Is Crypto Lending Safe and Legit?

Is Crypto Lending Safe and Legit?

Crypto lenders will be happy to learn that interest rates of up to 15% can be garnered when lending out crypto on DeFi sites, much better rates than available from traditional lenders on the main street. But these high levels of interest do come with risk penalties attached and only you can weigh up the pros and cons of lending out your capital. Thankfully, you have Gameland on side to give you much needed information!

In addition, crypto borrowers often ask ‘is crypto lending legit?’ when faced with the high collateralization charges made for loans. We appreciate that different platforms offer varying rates, but most loans require 50% collateralization, meaning you have to put down 100% of the loan you’re borrowing as crypto asset collateral. This article will answer all your questions about the safety of crypto lending and provide you with the knowhow needed to make informed decisions about your crypto lending or borrowing.

How does a crypto loan work?

If you’re querying “How does a crypto loan work?” you’ve come to the right place! In many ways crypto lending works in a way that’s very similar to traditional secured lending. Collateral is usually requested, in the form of cryptocurrencies, and platforms take a variety of crypto assets as backing for loans. This is very similar to a secured loan in the traditional banking marketplace. In most instances the collateral is over 100% of the amount of money being borrowed, leading many people to question the legitimacy of such loans. We discuss the reasons for over-collateralization of crypto loans below, alongside heaps more common queries raised by concerned consumers.

There are lots of reasons for borrowers to choose crypto loans rather than simply selling on their hard-earned crypto assets. For example, if the market is on the rise, potential borrowers may want to stick with their chosen crypto rather than sell it off and face losing any gains in value.  The beauty of a crypto loan is that you get your crypto assets back at the end of the loan period, so you can retain your crypto yet still qualify for loans to help with daily living expenses or one-off purchases.

There are lots of different types of loan available in the crypto lending sphere, with differing interest rates and loan terms. You’ll need a crypto lending calculator to hand when working out all the different percentage rates of interest, and it’s a good idea to check out some of the useful crypto lending reviews available here at Gameland before coming to any firm decision.

First off, though, let’s take a look at crypto lending risks and assess just how reliable these loans will be for you.

How safe is crypto lending?

We know you’re keen to cut to the chase, so here’s our assessment of the risks posed by crypto lending:

Deposit risk in insolvency cases

It’s not possible to compare crypto savings accounts to bank deposit accounts; they are two totally different animals. In most global jurisdictions bank deposits are protected up to a set amount by statutory deposit insurance. In the United States, for example, funds are protected up to $100,000 if the bank should become insolvent. Where your funds fall under the statutory limit federal authorities guarantee to reimburse the cash. This is not the case with a crypto lending platform.

Of course, the consumer pays for this federal capital protection by way of limited returns on savings. In contrast crypto savings offer up high interest rates, often in double digits, but no federal protections in the event that the platform becomes insolvent. So you could lose all your money if the platform goes bust. The same is true for crypto borrowers with collateral on deposit with platforms. If a platform goes bust you become one of the many creditors waiting in line for a payout. This makes it vital to check out the history and economic situation of any crypto lending platform you plan to use. Why not investigate our Celsius Network review to find out more about this popular lending platform?

DeFi platforms are the exception to this insolvency scenario, as there is no private company behind the scenes. This means the platform cannot file for insolvency. You’ll find the risks relative to DeFi platforms are mainly of a technical nature.

Counterparty risks for CeFi loans

Another crypto lending risk relates to the use of assets by crypto platforms. Crypto platforms receive funds from both savers and borrowers; and will have terms in their contract relating to what they can do with these funds. You will find a clause within the terms and conditions of the platform stating that the platform may lend, sell, pledge or invest your funds at will. On the whole they lend funds to crypto exchanges, hedge funds and other investors.

This creates a counterparty risk because if the third party receiving these assets fails to return the funds then the crypto lending platform you are using could become insolvent. Platforms attempt to mitigate this risk by over-collateralizing the assets that are lent out.

Again, this scenario does not apply to DeFi platforms like Aave, as they don’t lend any assets to third parties. Assets are only lent to other users of the platform, and collateralization is coded into the blockchain. However, the protection of your assets does ultimately rely on the security of the smart contract system in place, so it  is only as reliable as the management teams on the platform.

Aave also supply zero collateral crypto loans, by way of flash loans. So, if you’re worried about crypto lending risk this could be the way forward for you. You’ll find zero collateral loans have the highest crypto lending rates, though. What’s more, you have to undergo a form of credit scoring to qualify for these loans, as they are much higher risk to platforms.

Holding your cryptocurrencies – Custody risks

In recent years crypto funding platforms have significantly improved their IT infrastructure, taking into account the risks posed by holding cryptocurrencies on site. Of course, where assets are lent out to third parties, this is not such a problem, but custody risks are very real when assets are held to any site. Cyber attacks are more and more commonplace, and although no thefts have happened to date that does not mean to say they will not occur.

