What is Crypto Lending?
|— Crypto lending is an alternative investment form.|
— Investors lend fiat money or cryptocurrencies to other borrowers in exchange for interest payments.
— You need to do your own research before lending crypto.
— There are several ways to lend crypto.
Decentralized Finance (DeFi) has exploded in popularity throughout 2019 and 2020 and is now one of the major use-cases of blockchain technology. With this new trend around DeFi, many new ways to grow your crypto assets are emerging. Today, let’s deep dive into crypto lending, which has gained popularity over the past few months by being a very popular DeFi example.
You already know what lending is
You’ve probably heard of people taking loans when they’re short on cash, right? It’d be either a bank or company lending them some money, which needs to be repaid with some interest. That interest is how the bank or company would make money.
What if you were the one receiving interest instead?
That’s right, there are solutions out there that would let you give out a loan with your crypto. Just like those companies, you’d get some interest from it too. However, it does work a bit differently than your standard loans. This solution is called Crypto Lending.
How does crypto lending work?
In short, crypto lending is an alternative investment form, where investors lend fiat money or cryptocurrencies to other borrowers in exchange for interest payments. So there’d be two main parties involved in this loan.
The lender, who will receive interest from the borrower in exchange for the loan. The borrower, who will deposit crypto-assets as collateral to secure the investor’s investment. That way, the lender can be sure that if something goes wrong, that collateral will be used to compensate him/her.
The lending process can be slightly different depending on the platform you use, but getting a crypto-backed loan will generally involve the following step:
Why would I want to lend my crypto to someone else?
Attractive interest rate
You can probably already guess the main benefit for lenders in this, right? Indeed, it’s interest. You will potentially get back more crypto than the amount that you’ve lent out, meaning you’ll be making a profit without needing to do anything for it. And who doesn’t like making a nice passive income? On top of that, the interest rate is way more interesting than the one of your savings account!
Avoid crypto volatility
In theory, you are able to lend the crypto you want. However, lending stablecoins may appear as a new solution for you all crypto owners. In case you are not familiar with what stablecoins are, they are cryptocurrencies designed to keep the same value as certain real-world assets (most of them are pegged to the US dollar for example).
By lending stablecoins, you are able to grow your assets without the variation risk that you usually have with crypto. In other words, you’ll likely know how much you’ll be getting back for lending your crypto assets. Of course, you have to keep in mind that zero risk does not exist, especially in the crypto universe.
Crypto Lending Best Practices
Do your own research
This cannot be said often enough – for many things in crypto, doing your own research can help you tremendously. Lending is no different in this. You don’t want to accidentally entrust a poorly secured platform, or even worse a scam. It’s best to go with lending platforms or smart contracts that have had its security audited well and that have a good track record.
Don’t be in a hurry
Don’t lend out a crypto you want to cash out soon. It’s probably pretty evident, but you cannot sell that which you’ve lent out to someone else. Furthermore, do not forget that even with the best security auditing, hacks may happen in the crypto world. Just in case the worst would come to pass to the platform you are using, it is good to keep in mind that crypto may sometimes be lost.
Know the parameters
The terms of the loan are vital to understand properly. You’ll want to make sure that you know beforehand when you’d be getting your crypto back and how much interest you’ll be getting out of it. Most importantly, it’s vital that there’s a good backup plan for you, in case the borrower isn’t able to pay you back. You’ll want to make sure that the platform or smart contract you’re using will still return your crypto, either through an insurance or collateral the borrower had to lock away.
So how can I start lending my crypto?
Different options exist, some that we’ve briefly crossed over already. Let’s go over them:
Exchanges and platforms
Crypto exchanges and other custodial platforms can provide lending services (Binance, Coinbase or Nexo). These are centralized services, meaning they’ll be acting as a middleman, overseeing the agreement between you and the borrower. You would have to send your cryptocurrencies to their platform before you can proceed with lending out your digital assets. Equally, they’ll give your repayment to an address on their platform too, meaning it will remain within their control until you manually withdraw your crypto.
While they’re often quite user-friendly and provide a wide selection of cryptocurrencies to lend, these two options can provide more requirements than other lending options. For example, you’d often need to make an account first, and be subject to Know Your Customer (KYC) processes where you’d have to provide your private information.
Wildly popular recently, several Decentralized Finance (DeFi) protocols allow you to lend out your cryptocurrencies without requiring a middleman (Compound or Aave). Instead, a smart contract would be used to ensure that the loan would be handled correctly. This smart contract will automatically make transactions if certain predetermined conditions are met.
When lending crypto, your assets are no longer in your possession: you are sending them to a smart contract. What you’ll get in returns are bonds that prove you are the owner of these lended assets.
Security is of course a concern here. In case of the most well known DeFi lending protocols, its smart contracts are well audited and public so that everyone can verify it manually. While that won’t exclude potential vulnerabilities, it does give some form of reassurance.
Unfortunately for DeFi, its smart contract operations means that it’s limited to a single blockchain. Therefore, the options as to which crypto you can lend are usually limited. Most often, it only concerns ERC20 tokens (running on the Ethereum blockchain).
How to lend your crypto with Ledger
If you’re interested in lending your crypto, then your Ledger hardware wallet is a great starting point. Simply connect your hardware wallet directly to Aave or Compound protocols, or via WalletConnect.
Let’s illustrate how this works using an example: Compound is a decentralized protocol that gives you the possibility to lend digital assets.
When lending your tokens, you deposit them into Compound’s smart contract. In exchange, you get cTokens which represent the claim to your lended assets and interests.
Security and control
cTokens are proof that the assets you lend and their generated interest belongs to you. By lending Crypto using your Ledger hardware wallet, your cTokens are stored securely within the device, which means no one else can claim your assets when lending them – only you.
When you want to get your assets and interests back, you can simply send your cTokens back to the smart contract and get your assets and the generated interests in return.
There is an incredible variety of new DeFi services available, and Ledger’s mission is to bring you the highest possible level of security for each one. So whether you’re looking to Buy, Swap, Stake or lend, Ledger enables you to secure your private keys and verify every transaction. Simply put – we unite security and ownership with ease of use, so you’re free to enjoy the incredible possibilities offered by DeFi.
Disclaimer: Exchange, lend, and other crypto transaction services are provided by third-party partners. Ledger provides no advice or recommendations on use of these third-party services.
Knowledge is power – so keep on learning! If you enjoy getting to grips with crypto and blockchain, check out our School of Block video Get Rich Quickly In Crypto