Depending on your outlook and where your digital assets are currently stored, crypto lending is either the best thing since bitcoin or money for old rope.
To its proponents, the rapidly-growing sector presents one of the most exciting and practical use cases for cryptocurrencies, as evidenced by its triple-digit annual growth.
To its detractors, crypto lending is merely rebuilding traditional finance on a blockchain.
The truth, as is so often the case, lies somewhere in between: crypto lending is both refreshingly new and comfortingly familiar.
On the one hand, the sector can be seen as a continuation of the sort of lending opportunities that were once taken for granted by savers the world over.
High single or even double-digit percentage returns could be enjoyed by savers who pledged their spare fiat to the custody of their bank.
Years of central bank erosion of interest rates, however, have reduced those returns to nothing and even to negative rates for many savers, who are now penalized for an activity that was once rewarded.
When viewed within this paradigm, crypto lending has emerged as a solution to a growing problem: if the banks won’t provide incentives to lend, their crypto counterparts will – and there have been no shortage of lenders and borrowers willing to accept their offer.
The giddying rate of innovation within the sector, though, suggests there’s more at play than merely a digital reimagining of traditional finance.
As a close examination shows, crypto lending protocols are powering products that simply wouldn’t have been possible in the financial world of old.
On the Never-Ending Evolution of Crypto Lending
Just as “number go up” has been the greatest incentive for most people to get into Bitcoin, the high APR offered by crypto lenders has been the primary reason why the sector has recorded such rapid growth.
Around three quarters of the $1 billion of assets locked in decentralized finance are lending related, while centralized crypto lending takes that figure past the $5 billion mark.
Lending comparison portals such as LoanScan provide at-a-glance comparisons of the leading lending rates, and they make for attractive reading for cryptocurrency holders with assets to park for the long term.
Cred, for example, which has just sealed a partnership with the Litecoin Foundation, adding LTC to its family of assets, offers 10% returns to lenders of LTC, BTC, BCH, and the other cryptos it supports.
It’s the sort of APR that mom and pop with their lifelong family bank account can only dream of.
The Cred-Litecoin partnership indicates another possible avenue for crypto lending to follow, one in which decentralized organizations and crypto communities supply their own lending options to members, underwritten by a trusted lending provider.
— Cred (@ihaveCred) February 10, 2020
In this case, LTC holders can commit to a six-month term and receive monthly interest payments, with the option to roll over pledged assets for additional periods.
It would be fair to say that crypto lenders are in it for the interest rather than the prospect of banking the unbanked and supplying open finance to the hard-to-bank.
Their reasons for entering the arena are immaterial, however; all that matters is that they are here and providing the liquidity that’s turned crypto lending into one of the most exciting frontiers for crypto innovation.
Dialing Down the Collateral Requirements
With centralized lending platforms, lenders can lock up their crypto in exchange for a fiat (cash) loan, or have it supplied to borrowers for a fixed rate.
With decentralized lending protocols, the latter provision also holds true, but there are additional caveats. Instead of a centralized authority to prevent borrowers defaulting on crypto loans, automated smart contracts ensure that the value of assets on hand to cover the loan (say, BTC used to obtain SAI) is sufficient.
Should the value of collateral fall below a certain threshold, such as in the event of BTC dropping in value, the loan will be automatically called in, and the pledged asset liquidated to repay the outstanding balance.
Allowing for the variance in crypto asset prices has resulted in defi lending requiring heavy over-collateralization of as much as 2x the value of the loan.
This seemingly intractable problem has, like so many crypto lending challenges, been met head on, with defi developers coming up with creative ways to safely reduce the heavy burden of collateralization.
This can be seen in the emergence of new products such as Maple, which is experimenting with credit scores, social media activity, and address transaction histories as a means of provisioning under-collateralized loans.
Elsewhere, products such as no-loss savings game PoolTogether are showing the ways in which lending can be gamified to spur greater P2P lending.
These are the sort of innovations that would be inconceivable in the risk-averse world of traditional finance.
It remains to be seen whether the experimentation that is flourishing within the crypto lending space bleeds through into other spheres, including fiat-based fintech.
What’s beyond doubt, however, is that the crypto lending genie is now out the bottle. It is an idea whose time has come, and with $5 billion already in the pot, there can be no going back.
Centralized and decentralized lenders will jostle for market share, and there will be failures along the way. Only a fool would predict the demise of crypto lending at this stage, though.
The market has come a long way in a little over two years – and the best is yet to come.
Disclaimer: This is a contributed article and should not be taken as investment advice