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Crypto lending & borrowing: What is it, how does it work?

ASTIG PH Team

November 28, 2023

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If you have some cryptocurrency such as Bitcoin in your wallet, you’ve probably thought about how you can use it to make some extra income. Sure, you can wait for the Bitcoin price to continue going up and sell later. But unfortunately, that’s not usually enough for most people (and possibly you). The good thing is that crypto provides lots of ways you can make an extra “coin”, and you don’t even have to be an active trader.

One of the best ways you can do this is through crypto lending. So what is it, and how can you take advantage?

Crypto Lending: What is it?

Crypto lending is not much different from the traditional lending and borrowing we are all familiar with. Generally, it involves lending your digital currency to other users, which they’ll then pay back with some interest. Before a person can borrow crypto, they will need to provide some form of collateral – typically another cryptocurrency. Having this collateral in place makes sure that your crypto is protected.

How Crypto Lending Works

Crypto lending is made possible by crypto lending platforms. These platforms are the intermediaries that make it possible for lenders to meet with potential borrowers. But in order to understand how the entire process works, it’s important to note that there are two types of crypto lending platforms: Centralized and Decentralized.

In the former, the platform is the central authority. It handles things such as setting the interest rates and approving loans. In Decentralized lending platforms, there’s no central authority. Here, the borrowing is done at a peer-to-peer level, and things such as the interest rate are determined by market dynamics (not the platform). The lending and borrowing part is then made possible by smart contracts, which are automation programs that run on the blockchain network. After the terms are agreed between the lender and borrower, the smart contract will then take over to ensure that all those agreements are met.

Both types of lending platforms are reliable, but you should always look at the reputation, interest rates and terms, supported cryptocurrency, and customer support before you choose one.

Pros & Cons of Crypto Lending

Here’s a look at the advantages and disadvantages.

Pros

• Access to Liquidity: Thanks to crypto lending, you don’t have to liquidate your assets to access funds. You can therefore trade or meet the financial needs you have without sacrificing your investment.
• A Passive Source of Income: This is an easy way of creating that passive income you’ve been thinking about. Keep in mind that you’ll also still gain from long-term price increments.
• High Degree of Transparency and Security: The risk of fraud or manipulation here is quite low, unlike in traditional lending.
• Lending & Borrowing Diversity: It usually doesn’t matter the type of cryptocurrency you hold. Whether it’s Bitcoin or a meme coin, you can lend or borrow. The interest rates and terms are also flexible.

Cons

• Subject to Market Volatility: This one is a constant for all digital assets. If the price of one of the cryptocurrencies involved goes very high or very low, you can end up losing, depending on which side you are.
• Smart Contract Have their Risks: Smart contract vulnerabilities may be rare, but they still pose a threat to crypto lending.
• There’s Always Risk of Defaulting: If a borrower defaults, the lender may have trouble retrieving the value of their assets.
• Threat of Regulation Changes: All crypto operations are subject to the evolving regulatory landscape. A negative one can easily lead to uncertainties and compliance challenges.

If you plan to try out crypto lending, it’s important to ensure that you understand even the small details. On top of that, be keen to choose the right lending platform and select a borrower carefully by analyzing their profile.