Storing your valuable cryptocurrency securely is a custody risk that sites tend to address by using professional custody service providers, like BitGo. These providers offer an outsourced storage system for crypto assets, and although they cannot be guaranteed 100%, they are the best solution in the marketplace at this time.

Some of the major CeFi platforms also insure against technical risks or theft of assets, although this is not the case with all providers. What’s more, these insurances will probably only offer protection for a small portion of the assets in safekeeping and won’t cover the entire loss in the event of a serious failure in security.  If you’re looking around at instant crypto loans, why not check out our informative reviews to find out more about different platforms?

Again DeFi crypto loans work differently to CeFi. With the DeFi platforms, lenders and borrowers manage their own crypto wallets, which are connected to the online platform. This cuts out any need for insurances or custody service providers, but does mean you have total responsibility for the safety of your crypto assets. This can be an advantage if you’re knowledgeable about online security issues, but can cause problems for novice crypto holders.

Smart contract risks

The technical risks of smart contract failure relate more to DeFi platforms than CeFi providers. That’s because there are people overseeing the running of CeFi operations, but DeFi platforms rely on the performance of the smart contract system solely. Smart contracts provide the automation to lending platforms, and are particularly relied on by DeFi platforms where no humans are available to oversee operations. When all’s said and done, a smart contract is only as good as its developer, so it’s important to choose a reliable and well respected DeFi platform to handle all your crypto lending needs.

The overriding problem related to crypto borrowing

One of the principal concerns for most borrowers is the security of their crypto asset collateral, as they will want to claim it back at the end of the loan term. Between April 2021 and October 2021 the price of Bitcoin fluctuated between approximately $30,000 and $64,000. This meant that crypto borrowers faced the problem of pledging additional crypto as their LTV ratio had risen too high. There’s really nothing that can be done about this issue, unless you opt to use stable coins tied to the value of fiat currency such as the US dollar. It’s important for borrowers to have additional crypto in place to prop up loans if need be.

Regulatory

Crypto regulations are not yet in place to regulate the performance and use of crypto lending platforms, particularly within the DeFi sector. Many investors are holding off from lending or borrowing for just this reason. In the United States the SEC has stated that cryptocurrencies are securities and should be regulated accordingly. Authorities are making similar statements around the world. Crypto lending platforms have offered to work with authorities to put meaningful regulatory measures in place, but the situation is still ongoing.

Where legal challenges arise to platforms, you’ll only be able to sue CeFi platforms, as they have recognised management teams behind them. With DeFi platforms, there is no regulated company running the platform, no CEO and no legal contracts in place.

What are crypto lending platforms doing to mitigate these crypto lending risks?

As has already been noted, crypto lending platforms have put certain measures in place to protect their customers. These include:

• Professional custody services to outsource the storage of crypto assets throughout the course of the loan
• Insurances in place to protect assets against theft or breaches of security. Not all platforms have insurances in place, and some offer insurance as an optional extra to borrowers
• Regulatory, as already discussed: a variety of online crypto lenders are working with lawmakers to put appropriate consumer protection measures in place

Other ways platforms protect against crypto lending risks include:

Over-collateralization

Most lenders require a 50% LTV ratio, or even higher. This protects both the lender and the borrower against fluctuations in cryptocurrency prices. It may seem that this over-collateralization is extremely high, as it means that you have to deposit up to twice as much collateral as you want to borrow. However, it does protect against any drop in value of crypto assets.

Margin calls

Loan margins are in place to protect against liquidation of collateral crypto assets. Platforms will generally send out notifications when assets drop to specific levels, asking you to pay off your loan early or bring your collateral level up to a more acceptable LTV ratio.

Stabilization

Stabilization measures are also in place with some lenders, whereby crypto assets are transformed into stablecoin holdings if the LTV ratio rises too high.

Multisignature wallets

Most CeFi providers take the key to your crypto wallet as security for loans. This means that if they go into liquidation, your crypto assets are lost. Some providers, though, do offer multisignature wallets, needing two keys to open them. This provides protection in the event the lender goes bankrupt.

Is crypto lending safe – Conclusion

As can be seen then, there are a number of crypto lending risk elements that you have to face if you plan to lend or borrow on crypto lending platforms. That said, any financial transaction has risk elements, and traditional banks and lenders are just as likely to experience cyber theft or fraud issues as online providers.

The online crypto lenders are working with regulatory bodies to provide solutions to the risks posed to customers, and most risks have been identified. Solutions are in place to protect against the most common risk factors, so the safety of your crypto assets is protected.

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Is crypto lending safe? FAQ