The digital assets world has grabbed headlines with the soaring value of BTC and the new businesses possibilities of the Ethereum general-purpose blockchain. But just as the possibilities of the blockchain always want beyond supporting an individual digital currency, so the possibilities of digital assets go beyond traditional cryptocurrencies.
Stablecoins — coins pegged to an underlying asset like fiat currencies, real estate or precious metals — are no longer an innovation, but a familiar feature of exchanges. But they’re also a feature of an increasingly popular — and lucrative — business space: crypto lending.
Currently worth over $5 billion, the crypto lending space is showcasing what can happen when the agility of a digital asset meets the reliable real-world value of an underlying asset like gold — and both are harnessed to provide business credit.
Let’s look more closely at what it is, how it works, and where it’s going next.
What is crypto lending?
Crypto lending relies on a simple concept: borrowers use their digital assets as collateral on fiat or stablecoin loans, while lenders provide the assets required for the loan in return for interest. This can also work the other way around, with borrowers using fiat or stablecoins to borrow digital assets. What’s crucial is this asymmetry, with the stability of stablecoins and fiat contrasting with the relative instability of digital assets like Bitcoin.
Beyond this, crypto lending is a straightforward proposition that in itself contains no groundbreaking idea. This is the same collateralized loans we’ve always known, just enacted on blockchains and using digital assets as a store of value.
However, credit and lending open up a huge range of applications for businesses, institutions, traders and even retail users. And while the underlying idea may be the same, there are new forms of execution made possible by blockchain that increase access to credit, as well as the inherent tendency of distributed peer-to-peer networks to drive down transaction costs and interest rates on loans.
How important is lending and borrowing for the crypto economy?
Lending is crucial for markets: it puts assets to work, delivers investment yield for lenders and allows new businesses to grow and flourish. Without lending and borrowing, assets lie stagnant and businesses wilt and die for want of growth fuel. It’s central to the success of a modern economy.
But how important is it to the success of the digital assets economy?
The transition to a fully-mature economy that includes lending will place blockchain-based finance (‘Decentralized Finance,’ often abbreviated to DeFi) center-stage, bringing many new investors — and borrowers — to the space.
Already, industry leaders are emerging. MakerDAO is perhaps the best known: it lends its stablecoin, DAI, to borrowers and accepts collateral in the form of ETH. There’s certainly a market: MakerDAO currently holds $508 million in ETH as collateral on loans or as profit.
Alternatively, consider EOS REX, which holds $437 million in EOS despite — or because of — a fairly niche business model: EOS REX lends EOS to users who want to stake extra bandwidth on the EOS blockchain.
Both these lenders are chiefly concerned with lending to extant digital asset users, inside the digital asset economy. But the next wave of crypto lenders might not be.
Types of lending platforms: centralized and decentralized
There are two types of digital asset platforms, centralized and decentralized. That holds true whether they’re exchanges (where digital assets can be traded for other digital assets, stablecoins, or fiat) or loan platforms.
The key distinction between centralized and decentralized lending platforms is the entity that manages decisions. In centralized platforms, it’s a business, and ultimately its employees. The assets being dealt with might be based on the blockchain, but the processes by which loans are arranged and executed are no more automated, distributed or secure than a standard website. In many cases, centralized loan platforms are not covered by significant regulation because the industry is so new. Other than this caveat, these are traditional financial technology companies whose product happens to be crypto lending. They rely on the defenses of the traditional financial world, like KYC, and they can form partnerships with other businesses and negotiate rates. Lenders of high-demand crypto assets like ETH and BTC will often find that these centralized platforms offer the best rates of return.
By contrast, decentralized loan platforms are managed by interlocking smart contracts or by the underlying structure of a blockchain. They’re built, and operate, on the blockchain themselves, meaning they’re distributed and secure, and decisions about loans are made by rules rather than by people. Decentralized exchanges like Compound and dYdX don’t use KYC and often don’t use traditional custody arrangements either; rather than professionals deciding rates, these are determined algorithmically based on supply and demand for that asset, on that platform, at that time. The results can be unexpected — spikes in interest rates for lenders at periods of high demand can see rates leap. dYdX lists its current and 30-day average interest rates, as well as a graph showing changes over time.
Here, you can see BAT — currently at 14.05%, with a 30-day average of 8.1% and a 30-day high of nearly 30%.
Crypto lending industry trends
Improved risk management
Digital asset lending as a sector is still figuring out how to manage risk. Typically, a decentralized digital assets lending business won’t perform KYC or credit checks. This makes loans easier and faster to arrange, and the collateralization is supposed to render KYC redundant anyway. But when this level of anonymity is combined with the relatively high price volatility of leading crypto assets, it’s hard not to think that many loan platforms are vulnerable.
That vulnerability runs both ways. What about the lenders that, in the words of The Best Binary Options Brokers, ‘are Ponzi schemes’?
TBBOB go into detail about how such schemes work:
‘in order to participate in the program, you will have to buy the… [platform’s proprietary token] and you will have to use a legit cryptocurrency to pay for it, so that the owners of… [the platform] remain anonymous.
