I've been asked by a number of friends and other people how lending in the crypto space works and how you can do this. Personally, I've been active in lending ever since I've stopped daytrading actively due to a lack of time, so I can share quite some experience. In addition, I currently help building up an all-new crypto-lending platform, but that's not the main focus here.
I'm splitting this article into multiple parts. This first part will cover the general principles of crypto lending and some places to go. In the following parts, I'll cover how it actually works on a particular platform in a more step-by-step manner.
Lending, huh?
Lending obviously means that one person gets a loan from another person or an institution like a bank. With cryptos, so far we only talk peer-to-peer lending, meaning that there are no banks but people with coins lend those coins to people who don't have them or want more of them. With cryptocurrencies, the interest rate is typically expressed in % per day because it's a short-term market, and interest rates start at 0.00001 or 0.0001 % per day.
Why would you do that?
For lenders, it's quite clear: You got cryptos, you want to keep them, but ideally have more. You don't have the time, expertise, or guts to trade the ups and downs of the coin itself, so you're looking for a safer and more convenient way to get an interest on your coins.
For borrowers, there are multiple potential reasons, and it depends on your circumstances as to what type of loan that you're getting is suited for you:
You want to place a bet on falling prices of the coin you're borrowing ("go short")
1b. You want to trade margin (which, in effect, is the same thing, but with a slightly different mechanism)You need money, e.g. to pay a bill
2b. You need cryptos, e.g. Bitcoin, to buy something that is cheaper in Bitcoin
I'll get to the distinctions between those reasons once I get to describe the mechanisms and platforms for these use cases. I'm also planning on articles about margin trading, so stay tuned :-)
Two kinds of crypto-lending
In general, there's two types of loans you can do: secured and unsecured.
Secured means that your loan will have to be backed up by collateral, typically different crypto coins. It's similar to your custodian bank, where you can get a short-notice loan by letting them use your stock as a security. In case you cannot pay back the loan, they will sell parts or all of your collateral to get back their money. For cryptocurrencies, there's also an intermediary who manages the risk of default for your loan and the respective collateral. Some exchanges offer that kind of service, but there are services specialized on that.
As an effect, the risk of default for the lender is close to 0, so it's a safe way of getting interest on your cryptos.
Secured loans are used for number 1 and 1b in the use case section above, where people want to go short in a certain coin and make a gain by the price going down.
Unsecured loans in contrast are loans that don't get backed up by such securities. As a result, the entire process of getting a loan becomes more complex and more risky (for the lender), but can also be more rewarding. It actually works similar to classic peer-to-peer lending, where a risk profile (or rating) is being created for the borrower, and depending on their anticipated risk of default, the interest rate will be adjusted to - ideally - make it profitable for lenders.
Unsecured loans are the ones used for items 2 and 2b of the use cases. People in need of liquidity typically don't have other cryptos to put in as a collateral, otherwise they probably wouldn't borrow, but rather sell.
Where to go
Now that you know what reasons and types of lending there are, you might want to know what's better and where to go to actually start making money.
Due to the high volatility of cryptos, most services and platforms focus on secured loans - margin trading and short-selling, so there's plenty of options already existing or under development:
and many more. There are differences in the models (e.g. centralized vs dezentralized), the offered coins and more details. I have no particular preference here, but if you hold part of your funds at one of the exchanges (even though many people don't recommend that), then that's probably a good place to start.
The exact same mentioned volatility makes the unsecured loans platforms have more difficulties gaining the same amount of traction, but still there are some live or currently working on such models:
I wanna leave it at that for the time being. Please leave a comment if there's anything that you'd like to have covered in the next parts so I can adjust a little bit. Other than that, I'll start covering some secured loans in the next part.