Investing in cryptocurrencies: How does crypto lending actually work?

Crypto lending is trending
Interesting returns lure
Total loss possible

Crypto lending is a crypto-based loan, with the loan business usually being processed via special lending platforms that bring lenders and borrowers together. In contrast to classic credit marketplaces, the lender cannot choose himself to whom he lends his money. Instead, with crypto lending, he makes his coins available to a stock exchange so that the latter then lends the coins to other users of the respective platform. The lender therefore has no insight into a loan project or the background to the borrower.

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Such crypto loans are typically over-collateralised, meaning the borrower is required to deposit a higher percentage of the cryptocurrency than they are allowed to borrow. But why would he borrow a cryptocurrency at all if he already owns it? The answer to this question is that he can use such a loan to leverage price gains (but also price losses).

The parties involved agree in advance on the number of coins to be lent and the duration of the license. Depending on the selected stock exchange, flexible periods are possible, but periods of between seven days and several years are also possible.

Interesting return

In addition, the level of interest is also determined, with this percentage value depending on the demand for crypto loans, the platform used, the crypto currency lent and the number of coins made available. According to “Coinratgeber”, returns in the mid-single-digit percentage range are not uncommon for the lender. That is significantly more than an overnight deposit at a conventional bank. Even returns in the double-digit percentage range are possible.

At the end of the credit period, the lender gets his coins back plus the contractually agreed interest. The technical platform receives a small share of this interest.

Numerous risks

As with loans in classic fiat currencies, the credit risk of the borrower must be taken into account. To mitigate this risk, crypto lending requires borrowers to deposit their own assets as collateral. If the situation then arises that you cannot repay a loan, these so-called securities can be liquidated in order to reduce the lender’s loss or, at best, to offset it.

However, other cryptocurrencies are usually used as collateral and their value can fluctuate widely. This is a risk for the lender, but for the borrower this has the advantage that he does not have to sell his own coins and can therefore continue to benefit from any price developments.

In addition, there are other risks associated with crypto lending. In view of the strong volatility on the crypto market, the coins can suffer significant price losses in a very short time, so that the investment may even have become worthless when it is repaid.

A total loss can also occur if the exchange used is hacked or goes bankrupt. According to the saying “Not your keys, not your coins”, storing your own coins on a centralized crypto lending platform already poses a risk because the coins are then no longer in your control.

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