Crypto loans are similar to traditional finance, except for how the funds are secured. Traditional financial institutions rely on a credit check to determine a borrower’s creditworthiness and risk.
Crypto loans allow traders to use crypto assets as collateral, which the lender holds until the loan is repaid in full. Crypto lending collects interest hourly and has a shorter loan term than traditional loans. Borrowers can borrow from seven to 180 days on trading platforms because digital assets are more volatile than fiat currencies.
Below are four rules to keep in mind when lending crypto.
1. Monitor changing regulations.
Crypto regulation is constantly evolving and often sparks political debate, especially in the United States. State regulators are known to crack down on Defi lending platforms because of the concern that Defi lending offers unlicensed securities.
In recent months, state regulators have served several cease-and-desist letters to popular lending platforms, including BlockFi, and some platforms have disclosed security breaches.
2. Use well-established lending platforms.
Legitimate lending platforms have measures in place to ensure crypto assets are safely stored, much like the way a traditional bank ensures assets through the FDIC. Traders should read the fine print to determine whether and how a crypto exchange protects digital assets from hackers and other catastrophes. The latest trend in the cryptocurrency marketplace is the practice of crypto lending. Crypto holders have been able to turn a profit in recent years as lending platforms emerge. These platforms serve as savings accounts for digital currencies but with higher interest rates than traditional banks.
Lending platforms connect crypto lenders and borrowers. Lenders can earn interest on unused crypto assets, and borrowers can take out a personal loan. Lending crypto is a smart way for crypto lenders to earn an attractive potential return on investment with the right crypto trading platforms. Crypto lending platforms offer traders the ability to borrow fiat currency against their shares of crypto. Lending platforms can offer attractive interest rates compared to high-yield savings accounts with traditional banks. CryptoVantage explains that the interest rate is determined by the amount of crypto being accumulated on the trading platform, the amount of time you are willing to tie up your digital assets, and the number of native cryptocurrencies you hold.
3. Use Stablecoins or fiat currency.
Some digital currencies are more volatile than others, specifically altcoins like Ethereum (ETH) and Cardano (ADA). As a crypto lender, you lose the ability to sell your digital assets and limit your losses if the coin value drops. If you are lending an altcoin that significantly increases in value, you won’t enjoy this gain because your assets are tied up with a borrower. The same is true if the interest rate increases or decreases.
Stablecoins such as Paypal USD are backed by the U.S. dollar or gold, which means that they can withstand volatility regardless of what happens in the crypto industry.
The most well-known Stablecoins include Tether, USD Coin, and Binance USD. Each of these coins is 1:1 with the U.S. dollar. It’s a good idea as a lender with altcoins to use a reputable crypto platform that features automatic adjustments when there are price fluctuations. This means that the borrower will have to pay back a higher amount should the value of the lent-out crypto rise during the loan term.
4. Avoid Defi platforms.
Unlike traditional banks that are FDIC-insured, Defi platforms aren’t backed by a third party. Lenders and borrowers can trade digital currency on either Defi platforms or Cefi platforms. Defi lending platforms use blockchain technology to track crypto transactions; however, Defi protocols are prone to technical errors and hackers. Cefi platforms are held accountable by those who run the company. Always ensure a Cefi platform has a recovery system in place, such as a third party that safeguards digital assets in the event they are compromised or lost.
Crypto loans are a good option for lenders with substantial crypto and risk tolerance to earn an attractive return on investment. It’s also a good option for borrowers who can’t pass a credit check for a personal loan and want a lower interest rate.