For some time profits will really be paid, but money from new deposits will be used for this purpose. Once the owners of… [the platform] decide that they accumulated enough money, they will dump the rest of… [the proprietary] tokens on the exchange and run away with cryptos you paid them with.’
That’s of serious concern too. As the sector matures we can expect to see a range of structural, regulatory and technological solutions to reduce risk to lenders, borrowers and loan platforms.
Integration into the financial system
The entire digital assets space has for some years operated as a de facto parallel financial system — the stated aim of pioneers like Satoshi Nakamoto and Daniel Larimer. However, it’s in the process of being integrated into the global financial system at an ever-increasing pace as digital assets service providers — trustees, exchanges, investment professionals and loan platform operators alike — seek the skills of the traditional financial world. Simultaneously the traditional financial world seeks the dynamism of the crypto market, helped by historically low yields. As a result, the crypto lending world currently resembles the interbank FX lending sector but will shortly find itself fully integrated into the global financial world.
Benefits of crypto lending and borrowing
Lending and borrowing in digital assets delivers the familiar benefits of the blockchain, which roughly speaking are twofold: first, it does some things which are familiar far better than was previously possible, and second, it does some things that were previously not possible at all.
Crypto lending lets you use crypto as collateral for fiat or stablecoins. You can use ETH, BTS or BTC to obtain gold, US dollars, or other assets; or you can put up dollars and stablecoins as collateral. There’s obvious scope for profit by trading here, by gaming crypto prices and loan platform interest rates, but there’s also far easier access to credit compared to the traditional banking system. If you or your business primarily holds BTC rather than dollars, most banks won’t even look at that as an asset; many won’t look at it at all. But crypto lending puts credit at your fingertips.
Low interest rates on loans
A lot of the interest charged on loans is absorbed by the running costs of financial institutions — or siphoned off as profit. With lenders and borrowers approaching platforms that run with far fewer staff than banks or that assign interest rates and loan agreements algorithmically, interest rates can be far lower. ‘The biggest benefit that blockchain can bring to lending in regards to the user is the absence of high rates of interest on loans. This is coupled with the absence of middleman fees as a result of decentralization (through the implementation of smart contracts),’ says Darshan Bathija, CEO and Founder of Bank of Hodlers.
Just like anything that happens over the blockchain, crypto lending is vastly faster than traditional loans. Without middlemen or unnecessary delays from financial institutions, loans can be arranged and funds made available in minutes or seconds, not days or weeks — a major advantage in fast-paced industries.
On blockchains, personal details are concealed but transaction details are immutable and public. If you want to know which transactions took place, when, just look. Everything is available for inspection.
Retain ownership of crypto assets
When you trade crypto for fiat or stablecoins, you lose the crypto — of course. But when you collateralize a loan with it, you still own it. You never need to step off the protection of the blockchain, or lose ownership of your crypto, to take out a loan.
Benefits of using gold tokens for crypto lending and borrowing
When compared with dollars, gold-backed stablecoins give users clear advantages.
Real asset value and price stability
US dollars may be the world’s reserve currency, but they’re a fiat currency — they don’t have any intrinsic value. And their purchasing power has fallen markedly over the last fifty years, such that a dollar in 1970 would be worth about $6 in today’s money, while gold has remained steady or risen. The value of the stablecoin is thus likely to match that of the underlying asset.
Lending crypto assets is an excellent way to divert capital to a use that can earn significant rewards for lenders. When those rewards are paid in gold-backed stablecoins, lenders can realize their returns in tokens that represent direct ownership of gold bullion or in major cryptocurrencies like BTC — major safe-haven investments that are currently attracting plenty of direct investment for just that reason.
How asset-backed tokens will revolutionize crypto lending
Crypto lending currently relies on a small number of pre-existing asset-backed tokens and stablecoins, as well as substantial trades in fiat. For example, about a sixth of dYdX’s 24hr trading volume is ETH/DAI; the rest is ETH/USDC and DIA/USDC, meaning the majority of current loans rely on fiat.
That picture is likely to change as an increasing number of businesses see the potential in creating their own stablecoins, and as precious metals businesses in particular move into the stablecoin market. Uniquely suited to be the asset that underlies a stablecoin, precious metals such as gold and silver are expected to experience a renaissance.
We’ve seen this firsthand, working with a major enterprise client who is a gold dealer. They have large amounts of gold in reserve, and wanted to create a gold-backed stablecoin to put it to work for them. Through our Stably Enterprise Stablecoin-as-a-Service program, we were able to design the coin, the smart contract and the architecture for the stablecoin, as well as finding the right partners, custodian, and legal and other support. The result is that there’s a new gold-backed stablecoin on exchanges and soon available on lending platforms.
Is this the norm? Not now — but it won’t be long before the capacity to create custom stablecoins draws more and more real-world asset holders and businesses into the crypto lending space, where they can put their assets to work, generate returns for themselves and their clients, and help fuel the next wave of business innovation.
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