What is crypto lending and how does it work?

Crypto lending is similar to a traditional lending model in that users can borrow and lend cryptocurrencies in exchange for a fee or interest. However, these loans use digital currency as collateral, similar to a securities-based loan.

The basic principle works like a mortgage loan or auto loan — you pledge your crypto assets to obtain the loan and pay it off over time. You can get this type of loan through a crypto exchange or crypto lending platform. While it’s seen a huge spike in interest in recent years, crypto lending comes with its own set of risks and is highly volatile, especially in the short term.

How crypto lending works

Crypto lending allows you to borrow money — either cash or cryptocurrency — for a fee, typically between 5 percent to 10 percent. It’s essentially a secured personal loan.

While you retain ownership of the crypto you’ve used as collateral, you lose some rights, such as the ability to trade it or use it to make transactions. Also, if the value of your digital assets drops significantly, you may end up owing back much more than you borrowed should you default on the loan.

People may consider crypto loans because of the benefits they provide and because they have no intention to trade or use their crypto assets in the near future. The acronym HODL, which stands for hold on for dear life, is a common refrain in crypto-focused online forums.

Potential benefits of cryptocurrency lending

While crypto loans carry a large amount of risk, there are some benefits. However, the examples listed below need to be taken into account alongside the inherent drawbacks and volatility.

• Low interest rates: While they’re generally not as inexpensive as mortgage or car loans, crypto loans are an inexpensive alternative to personal loans and credit cards. You can often get a crypto loan with an interest rate below 10 percent.
• No credit check: Crypto lending platforms and exchanges typically won’t run a credit check when you apply, making it an incredibly attractive financing option for people with poor credit or no credit history.
• Fast funding: Once you’re approved, you can get your loan funds in as little as a few hours.

Why not to consider cryptocurrency lending

Due to the nature of cryptocurrency, there are typically more reasons to not use this method of lending than there are benefits.

Margin calls

A margin call occurs when the value of your collateral drops below a certain threshold and the lender requires you to increase your holdings to maintain the loan. In some cases, the lender may even sell some of your assets to cut your loan-to-value ratio. Because cryptocurrencies are extremely volatile in the short term, the chances of this happening can be high.

No access to your assets

As long as your loan has an outstanding balance, you can’t access your holdings to trade or transact. This can be a significant problem if the price of the currency drops significantly or you need cash in a hurry.

Repayment terms can vary

These loans usually function like traditional installment loans, and depending on the crypto lending program, you may have less than a year to pay back what you borrowed. In other cases, you can create your own repayment schedule. With shorter repayment terms it’s crucial that you know beforehand whether you can afford the payments.

Not all digital assets are eligible

Depending on the crypto lending platform you use, you may need to exchange your currency for an eligible asset. This may not be preferable if you want to hold onto your specific asset and it doesn’t qualify as collateral on a given platform.

Interest account funds aren’t insured

If you’re lending your own digital assets, the funds in a crypto interest account aren’t insured like the money in your bank account. So if the exchange fails, you could lose everything.

Interest account withdrawals can be slow

You can generally request a withdrawal from your crypto interest account whenever you want. But depending on the platform, it could take several days for those funds to be released so you can use them. This can be very damaging if the value of your assets drops quickly and you can’t trade them.

The bottom line

Before you engage in either side of crypto lending it’s important to understand the risks, especially what could happen if the value of your cryptocurrency drops swiftly and significantly. If you’re considering crypto lending in either form, make sure you consider both the benefits and drawbacks, as well as all your other options, before you make a decision.