How does Crypto Lending Work? Benefits and Risks

Cryptocurrency lending has grown in popularity over the past few years. More and more people are hearing about this exciting new type of investing, and more projects are popping up to help improve their experience. As per the latest trends, this space is expected to rise even further with more and more people coming forward with their lending capabilities. Many people find it hard to understand how crypto lending works and what they can do with this advanced technology. This guide will outline how cryptocurrency lending works, the benefits and risks involved with it, and the kind of project you should be looking at before putting money into one.

What is crypto lending?

Crypto lending is a new type of financing that allows you to earn interest based on the value of your crypto assets. Private lenders take custody of your assets and use them as collateral for loans. They then return at least some portion of your investment every day until the loan is repaid. Crypto lending is a simple concept that enables you to borrow cryptocurrency with a payment plan. You are basically lending your crypto to a lender and getting it back after a set period of time. 

There are two reasons this type of loan can be advantageous: It allows borrowers to make use of their digital assets elsewhere, like trading or buying more altcoins – without having to sell their own crypto. Secondly, the interest rate is lower than regular loans which means there are no hidden fees associated with this type of financial product. Learn how crypto lending works with this step-by-step guide to crypto lending in easy-to-understand terms.

Types of cryptocurrency

A cryptocurrency is a digital or virtual currency that is protected by cryptography, making counterfeiting or double-spending practically impossible. Many cryptocurrencies are decentralised networks built on blockchain technology, which is a distributed ledger enforced by a network of computers. Using this technology, participants can confirm transactions without needing a central clearing authority. Potential applications include fund transfers, voting, settling trades, and others.

There are thousands of different cryptocurrencies in circulation and the figure keeps increasing. Part of the reason why is because of the way cryptocurrencies can be created. The source code of one can be used to build another. Cryptocurrencies are often not issued by any central body and making them potentially immune to government interference or manipulation. Below are the main types of cryptocurrency.

Bitcoin

Bitcoin is considered the first cryptocurrency created which is designed to act as money and a form of payment outside the control of any one person, group, or entity, thus removing the need for third-party involvement in financial transactions. Bitcoins are rewarded to blockchain miners for their work done to verify transactions and can be purchased on several exchanges.

Bitcoin has become the most well-known cryptocurrency in the world, and its popularity has inspired the development of other cryptocurrencies. Competitors attempt to replace it as a payment system or used it as a utility in other blockchains and emerging financial technologies.

Tether

Tether is a cryptocurrency stablecoin pegged to the US dollar and backed “100% by Tether’s reserves. It’s owned by iFinex, which is a company from Hongkong that owns the crypto exchange BitFinex. Currently, it’s the third-largest cryptocurrency after Bitcoin and Ethereum, and the largest stablecoin with a market capitalisation of almost $83 billion.

Ethereum

Ethereum is a technology for building apps and organisations, holding assets, transacting, and communicating without being controlled by a central authority. You won’t need to hand over all your personal details to use Ethereum. You’ll be able to control your data and what is being shared. Ethereum also has its own cryptocurrency, Ether, which is used to pay for certain activities on the Ethereum network.

Just like Bitcoin, Ethereum lets you use digital money without payment. But Ethereum is programmable, which means that you can also build and deploy decentralised applications on its network. It’s more like a marketplace of financial services, games, social networks, and other apps that respect your privacy.

Terra

Terra is the blockchain technology that houses the LUNA coin and associated stablecoins like TerraUSD. The LUNA coin is used as a protocol token to reduce the volatility of the stablecoins on the Terra blockchain.

The aim of Terra was to create stablecoins to combine the decentralized freedom of cryptocurrencies with the stability of fiat money. However, due to the faults in Terra’s ecosystem, LUNA saw a massive crash in its price.

XRP

XRP is the native cryptocurrency of XRP Ledger, which is an open-source, public blockchain designed to facilitate faster and cheaper payments. If a person uses XRP as a bridging currency, it’s possible to settle cross-border transactions in less than five seconds on the open-source XRP Ledger blockchain at a fraction of the cost of the more traditional methods.

XRP Ledger is a permissionless network of peer-to-peer servers that powers XRP operations. It intends to act as a bridge between hard-to-match currencies. So if there are no market markers on the network willing to trade shekels for shillings, one can sell the shekels for XRP and then use XRP to buy shillings.

How does crypto lending work?

Crypto lending lets users borrow and lend cryptocurrencies with interest. Borrowers can instantly get a loan and start investing just by providing some collateral. When the collateral falls below a certain value, they will need to top it up to the required level to avoid liquidation. When the loaned amount plus a fee is returned, the capital is unlocked. They can also get collateral-free loans known as flash loans, which must be paid back within the same transaction. If the borrower cannot do this, the lending transaction is reversed before it has the chance to be finalised. Crypto loans make borrowing and lending simple, and the process is completely automated by smart contracts. 

Benefits of cryptocurrency loans

1. Capital is easily available. Anyone who can offer collateral or refund the cash in a flash loan or quick cash loan is eligible for a crypto loan. This makes them easier to get than a regular financial institution loan, and they won’t look at your credit score.

2. Loans are managed using smart contracts. A smart contract automates the whole loan and borrowing process, making it more efficient and scalable.

3. It is simple to get passive money with minimal effort. Borrowers may store their cryptocurrency in a vault and start earning without having to handle the loan themselves.

Risks of crypto lending

1. Depending on your collateral, you have a high danger of liquidation. Even with heavily collateralised loans such as car loans, crypto values might decrease unexpectedly, resulting in liquidation.

2. Smart contracts are vulnerable to cyber-attacks. Badly constructed code and back-door vulnerabilities might lead to the loss of your loaned amount or collateral.

3. Borrowing and lending might put your wealth in danger. While diversifying your portfolio is a smart idea, doing so via crypto-backed loans introduces additional risks.

Things to consider

You’ll have the highest chance of success with a crypto loan if you choose a reputable crypto lending platform and reliable assets as collateral. But, before you lend or borrow, keep the following points in mind:

• Understand the dangers of transferring custody of your crypto holdings. Once the funds leave your wallet, you must rely on someone else (or a smart contract) to handle them. Projects can be the subject of hackers and fraud, and your funds may not be instantly available for withdrawal in such situations.
• Before lending your cryptocurrency, consider the market circumstances. Your coins may remain frozen for an extended length of time, making it unable to respond to crypto market downturns. Lending or borrowing with a new platform can be dangerous as well, and you may be better off waiting until it gains more trust.
• Read the loan terms and conditions carefully. There is a variety of choices for where to obtain loans like secured loans. You should seek lower interest rates as well as more advantageous terms and circumstances.

Conclusion

Cryptocurrency may be a good investment if you’re ready to recognise that it’s a high-risk bet that might pay off – but also that there’s a big possibility you’ll lose it all. Cryptocurrency prices have been decreasing in 2022 as a result of a global crypto price meltdown. Before you purchase and sell digital currency, understand the risks so you can decide whether it is a smart investment for you and your personal finances. It is critical to proceed with caution when investing in bitcoin or other cryptocurrencies.

Author’s Bio: 

Marjorie Hajim

Marjorie Hajim is the SEO Manager for Friendly Finance. Friendly Finance is a leading loan matching service in Australia specialising in consumer finance. She loves growing businesses with a focus on their online presence and is passionate about organic growth and all things digital.

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