The evolution of crypto lending is continuing at pace, with new projects regularly coming onstream. These platforms, most of which exist in the decentralized finance (DeFi) realm, offer users the ability to obtain loans without having to contend with intermediaries and accept counterparty risk. In concert with asset issuance, payments, governance, and insurance, crypto lending is helping to construct a new and fairer blockchain-based financial system.
Crypto Lending Ecosystem Expands
The crypto lending landscape currently comprises institutional lenders, exchange platforms, and Defi lending protocols, with loans broadly falling into the category of undercollateralized, collateralized (or overcollateralized), and flash. Borrowing against one’s crypto holdings has never been easier, and the difficulty of acquiring a bank loan – not to mention the generally unappealing terms – only serves to underline the value that smart contract-secured lending protocols represent.
Evidence of the strength of crypto lending is all around us. Late last year, DeFi project Aave raised $25 million from major venture capital firms blockchain.com and Blockchain Capital, and its native AAVE token has since become one of DeFi’s runaway successes, pushing the protocol’s Total Value Locked (TVL) past $5 billion. Collateralized lending platform Maker, meanwhile, has issued almost $2 billion worth of USD-pegged DAI stablecoin loans since launching during Bitcoin’s late 2017 bull run.
The ability for users to earn yield through lending crypto assets, or acquire loans in their preferred crypto without having to supply credit history and labor through an invasive application process, is undoubtedly helping to drive the adoption of virtual currencies. Crypto lending protocols directly match borrowers with lenders, with flexible repayment durations, favorable interest rates, and different assets accepted as collateral. Moreover, borrowers often get to choose whether they prefer fiat, crypto, or stablecoins.
And it’s not just individuals who are taking advantage of lending platforms: SMEs and enterprises can acquire loans (often to finance crypto projects) while firms with appreciable crypto holdings can generate revenue by locking up their wealth for a set period of time. Even unicorns can lean on loans: Bitfinex, the fifth-largest digital asset exchange by trade volume, acquired $750 million worth of loans from stablecoin platform Tether, creators of the popular dollar-pegged USDT. Individual borrowers, meanwhile, can use their loan to buy a property, pay for a holiday, or diversify their investment portfolio.
How Crypto Loans Differ
As mentioned, there are several types of crypto loans: undercollateralized, collateralized, overcollateralized, and flash. It pays to understand the differences.
Undercollateralized crypto loans, such as those offered by the popular Lendefi protocol, give users access to digital assets without the need for them to fully cover the principle. The borrower is able to invest a higher amount than the equity they have deposited into the smart contract, providing a form of leverage. This is best understood in the context of mortgage loans.
When users take out a mortgage, they need only put up a tiny fraction of the property’s value as a deposit while obtaining financing for the remainder. Similarly, with undercollateralized loans via Lendefi and others, users acquire substantial crypto loans with a modest investment outlay.
Collateralized loans, on the other hand, originate from clients staking an asset against the funds they are receiving in return. When the loan is paid off in full, the client receives their staked cryptocurrency back, along with an increase in value it has enjoyed during the staking period. Collateralized loans can be backed not only by business assets but also real estate, cars, property – anything of tangible value. BlockFi is one of several platforms offering USD loans backed by users’ digital assets.
As for flash loans offered by the likes of Aave, they are rapidly executed, collateral-free loans that must be paid back quickly – usually within one Ethereum block. These specialized loans are deployed by crypto traders to mitigate arbitrage discrepancies in crypto prices across different decentralized exchanges (DEXs). Flash loans can also be used for self-liquidations, wherein traders avoid triggering taxable events. Last year, Aave lent out over $2 billion worth of flash loans, with the largest valued at a cool $200 million.
Although flash loans can help to tighten spreads and reduce inefficiencies, a combination of bad code and unreliable price feeds has led to several attacks on providers in recent times, with regulators also sounding concerned about the risks involved.
With over $73 billion in new loan generation forecasted to manifest by next year, the crypto lending space is in rude health. And banks thought they only had Bitcoin to worry about.
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