In its simplest definition, crypto lending is the procedure of getting a crypto-asset loan via a lending platform with an attached interest rate.
Thanks to the blockchain revolution in the past few years, now it is possible to get a quick loan in the form of a digital asset. Crypto lending usually ‘emulates’ the lending procedure in the traditional financial industry, but it ‘converts’ everything digitally to the blockchain.
How Does Crypto Lending Work?
Imagine what you need to get a loan in the traditional financial industry.
Usually, you need to register yourself on the lending platform, put your collateral, and get your loan after it gets approved manually.
In crypto, it works similarly, but it is automated and more efficient. Thanks to the digitization of assets, everything can be done directly on the internet. With crypto lending, you show your collateral in the form of cryptocurrency, and you get your loan in the form of crypto or fiat.
The KYC registration process can also be done on the internet. In some decentralized lending platforms, you don’t have to prove your identity, as the loans are processed directly on the blockchain itself.
The basic idea of crypto lending remains the same as traditional lending procedures.
First of all, the lender has to show the crypto assets that he or she wants to make available to loan. Then, the borrower will go to the lending platform (could be a crypto exchange or dedicated platform for lending), where he/she will see the lender’s crypto and its interest rate.
Once the borrower agrees to the terms, he/she can borrow the crypto assets from the lender with their collateral instantly. The borrower will have to pay back the borrowed assets along with interest later on.
On many platforms, the borrower needs to over-collateralize his or her own assets before he or she can get the loan. Take the example of MakerDAO, a decentralized application for lending. With MakerDao, you can get a stablecoin (DAI) loan instantly once you over-collateralize your ETH.
For example, to get a 100 DAI ($100) worth of loan, you should put at least $150 worth of collateral in the form of ETH. This system is used to minimize risk, considering that crypto is a volatile asset class.
Different Types Of Lending
The good thing about the crypto space is that it’s moving at a rapid pace. Previously, there were limited options when it came to lending applications. But Now, we have a lot of variations. There are different types of lending platforms, but usually, they are divided into the centralized and decentralized camps.
Let’s use an example to understand the difference.
A centralized lending platform is typically more constant and regulatory-friendly — Nexo is an example. As mentioned on its official website, Nexo is an ‘instant crypto credit line’ website where you can get a crypto loan by using your own crypto as collateral. However, Nexo is a centralized service, and you need to verify your identity (KYC) by submitting personal information.
Onfido, a third-party verification provider, is the company responsible for ‘analyzing’ your KYC documents on Nexo. To get full access to Nexo services, you need to complete the KYC process. Since Nexo is a centralized lending platform, they can deny your use of the platform if they find something suspicious with your account.
We also have decentralized lending platforms.
The assets on these platforms are usually issued directly on the blockchain. A perfect example of this is MakerDAO.
With Maker, you need to collateralize your crypto assets (i.e. ETH) to get your stablecoin loan (DAI). As we have written above, you can currently get a $100 worth of DAI loan by putting at least $150 worth of ETH down as collateral.
Everything is done directly with smart contracts on the Ethereum blockchain. You can get your loan instantly because everything is done in a decentralized way. And of course, no KYC verification is needed here because there’s no centralized entity ‘reviewing’ your account.
There are pluses and minuses in each camp.
With centralized platforms, you get more ‘peace of mind’ because usually, they need to be approved by government before they can offer such a service. You know they are legal, and that there are real people behind the system.
Meanwhile, with decentralized platforms, they often operate in a grey legal area. And, usually, they are less user-friendly and might not appeal to people who are still new to crypto.
The Future Of Crypto Lending
The future is bright for crypto lending. Theoretically, all kinds of digitized assets on the blockchain are possible.
If you feel crypto lending is too ‘risky’ because the crypto price is highly volatile, you do not need to worry. There are many startups trying to solve this issue. For example, stablecoin lending involves crypto assets that maintain their value 1-to-1 to USD or other fiat currencies.
It’s not impossible that, in the future, we will have more real-life assets on the blockchain. Lending platforms could lend crypto assets backed by precious metals or even real estate, all of it being ‘guaranteed’ by big governments. It will become more appealing to traditional borrowers and lenders.
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