The exchange of cryptocurrencies between people and the purchase of a pizza at a cost of 10,000 BTC from Papa John’s were the first use cases, which were followed by trading on exchanges and lending, ie the ability to make loans in crypto, including of course also bitcoin (BTC) and ethereum (ETH).
The actors of this nascent economy soon understood that cryptocurrencies were not just mining and speculation, but a new financial tool to support the real economy through crypto lending.
We can outline two main forms of crypto lending:
- Social lending.
Speculative lending with cryptocurrencies
This type of loan is mainly practised by exchanges. Poloniex and Bitfinex are among the first platforms to have implemented it. The tool is called margin funding on Bitfinex.
The definition provided by Bitfinex is appropriate because it is precisely lending crypto to traders who practice margin trading.
Margin trading is an investment practice that uses funds borrowed from a broker to engage in leveraged financial trading.
Cryptocurrency exchanges, especially in the early years of life, not being able to count on large economic resources, have offered the opportunity to its users to become brokers, lenders of crypto assets for other customers interested in margin trading on the given platform.
How does speculative crypto lending work?
Imagine you want to lend 1 bitcoin (BTC) deposited on a cryptocurrency exchange that offers crypto lending service.
To offer your bitcoin, you must place it in the activated lending section of the trading platform, specifying:
- the amount to be lent
- for how many days
- what our earnings should be in the form of daily interest rate
The daily interest rate is chosen manually, based on the desired economic return, or following the trend of the exchange’s loans. Choosing the second option will allow your bitcoin to be placed faster.
In most cases, the loan has a minimum duration of two days and a maximum of sixty, once loaned the amount is bound until maturity or until the moment when the trader decides to return the amount borrowed.
Crypto lending risks: earnings and costs
Most of the exchanges that offer a crypto lending service guarantee the return of capital at 100% plus credit.
Regulations change from platform to platform and you should read the information notes before joining.
As far as earnings are concerned, they vary.
This is a real lending market, where those who lend at lower rates have a better chance of lending.
The best times to make loans coincide with the increase in the trading volume of the cryptocurrency, as there is more demand and traders are willing to pay more interest.
On the cost side, the trading platforms retain a percentage of the accrued interest. Some platforms charge 15% on accrued interest, while others charge up to 50%.
How does crypto lending affect the real economy
This typology is nothing more than social lending (peer-to-peer lending) already practiced by multiple online platforms with legal tender money.
Where is the difference between social lending with fiat currencies and social lending with cryptocurrencies? In the interests of the lender.
Some crypto social lending platforms recognise up to 25% interest on the cryptocurrency loaned.
Risks of social lending with cryptocurrencies
Those who know social lending know that it is not risk-free, the borrower applies for a loan to finance a business activity which may not perform well.
In essence, by lending cryptocurrency, the lender bears a percentage of the applicant’s business risk.
Regulated platforms follow industry regulations and divide investment opportunities into risk classes.
Each risk class has a maximum interest rate ceiling for the lender: the higher the risk, the higher the interest rate.
Where to invest with crypto social lending
A lot depends on the platform to which the investor decides to entrust their crypto assets.
Some companies specializing in loans with digital currencies offer money to small entrepreneurs to buy new tools, buy goods, expand the market, hire new staff and open a new business online.