Let’s cut to the chase, we know what cryptocurrency is and what it’s used for. Most of us understand that it’s a kind of decentralised digital currency that isn’t subject to control by any central entity. But how is it used to facilitate loans?
Many people take out loans when they’re short on cash. These loans could be from the bank, a mortgage institution, a private company, or an individual, and oftentimes these loans come with interest rates. For the most part, this is how the banks or the private company make money. You put in an application for a loan, your loan request is approved based on your credit score or by how much you are deemed to be able to afford to pay back; your loan is disbursed and at the end of the agreed term, you pay back the loan with interest.
Recently, though with the growing popularity of cryptocurrencies as financial instruments, we have started seeing a new type of lending known as crypto lending. Cryptocurrency lending is pretty much the same as regular lending, but with a few exciting changes and possibilities.
Crypto lending is an alternative form of investment in the decentralised finance (DeFi) space where investors lend fiat money or cryptocurrencies to other borrowers in exchange for interest payments. In this case, investors or crypto lending platforms lend you cryptocurrency while you deposit a certain amount of your holding on the platform as collateral to back the loans you are given. The amount of cryptocurrency that you deposit is what determines how much of a loan you can get. Once this loan is approved, you receive it either in your fiat or crypto wallet depending on the options you choose while requesting for the loan. After the loan tenure is complete, you pay back the loan with the agreed interest rate and can then withdraw your crypto which had been held as collateral.
There are always two main parties involved in this crypto lending:
The idea of using crypto as collateral is to give lenders a sense of assurance that their investment is safe in the case where a borrower does not pay back their loan. Crypto lending is helpful on a fundamental level because credit and lending markets increase the amount of productive work money in supply by reallocating it from those without an immediate use case to those with one. This increases the utility of that money for all parties, giving borrowers access to capital and giving lenders yield.
This is a massive opportunity for crypto markets and users, that have traditionally had two use cases for crypto: HODL or trade. For hodlers, cryptocurrency has had one function, which is to sit in their wallets. While some may argue that it serves a purpose by limiting supply on the market, we can generally agree that it is not a particularly productive use of a capital asset. With the advent of crypto-asset lending, the utility of those assets has increased significantly. A formerly static investment can now generate passive yield for lenders, and borrowers can either receive fiat without having to initiate a taxable sales event or receive crypto assets for trading, arbitrage or market-making. These are substantial improvements for individual hodlers and major institutional investors alike.
Crypto lending platforms are divided into two categories: centralised and decentralised lending platforms.
There are a few risks involved in crypto lending which are important to take note of.
As the crypto industry continues to grow, the lending ecosystem is going to remain a pivotal piece in its success story. And we can expect to see improvements in the present model that will further move the DeFi space towards widespread adoption. Crypto lending, nonetheless, is already a lucrative venture for some who prefer to hodl their cryptocurrency and make it earn them passive income.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.
Stay informed with the latest updates to buy, sell, and store your crypto on the go.
Get the Yellow Card app to buy, sell, and store your crypto on the go.