Crypto Lending? How Investors Earn Crypto Without Buying Or Mining It

In 2018, Lendingblock, a securities platform for cryptocurrencies and digital assets, introduced crypto lending to the cryptocurrency industry. According to Forbes, investors found this new use case to be a leap forward to the triumph of digital assets. Credmark insight reveals the growing popularity of crypto lending and interest in generating yield on crypto holdings. In 2019, the overall amount of crypto loans generated was $8 billion compared to $1 billion in 2018, representing a 700% growth.

More recently, Goldman Sachs Group Inc. offered its first ever lending facility backed by Bitcoin, in a significant step for a major U.S. bank that accelerates Wall Street’s embrace of cryptocurrencies. The secured lending facility lent cash collateralized by Bitcoin owned by the borrower.  This is unique given Goldman Sach’s membership as a Financial Holding Corp within the US Federal Reserve Banking System and requires a level of collateral and reserve monitoring and reporting requirements for lending facilities.  Several crypto-friendly banks including Silvergate Capital Corp. have already provided U.S. dollar loans backed by Bitcoin.

Cryptocurrency started out as an opportunity to store value and make unconstrained payments. This was back in 2009 when the genesis block was mined. Today, June 6th 2022 , the crypto ecosystem has expanded to a $1,256,790,333,125 USD market capitalization, due to the blooming innovation in blockchain technology. This has given birth to innovative products and services and empowered decentralized finance (DeFi).

As promising as it all sounds, crypto lending comes with a number of financial, security and regulatory risks and challenges. Below, we learn how to manage them and identify the major players (Investors, Borrowers, Platforms & Regulators) of this ecosystem.

What is Crypto Lending?

Crypto lending is the process of providing another with a crypto-backed loan under conditions that promise its refund. It is a centralized or decentralized financial procedure where the borrower compensates the lender for the loan through interest payments or crypto dividends.

A crypto-backed loan is a secured loan obtained through a cryptocurrency exchange or another cryptocurrency lending platform. The loan works similarly to a mortgage or vehicle loan in that you protect your loan funds with an asset — in this case, your digital assets. While a lending platform or wallet is usually involved in the lending process, the high risk high reward peer-to-peer (P2P) model also exists in lending. 

Crypto lending derives its popularity from another popular use case where cryptocurrency owners, indifferent to short term price volatility, hold onto their assets for prolonged periods. The end goal is to cash out when the stored currency has peaked in price. On the Bitcoin side, 19% of the total supply of Bitcoins was unshaken in the last 7 to 10 years, according to Glassnode data. Crypto lending leverages that use case with the ability to get steady passive income from their deposit.

How Does Crypto Lending Work?

Similar to traditional finance (TradFi), borrowers with need for instant funding will stake an asset and receive money in response, compensating a lender with interest. An intermediary known as the lending platform facilitates this operation in return for a portion of the interest paid by the borrower. The following graph from Medium illustrates the process and all the entities involved.

Medium: Crypto lending cycle and involved parties

The common path to crypto lending is to use one of the crypto-based savings accounts service providers in the industry. Lending platforms act as a meeting point for both the borrower and the lender, often without sharing identifiable information on one another. The College Investor put together a list of renowned service providers in the field and compared the advertised yield on each.

Company	Stable Coins (e.g. USDC)	Bitcoin
Hodlnaut	Up to 13.86%	Up to 5.33%
KuCoin	6.10%	0.68%
Celsius Network	18.63%	Up to 6.20%
Gemini	Up to 7.4%	2.05%
Coinbase	1.25%	4.00%
Crypto.com	6-12%	4.50%
YouHodler	Up to 12%	4.80%
Outlet Finance	Up to 6%	Not available
Ledn	8.00%	5.25%
BlockFi	7.00%	0.1%-3.0%
Nexo	Up to 17%	Up to 8%

Lending platforms also enable users to earn interest on other cryptocurrencies like Ethereum and Tether, however, the yield on staking varies per currency, platform and agreement.

Lending between DeFi and TradFi

There is no doubt that traditional banking yield is incomparable with crypto lending yield. Some crypto lending platforms offer more than 20% interest on crypto deposits. This high reward comes with high risks, however. Crypto firms generally do not apply any reserve requirements while accepting deposits or offering lending services. 

The intermediary in traditional financial institutions, such as banks, acts as a medium between the borrower and the lender. The assets are secured by FDIC insurance up to $250,000, remain under the ownership of the lender, simply in custody of the bank, and can be withdrawn at any time. Crypto firms do not offer depository insurance like in traditional bank saving accounts. 

In DeFi, those benefits and more, when available, are considered a luxury, in exchange for high interest rates that range from 3% to over 20%. Notably, those clear risks do not discourage a wide number of investors from leaning toward crypto lending. According to Statista, Crypto Lending Total Value Locked (TVL) as of March 2022 constituted around $47 billion, accounting for about half of the total value locked up in DeFi based on the Ethereum blockchain.

Lending Platforms Risk Management – Regulators Are Concerned

There are two types of crypto lending platforms: centralized and decentralized. Centralized (CeFi) Platforms are more honest to traditional financial institutions. They identify customers using Know Your Customer (KYC) procedures and run credit checks before providing them with any loans. These procedures contribute to safeguarding the digital assets of lenders. Nevertheless, CeFi platforms transact with hedge funds, cryptocurrency exchanges, and other institutional investors. 

With regard to the obscure source of lent assets, this all exposes the platform to money laundering, sanctions and other types of law violations and risks. Therefore, CeFi platforms must incorporate enhanced due diligence, suspicious activity monitoring and reporting, and other security measures in order to safeguard customer assets and steer clear of regulatory hassle.

Decentralized Platforms enable lending cryptocurrency without the need for an intermediary or a financial regulation. A smart contract is used to establish an agreement between the lender and the borrower. It sets the loan’s interest rates and conditions, and fulfills the transaction.

Crypto lending has recently provoked numerous heated disputes among regulators, particularly in the United States. BlockFi, a popular lending platform, received cease and desist letters from numerous state attorneys general, and a $50 million fine from the U.S. Securities and Exchange Commission (SEC). The company compensated different states with $50 millions more to settle the charges. Larger and well established crypto firms were also struck by the SEC, namely Coinbase. in 2021, the SEC forced Coinbase to halt its crypto lending program.

“I guess the main concern from the regulators standpoint is that there’s very little disclosure about what’s actually happening behind the scenes with these companies” –The Wall Street Journal markets reporter Alexander Osipovich. The reporter explains how regulators worry beyond the bold risks of crypto lending. With the current desync between crypto finance and regulation, crypto might get so big that it will impose a systematic financial risk.

How Blockchain Analytics Makes Crypto Lending Environment Safe

On Apr 28, 2022, Adrienne A. Harris, Superintendent of the New York State Department of Financial Services (DFS), issued new guidance for cryptocurrency firms. Ms. Harris stated “Blockchain analytics tools provide companies with an efficient, data-driven way to conduct customer due diligence, transaction monitoring, and sanctions screening, among other things, which are all critical elements of our virtual currency regulation”.

Blockchain analytics tools supplement crypto adoption. They facilitate the above requirements and facilitate the processing of payments. Worthy of mention, regulatory requirements are far from advanced. In the U.S. alone, regulations build up from the several federal and state level authorities. Blockchain analytics tools don’t make compliance with those regulations easier, they rather make it possible. 

Using valuable data and insights, compliance and financial officers make educated decisions. They count on blockchain analytics tools to eliminate redundancy and leverage the potential of the business to its competitive advantage in a secure and compliant manner.

Build A Secure Environment For Digital Assets and Cryptocurrency