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crypto loans

Crypto loans: what is it and how it works?

By CrypptoCat | SKCrypto | 17 Aug 2022


The purpose of this article is educational, I don't sell any services or products. I just want to introduce the crypto lending and borrowing industry, to tell how it evolves and what is interesting in it, which is not represented in traditional finances. DYOR and let's go!

crypto loans

The idea

Crypto loans became popular in 2020 when the pandemic began. In many countries, the rates of lending in traditional currencies have decreased and it has become more difficult to obtain loans. On the other hand, those who were looking for where to invest their money faced a drop in profitability from traditional investment instruments due to the fall of the economy and also turned their attention to a new area.

To make it more straightforward, let's look at a couple of examples.

Example 1

Let's say you have 1 bitcoin, and you bought it for $45,000. Now its price is hovering around $23,500, but you believe in further growth and do not want to sell it. At the same time, you need some money right now. What to do? Sell ​​some bitcoin at the current rate and lose potential benefit?

You can do this, but it's not the best option. You can use your crypto as collateral and borrow the required amount in stablecoins. So you will not lose money if the asset increases in price during the lending period, because you still have 1 BTC. The loan will need to be repaid in the same currency that you borrowed.

But if the asset becomes cheaper and you decide to repay the loan from the collateral amount, you will have to pay more. If the asset falls in price extremely, then the platform will close (liquidate) your position and you will lose the entire margin.

Example 2

Let's say you have $10,000 in stablecoins. Times are turbulent and you don't want to invest in altcoins, but you also don't want to cash out. Yes, you can just HODL your tokens, but also they can be used to lend to people from example 1. Thus, you will earn interest in lending to others. At the same time, you do not need to take receipts and debt obligations, the platform itself is the guarantor of your contribution. By investing money like that, you get interest rates on them, and additionally other tokens and trading commissions on the platform as a reward.

As a lender, you face some risks. For example, the platform may go bankrupt or cheat its customers. Money can be stolen by hackers. If you provide BTC or ETH (not stablecoins at all), their prices may depreciate.

Example 3

You are not only an investor but also a trader. And playing on the difference in the exchange rates, you can increase your deposit.

Let's say you are sure that Ethereum will become cheaper. Having $10,000 as collateral, you can borrow 6 ETH. And immediately sell them for $1500/ETH. Thus, you have $9,000 on your balance. A month later, the price of Ether dropped to $1,200, and with your $9,000 you can now buy 7,5 ETH. Applying simple arithmetic, you need to return 6 ETH, 1,5 ETH minus interest for using the loan will be your earnings in this case.

Pros, cons, and differences

The main difference from traditional lending and at the same time advantage is that the client’s financial history, the origin of funds (except in cases of theft), speed and convenience do not matter here. No need to collect a bunch of papers, wait for the decision of the bank, and so on. The lending platforms don't care about the sources of your income unless the funds have been stolen from other platforms.

At the same time, if a bank gives a loan without collateral, but based on your sources of income, monthly income, and so on, another crypto acts as collateral in the crypto loan. Do not believe projects that promise loans without collateral, this is a scam.

If you understand what you are doing, you can “loop” money on different platforms. It means reinvesting several times and earning on commissions or farming promising tokens, when the final income is higher than the commission for using the loan. The same is true for trading, as in example 3.

The main disadvantage here is high volatility. As in the whole crypto industry. By borrowing money, you can lose your collateral if it depreciates quickly. In addition, not all sites should be trusted and you always need to diversify.

How does it work?

As with exchanges, this industry has centralized services and decentralized ones. The first is, for example, Binance Loan and BlockFi, and the second is Compound and Aave.

The difference is in the case of a centralized service you need to go through verification, while in the second one you only need a wallet and all interaction takes place through smart contracts.

These platforms have been working for a long time and the principles of their work have already been described above. You register or connect a wallet, make a deposit from among the supported assets and, depending on this, get the opportunity to borrow the same asset or another one from among those presented. There is a significant disadvantage for which these sites are criticized.

So, you can deposit only a limited number of tokens. Usually, these are stablecoins and assets with a large market capitalization, such as BTC and ETH. If lesser-known cryptocurrencies are gathering dust on your wallet, you won’t be able to take a loan for them.

The second not very convenient point is that the interest is usually floating. Unlike the same traditional banking sector. This is inconvenient because it does not allow you to calculate your possible profit and loss and is unpredictable for the end user.

There are young projects with a different approach. For example, Primex is a cross-chain decentralized exchange where the lender lends his funds at a fixed percentage for a fixed period of time, which gives him the opportunity to better calculate the profit of the investment. In addition, he can lend his funds only to certain traders selected by the platform and receive additional interest accruals for this.

This is a startup that is just developing its product, so you can test the beta version without risking real money and understand how everything works.

An even more interesting approach is offered by the Qoda project. There are not only fixed interest rates and terms, but also the ability to choose them yourself. Unlike other similar services, the marketplace model is used here. It means that absolutely any user of the platform can create a loan quote or offer a credit at their own interest and for any period. Moreover, any altcoins can be used on this platform. In fact, this is P2P, where supply and demand are regulated by the users themselves.

Therefore, if somewhere on your account you have some no-name tokens waiting for better times, they can be loaned on this platform. Suddenly someone will come in handy for trading.

Qoda is also just being developed, so you can "play around" with the protocol on the test network without real money. 

Conclusion

Crypto loans are, in fact, an opportunity to earn on your crypto by lending it, or by increasing the initial deposit through secured loans. If you haven’t been interested before, it makes sense to dig deeper to figure out how it works and not just hodl your tokens on wallets or exchanges.

DYOR

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CrypptoCat
CrypptoCat

Crypto Content Creator, Enthusiast, Ambassador and DeFi Believer


SKCrypto
SKCrypto

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