Cryptocurrency Lending & Borrowing Explained | What Is Crypto Lending?
Applying and being approved for a loan is time-consuming in conventional banking systems. The borrower must wait for several days, visit banks regularly, and complete various forms to get a loan approved. Due to this hectic process, the financial industry has taken a positive step toward Fintech adoption. Fintech enables digital lending and eliminates the additional costs associated with intermediaries.
A Crypto loan is a different way procedure than a traditional bank loan. The inconveniences of applying for a loan in a conventional banking system include in-person visits to the bank, lengthy forms, lengthy verification processes, and pending approvals. Even if you apply for a bank loan online, you will need to visit the branch in person to complete other processes such as sanctioning the loan and verifying the documents.
On the other hand, crypto lending is completely automated and online. You can apply for a loan online in various ways, and same as a loan application, your crypto loan would be sanctioned entirely online. There are mainly two types of Crypto loans: centralized and decentralized. The primary distinction between these two types of crypto loans is who manages them, whether a smart contract or a central body, and whether custodial or KYC (Know Your Customer) authentication is used to verify the borrower’s identity. In a centralized cryptocurrency loan process, a single authority sanctions the loan based on custodial security. In contrast, a decentralized cryptocurrency loan is sanctioned by a smart contract and is not reliant on any central organization to enforce loan terms and conditions.
Crypto loans are preferable and profitable due to their feature of saving assets’ value. Additionally, it saves you the time and effort you put in when visiting banks. While both centralized and decentralized crypto loans benefit the lending sector of finance, the decentralized crypto loan is gaining traction due to its distributed nature and lack of custody.
With the help of this article, we will delve into the details of crypto loans, especially decentralized non-custodial crypto loans.
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What are Cryptocurrency Loans?
Crypto loans are loans secured by a borrower’s crypto assets. It pays interest to crypto lenders in the form of ‘crypto dividends’ in exchange for the crypto loans they lend in fiat currency. The borrower receives fiat loans or currencies like ETH or BTC in exchange for crypto assets. These crypto-assets and currencies then serve as a guarantee if the borrower can not reimburse them.
Also, crypto loans help increase the value of borrowers’ crypto assets by holding them without any intention of selling them. But you can not use these crypto-assets pledged as collateral for trading during the loan’s term. The exchange of crypto loans occurs between the lender and borrower at a predetermined interest rate on loan. As with traditional loans, the borrower receives the loan amount in his account and is responsible for repaying the EMIs to the lender. Once the borrower has fully repaid the amount, the lender releases the borrower’s crypto assets used as collateral for the loan.
The following are some of the advantages of crypto loans:
- There are no physical bank accounts.
- Loan portfolio diversification
- Passive income to lenders
- Exchanges without permission
- There are no geographical restrictions.
- Transaction fees are minimal, and interest rates are competitive.
Now that we’re familiar with crypto loans let’s look at the various types.
Different Types of Cryptocurrency Loans
There are mainly two types of cryptocurrency loans: DeFi and CeFi. The difference between these two types is that a smart contract manages deFi while an authority or a business manages the other one.
CeFi Crypto Loans
In this type of crypto loan, the authority or company manages the users and their processes. They are responsible to performs KYC and exchanging cryptocurrencies and fiat currencies with the custodial to secure the assets during this onboarding process. The centralized loan is adaptable in forming relationships with diverse businesses and negotiating customized loan contracts.
In margin-based centralized crypto loans, authorities platforms rely on user attention to attract users. Additionally, they offer competitive interest rates and have agreements with cryptocurrency lenders.
DeFi Non-Custodial Crypto Loans
Decentralized crypto-loans operate similarly to peer-to-peer loans, with borrowers and lenders connected via a blockchain-powered Defi crypto lending platform. These types of loans are governed by smart contracts and are not centralized. In this type of crypto loan, individual borrowers obtain cash loans using their digital or crypto assets. Following that, these cash loans are used as working capital.
DeFi platforms are frequently non-custodial, do not require KYC, and only accept cryptocurrencies as a payment method. According to market supply and demand, the interest rates offered by centralized lending services tend to be higher. Because of the openness of the protocols and the use of public blockchains to store transactions, DeFi is more transparent than centralized systems.
The following section will examine several advantages of decentralized crypto lending.
Advantages of Decentralized Cryptocurrency Lending
Compared to conventional lending, decentralized crypto loans offer the following advantages:
Smart contracts monitor the loan and interest regulation processes for DeFi’s crypto loans. As a result, on-chain users can see and audit DeFi crypto loan data on a public blockchain. Additionally, the blockchain records individuals’ previous interactions with the loan blockchain protocols and their lent and borrowed positions. A market data feed for the DeFi crypto loan protocol is available to all members.
Users vote on loan protocol modifications in the absence of a central authority. Many protocols, in particular, issue governance tokens to users, granting them proportional voting rights.
A lending platform’s funds are pooled and can be profitably used. With the help of smart contracts on the blockchain, lending, borrowing, and arbitrage can all be done cheaply and quickly.
If the market’s supply-to-demand ratio changes, DeFi loans can automatically adjust their interest rates.
Lenders no longer need to trust borrowers’ creditworthiness, as properly structured smart contracts require liquidation in the event of default risk.
Now that we’ve discussed the benefits of decentralized crypto loans let’s look at some of their key components in the following section.
What are the Critical Elements of Decentralized Cryptocurrency Loans?
