AAccording to the FDIC, the national average interest rate on savings accounts currently stands at a pitiful APY of 0.04% – a pittance compared to the money your bank makes by lending your deposits. As a crypto lender, you benefit from interest rates of up to 15% APR. But before you give up on your savings account, you’ll need to learn four basic rules to help minimize your risk and maximize your chances of successful investing.
How does the bitcoin loan work?
The crypto loan works the same way as a hard money loan: a borrower must first put in place a risky collateral – in this case, part of their crypto – that you, as the lender, can. enter if the borrower fails to make payments. Usually the collateral should be more than 100% of the amount they borrow. In return, you know that if the going gets tough, you can quickly get your money back by claiming the guarantee.
Why would a borrower want to borrow funds, rather than spending the equivalent amount on what they already have? Well, suppose you have a bunch of Bitcoin (CRYPTO: BTC), but the Bitcoin market is on the rise. You might not necessarily want to sell it because you are missing out on potential earnings. Instead, you can use your Bitcoin as collateral, borrow a stablecoin such as Attached (CRYPTO: USDT) – with its value indexed to the US dollar – and always obtain liquidity. Once you’ve paid off your loan, you get your Bitcoins back – and if their value has increased in the meantime, great.
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The crypto loan is just one of the many paradigm shifts in decentralized finance (DeFi). Lenders can profit from their crypto wealth without selling much of their crypto holdings, which could trigger a capital gains tax and cost them long-term gains if the crypto market enters a market. another bull run.
With that in mind, pay close attention to the following five rules for a successful crypto lending business, so that you and your assets are ahead of the game.
1. Watch for changing local crypto regulations
Recently, especially in the United States, the regulation of crypto has sparked a lot of heated debate among politicians. One popular lending platform in particular, BlockFi, recently received cease and desist letters from attorneys general in several states – just in time for its proposed IPO.
State regulators have since cracked down on all DeFi lending platforms over concerns that DeFi loans constitute an “unlicensed securities offering.” Adding fuel to the fire, earlier this month another platform, Poly Network, exposed a security breach that cost users $ 600 million.
Coinbase (NASDAQ: COIN), one of the largest decentralized exchange platforms in the world, just announced that it plans to contact the Securities and Exchange Commission with its own regulatory framework. It should be noted that this happened just weeks after Coinbase was forced to shut down its own crypto lending operations due to SEC securities law violations. As the growing popularity of crypto attracts closer scrutiny from regulators of all stripes, expect more of the big crypto players to embrace this type of regulation on their own terms – or risk seeing each other. impose by governments.
2. Use only well-established lending platforms
Legitimate lending platforms will most often work with specialist providers to ensure that your crypto is stored securely, like a traditional bank. To find legitimate platforms, look for centralized platforms and margin loan funds, as opposed to DeFi platforms (more on this in Rule 4).
Check the fine print to see if and how an exchange will protect your investment from theft or other disasters. Celsius insures all of its users’ assets against loss through Fireblocks and Primetrust, both of which offer insurance for all assets held on the Celsius platform and wallet. Keep in mind that this insurance does not cover any losses you incur on the funds you have borrowed, for example, in the event of a hacker entering your wallet.
Additionally, Crypto.com has an impressive crypto insurance policy through a division of Lloyd’s of London. It will cover up to $ 750 million in total losses across the entire exchange, including theft by third parties; Note that we are not sure if this will cover all holdings on Crypto.com, as the company does not disclose the amount of its assets under management. Yet, this type of protection greatly extends the security of your funds.
3. Borrow, lend and pay your interest in stablecoins or fiat money
Altcoins like Ethereum (CRYPTO: ETH) and Cardano (CRYPTO: ADA) are volatile. If they go down while you lend them, you won’t have the freedom to sell them and limit your losses, since they are all tied to the borrower. On the flip side, an altcoin that you are currently lending could generate big payouts – great for borrowers, but not so good for you. Ditto for interest; if you are rewarded for your altcoin loan, who can say that the value of those coins will not bottom out the very next day?
But stablecoins are backed by either the US dollar or gold. No matter what happens with the crypto industry, they are always in a better position to resist volatility. Attached (CRYPTO: USDT), USD coin (CRYPTO: USDC), and Binance USD are the most well-known stablecoins, each pegged at 1: 1 to the US dollar.
If you insist on lending altcoins, you don’t have to lose the winnings when a particular coin you lend suddenly increases in value. Look for reputable platforms that offer automatic adjustments during price fluctuations; If the value of the crypto you lend increases while you lend it, the amount the borrower has to repay increases to match. This not only prevents borrowers from receiving profits that are not included in their loans, but also gives you, as a lender, earnings that you can pocket or apply as credit for your next investment. As for interest, getting paid in stablecoins preserves your rewards for lending your coins in the first place, but still gives you the freedom to trade those stablets for a rising altcoin the next time you see it go up. .
4. Unless you are a seasoned crypto trader, avoid DeFi platforms
If your bank fails, the government will give you back what you lost – up to $ 100,000 per account. But on DeFi platforms, if you lose all of your assets in an unexpected way, you don’t have any third parties to hold responsible.
Users can lend or borrow digital currency through DeFi platforms, such as Compound Where Aave, or via centralized financing networks (CeFi) such as Celsius. All DeFi loan services track their transactions with a blockchain; no traditional bank or other central authority is involved. While it’s nice not to have to trust a third party with your assets, DeFi protocols are prone to technical errors and hackers.
However, on each CeFi network, the people who run the company act as the central authority. Therefore, as a lender, you have to really trust that whoever controls the platform will always act in good faith. Make sure that any CeFi platform you are looking for has a recovery system, such as a safekeeping company that protects your money, just in case your assets are compromised or lost.
There is another more common and reliable method of becoming a crypto loan investor: joining a margin loan fund such as Invictus Capital. Invictus offers a transparent service that allows lenders to profit from the crypto they hold in their wallet. In a securities account, your money is under the management of a large financial institution, such as Citigroup, who must adhere to the strict custody rules set out by the SEC, and provide you with monthly account monitoring statements. These funds won’t pay you back if your holdings lose value in the market, but they will protect you if the creators of a currency scam and leave town with your money.
The road ahead
Despite the many risks associated with crypto lending, I would feel cheated by missing out on its great potential for ROI. On the flip side, you might want to wait until the industry resolves all of its ongoing regulatory wrangling. What if you lent a generous portion of your assets only before the SEC decides to ban all crypto lending? This kind of uncertainty will not help you or anyone else to sleep well at night.
Once the dust settles and the SEC officially releases a clear set of rules and regulations for crypto borrowers and lenders, and you’re well prepared with a wealth of research and knowledge, crypto lending could be worth your while. all in the long run. Remember to work with a reliable and established lending platform that tells you exactly how and where your money is stored and protected when you are not using it.
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Isabelle Korman owns Ethereum shares. The Motley Fool owns shares and recommends Ethereum. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.