand everything about their advantages and disadvantages before you start to dive into this investment model. 

Pros

1. More credit access

This system has more comprehensive credit access as borrowers do not need a traditional bank account to borrow or lend crypto. One-third of people in the world do not have a bank account. Therefore, crypto lending is a great solution to open credit access for people in emerging markets.

2. Easier to get

A Crypto loan is far easier to get than a traditional loan because the process tends to be very fast and easier to access. Sometimes it does not involve credit checks or credit histories. Many DeFi lenders have flexible terms with lower fees compared to a traditional loan.

3. Work for bitcoin 

Users can also lend their bitcoin. Since bitcoin operates using proof of work, they will not be able to stake it, but it is possible to lend it.

Cons

1. Few coin selection

There are only a few coin selections at the moment. In fact, big lending platforms available today only support around 10 to 30 coins. 

2. Limited platform

There are only a few crypto lending platforms available at the moment. Therefore, it has less competition. 

3. Alternative collateral

Many crypto loans in DeFi at the moment are over-collateralized. This means borrowers supply tokens that are often worth more than the actual loan. Therefore, crypto lenders often have favorable terms. However, a new approach to collateral may be a challenge for lenders to learn but eventually can forge stronger connections between traditional finance and DeFi.

 

Crypto lending is a bright and innovative way to earn passive income from your crypto holdings. While it has some pros and cons, this crypto lending is generally a safe practice, just like other investment models. 

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