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Crypto Lending 101

Don’t know where to start with cryptocurrency lending? In this post we outline all the key terms and concepts you need to know.

29 May
2020
SelfKey
Identity Wallet
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Cryptocurrency lending is a vast industry that is constantly evolving. Whether you’re brand new to crypto lending or have a lot of experience, every platform has its own way of doing things. In this article, we outline the key terms you need to know to embark on your crypto lending journey.

What is a cryptocurrency borrower?

A cryptocurrency borrower is someone who is looking to take out a cryptocurrency loan. A borrower can be looking to take out a crypto loan for a variety of reasons. They could be looking to margin trade, take out a loan for their business, help fund a downpayment for a house, pay off other debt, or a variety of other reasons. 

Typically, there are two ways someone can borrow. The first is that a borrower can use their crypto as collateral and be paid out in fiat currency or stablecoin. The second is that a borrower can use fiat or stablecoins as collateral for a crypto loan, which is more common for activities like margin trading.

What is a cryptocurrency lender?

A cryptocurrency lender is someone who is offering up their cryptocurrency for loans. Lenders typically agree to loan as they are paid interest, and it’s a good way to make use of their crypto while still holding onto it. 

There are two different ways that someone can lend out their cryptocurrency. The first is a peer-to-peer lending platform, where lenders and borrowers are matched based on the terms of the loan. The second is that the lender’s crypto is added to a pool of funds. This means that lenders can start earning interest right away, don’t have to worry about finding a borrower, and their crypto is typically very well protected by the platform.

What does collateral mean in cryptocurrency lending?

In cryptocurrency lending terms, collateral means using crypto, altcoins, stablecoins, or fiat currency as a safeguard or warranty against the loan. That way, if a borrower fails to pay back their loan, the lender and the platform haven’t lost the value of the loan. Collateral also ensures that the borrower is more likely to pay back their loan in the first place.

Typically, collateral in cryptocurrency lending is in the form of cryptocurrency. Generally, a collateralized loan will have a much lower interest rate than a non-collateralized loan. Once a loan is fully repaid, the borrower will receive their collateral back in the wallet or account of their choosing. 

On most platforms, the most popular cryptocurrencies, such as Bitcoin and Ethereum, are accepted as collateral. Other platforms offer more niche altcoin options, but the interest rates may be slightly higher depending on the altcoin. A few platforms let you use fiat currency or stablecoins as a collateral for a crypto loan, but there aren’t many platforms like this currently on the market. 

What does principal mean?

Principal can refer to a number of different things, but in crypto lending terms, it refers to the original sum of money that was borrowed. You’ll often see it mentioned in the terms of a crypto loan; it will typically state the borrower has to pay back the principal plus the agreed upon interest. 

The amount of interest a borrower pays is typically determined by the principal. Generally a higher principal means a higher interest rate. In crypto lending, other things that can affect the interest rate are the Loan-to-Value ratio (LTV), the type of collateral, and in what cryptocurrency the loan is being paid back in.

What is liquidation in cryptocurrency lending?

A liquidation occurs when a borrower fails to pay back their loan within the specified loan terms. The platform then liquidizes the crypto that has been held as collateral in order to pay back the lender or the pool of funds. Usually, a platform gives plenty of notice before this happens, and it is clearly laid out in the loan terms.

Although liquidation is an unfortunate part of cryptocurrency lending, it is an important one. It lets lenders know that their crypto is being taken care of, and that the platform is ready to step in if a borrower defaults. Additionally, it deters borrowers who are looking for fast cash and have no means to repay the loan, which is why they have to use crypto as collateral.  As crypto lending platforms generally do not perform credit checks (which is one of the benefits of crypto lending), taking collateral is a way to ensure repayment if a borrower defaults.

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What is Loan-to-Value ratio (LTV)?

Loan-to-Value ratio (LTV) is a financial term that is used in traditional banking and in cryptocurrency lending. It’s a term used by lenders to express the ratio of the loan to the value of the collateral. In crypto lending terms, LTV is pretty important as it is tied to the value of the collateral.

Typically, a higher LTV means that the crypto used for collateral is worth less. Some cryptocurrency lending platforms allow you to choose the LTV so that you can still get funds with less collateral. However, a higher LTV is also higher risk, so the interest rate is usually higher.

Additionally, the LTV may fluctuate over the course of your loan depending on the price of your chosen collateral cryptocurrency. As the price of crypto is constantly fluctuating, so does the LTV. When your crypto is worth more, the LTV will go down; when it’s worth less, the LTV will increase. As a result, some platforms will require that you deposit more collateral or repay your loan if the LTV reaches a certain percentage.

How are cryptocurrency loans repaid?

Paying back a crypto loan is usually pretty straightforward, but the process does vary from platform to platform. Typically, monthly payments need to be made, and in some cases, are automatically withdrawn from your account. Some crypto loan platforms will offer you a lower interest rate (and therefore, lower monthly payments) if you pay the loan back in a certain token. For example, Bankera offers better interest rates if you pay back a loan in their native token BNK. Additionally, most platforms accept early repayments, but double check that there aren’t any added fees for doing so.

As for which currency a loan needs to be repaid with, this varies depending on the platform. Normally if you are borrowing fiat currency or stablecoins, you will need to pay back the loan in fiat or stablecoins plus the agreed upon interest rate. A good rule of thumb is that you repay with whatever cryptocurrency, fiat currency, stablecoin or altcoin you borrowed in.

The terms for repayment are clearly laid out in the terms of the crypto loan, and the platform you choose should clearly outline it for you. If you are late to repay, you may be penalized with a higher interest rate, or in extreme cases, have your collateral liquidated. For example, Binance Loans only gives you three days before they liquidate your collateral. Make sure you understand the penalty for late or defaulted payments on your chosen platform before you apply for a crypto loan.

What is a good interest rate for cryptocurrency lending?

Interest rates vary greatly across the different crypto lending platforms, and it also depends on whether you are a lender or a borrower. The average interest rate for lenders is around 8% for stablecoins, which is far better than a standard savings account at a bank. This is why crypto lending has become so popular, because it allows crypto holders to earn money while holding onto their assets. However, beware of platforms that offer interest rates that seem too good to be true, because they generally will be.

As for borrowing, interest rates range greatly. It mostly depends on what type of cryptocurrency you use as collateral. As mentioned earlier, some crypto lending platforms offer a lower interest rate if you repay the loan in a specific cryptocurrency, altcoin or stablecoin. Do your due diligence on the interest rates offered by different platforms if you’re planning to take out a crypto loan.

Conclusion – Crypto Lending 101

While cryptocurrency lending is constantly evolving and still very much in its infancy, this article outlines all the basic terms you need to know to effectively explore the world of crypto loans. As always, make sure to do your due diligence before you start lending or borrowing. While there are dozens of great crypto lending platforms available, there are also some less than favorable ones.

If you’re looking to explore the world of crypto lending, we have a new addition coming to the SelfKey Marketplace. Our next release is the SelfKey Cryptocurrency Loans Marketplace where SelfKey Wallet users can get access to the world’s most exciting lending platforms and use cryptocurrencies as collateral to withdraw fiat loans. This is an exciting prospect for the SelfKey community and adds impressive new functionality to the Wallet.

If you want to start exploring the SelfKey Wallet now, download it here and keep an eye out for the launch of the SelfKey Cryptocurrency Loans Marketplace.