Decentralized cryptocurrency loans have two distinct characteristics. First, they frequently depart from the current subjective framework of centralized credit assessment and collateral evaluation; second, they utilize smart contracts to monitor crypto exchange. The following are the critical components of decentralized crypto loans:
Value locked refers to the component of a decentralized lending protocol’s smart contracts that originate from user deposits. This locked value serves as a reserve to compensate the depositor in the event of redemption and is also used as collateral.
Decentralized cryptocurrency lending platforms issue IOU tokens to their users in exchange for their deposits. After some time, these IOU tokens are used to redeem the deposits. They are naturally transferable and can be exchanged.
Collateral for a decentralized crypto loan comprises the borrower’s deposits in part or in full. The value of the collateral, combined with the final loan-to-value ratio of the underlying asset, indicates the maximum number of crypto assets that a user may borrow.
By utilizing a smart contract, the liquidity status of collateral is automatically triggered. When the loan-to-value ratio exceeds a critical threshold, referred to as the liquidation threshold, as a result of accrued interest or market movements, any network participant can compete for the collateral liquidation. External data providers, also known as ‘price oracles,’ provide the smart contracts with market price data for the locked and borrowed assets.
Rate of Interest
In decentralized lending, smart contracts, which act as an agreement between the lender and borrower, affect borrowing and lending rates. The smart contract automatically adjusts these interest rates in response to the current supply-demand dynamics.
Token for Governance
Certain decentralized crypto lending platforms distribute governance tokens to their users, allowing them to vote on and propose changes to the lending protocol, such as interest rate changes. Governance tokens are typically used as a reward system to incentivize user participation in lending and borrowing.
Now that we’ve identified the distinct components of decentralized crypto lending let’s examine its mechanism in the following section.
How Does Decentralized Crypto Loan Work?
Decentralized crypto loans operate in a way that connects lenders and borrowers via smart contracts that regulate loan processes and interest rates. For security purposes, these smart contracts monitor both parties. Thus, three entities are involved in Defi’s crypto loans:
They are those who lend their fiat currency in the form of crypto loans to earn passively through crypto dividends or interest on the loaned amount. Additionally, decentralized crypto lenders profit from their cryptocurrency investments.
Blockchain Technology Platform
The blockchain platform handles transactions involving lending and borrowing between two parties by triggering a smart contract. It keeps track of all lending factors, including the interest rate and collateral, if the borrower defaults. Lending protocols automate the entire process of decentralized lending without the need for an intermediary and do not require both parties to reveal their identities.
Borrowers are individuals seeking a specific amount of crypto loan collateralized by their crypto assets. They connect with the DeFi crypto loan platform and then apply for a crypto loan. The borrower pledges his crypto assets to secure the lender’s loan amount. Here, smart control manages the loan process’s technical complexities, including collateral blocking, loan approval, and interest rate. The borrower must then repay the entire loan amount before receiving the crypto-assets and stakes pledged as collateral.
Detailed Steps of the Procedure
Step 1: The borrower makes a request for a crypto loan on a platform (backing it up with his crypto)
Step 2: After the platform approves the loan request, the borrower stakes his cryptocurrency as collateral. The borrower will not be able to recover the staked amount until he repays the entire loan.
Step 3: Through the platform, investors (lenders) fund the loan automatically. Typically, this process is invisible to investors, as their cryptocurrency balances remain unchanged.
Step 4: Investors receive interest regularly (usually weekly or monthly, and rarely at the end of the lending period).
Step 5: Once the borrower has repaid the loan in full, he will receive his crypto collateral.
While the specifics of cryptocurrency lending vary by platform, the underlying concept is consistent across all platforms.
In some cases, cryptocurrency lending also uses smart contracts, which make the lending and borrowing process safer by enforcing the terms of the contract.
How Can We Help in Terms of Crypto Lending Platform Development?
Suffescom targets businesses and entrepreneurs interested in launching their DeFi-based decentralized applications (dApps) for peer-to-peer lending and borrowing of Crypto loans. It offers the following services for developing crypto-lending platforms:
Consultancy and Concept Generation
We offer consult services to assist you in comprehending the crypto loan platform’s mechanism. Our consulting and ideation services chart will walk you through the various features and tools that we incorporate into the lending platform.
Development of Smart Contracts
Our smart contract development experts design and code platforms for lending and borrowing decentralized cryptocurrency loans. We ensure that they are secure, trustless, and permissionless.
Backend and Frontend Development
Our experienced developers will collaborate on the structure and design of your DeFi platform. We develop the front and backend of your lending platform, integrating the most appropriate tools, admin panels, and security functions to ensure an intuitive user interface.
Development of a Wallet
Additionally, we develop wallets to facilitate multi-currency lending and borrowing. This enables the borrower and lender to conduct a lending transaction involving a variety of cryptos.
Development of Stablecoins
Additionally, we develop stablecoins to enable peer-to-peer lending between lenders and borrowers. Borrowers need to convert the stablecoin to cash.
We develop a protocol tailored to your DeFi crypto lending platform’s needs, establish and modify its rules, interest rate, LTV rate, liquidation penalty, and define the accepted digital currencies.
We integrate high-level encryption and security features optimized for your P2P lending platform to ensure maximum security for collateral, crypto-assets, and user credentials.
Upgrading and Maintenance
We constantly analyze new features and integrate robust technologies to ensure the platform’s scalability.
Decentralized crypto lending has the potential to transform the financial sector completely. Payments, trade, investing, insurance, lending, and borrowing rely on blockchain technology to decentralize conventional financial services. DeFi has enormous potential to transform the global financial environment by offering attractive opportunities for passive income from crypto assets and competitive interest rates on lending.
If you are interested in developing a DeFi crypto-loan platform, please contact our blockchain experts and professionals for assistance.