What Are the Pros & Cons of Cryptocurrency Lending?
Cryptocurrency lending has a few different pros and cons that should be considered before lending any of your digital assets. First and foremost, an overarching benefit is that you’re participating in a new technological movement and by experimenting with the lending aspects, you’re further educating yourself and gaining valuable experience in a field most people haven’t even heard about yet. On the pro side, investors can easily earn interest/returns on their digital assets. Users lending their cryptocurrency may receive a higher interest rate than many traditional lending products are able to provide, plus there is also the potential for increased returns, as the value of the crypto asset that was lent out may grow.
Furthermore, when compared to traditional banking & finance, crypto lending provides a very low barrier to entry, for both borrowers and lenders. This is because only crypto collateral is needed, with how much you have determining how much you can borrow, or alternatively how much you can lend out. Finally, crypto lending allows lenders to diversify their portfolios beyond traditional assets, which can help mitigate some of the risks associated with investing in a single asset class.
On the con side, crypto is a volatile asset, which of course means lending it can be more volatile when compared to traditional lending products. This is because the value of the underlying asset can fluctuate rapidly. Additionally, as with virtually all types of lending, there is the risk that a borrower may default on the loan. In the worst-case scenario, this would lead to the loss of the entire loan amount. Finally, crypto lending is still quite a young industry, with little regulation, and protection for investors is up to each lending platform.
What Are the Risks Associated With Crypto Lending?
As mentioned above, crypto lending involves several different types of risk. The first is that the value of the borrower’s collateral can drop below the loan’s value, leading to a forced sale of said collateral, and a loss for the lender of the loan. The second is that a borrower defaults on the loan (in other words, the loan is not repaid), leading to a loss of the lender’s funds. Additionally, once deposited, you cannot use your assets for anything else other than borrowing against them until you unwind your lend position. While liquid staking options like $yyAVAX exist and allow for more fluid movements of funds and open up more investment and lending opportunities, most crypto does not offer this feature, as the tech is still in its infancy. Finally, there is always the risk that a lending platform could be exploited, hacked, or that a lending platform is actually an outright scam. All of these risks can be mitigated to some extent by the platform’s developers and/or design features. For example, an insurance fund may be created by the lending platform to reimburse victims of a hack.
How Does Crypto Staking to Earn Interest Differ From Cryptocurrency Lending, and is One Option Better For Investors Than the Other?
Cryptocurrency staking refers to the process by which investors earn returns (or yields in this context) by committing their tokens to help validate transactions on a Proof-of-Stake blockchain (which is a specific type of blockchain network). Staking earns interest through staking rewards (emissions the blockchain pays to stakes for securing the network – the equivalent of what BTC miners are paid under Proof of Work). The staking fees are fixed, and only increase or decrease when the number of people staking increases or decreases (fixed emissions). In other words, In return for their tokens being “staked”, investors receive regular rewards of additional tokens for committing or staking their tokens (similar to locking up other forms of collateral in traditional financial roles).
For example, the protocol Geode Finance offers the ability for DAOs to create their own branded liquid staking product to offer to users. This product essentially allows a DAO to create a special staking token that represents funds staked on the chain and validates network transactions. Investors who stake through tokens like this are able to participate in staking practices and should they choose to simply hold the asset, they will typically see returns in the range of 7-9% APR. That is all they have to do. However, investors can also choose other options like lending and leveraging their assets.
This is different from crypto lending, as that is a process where investors can earn interest on their cryptocurrency holdings by loaning them out to individuals or organizations seeking collateralized crypto loans. Crypto lending earns fees from borrowers, like a traditional loan. These fees can fluctuate depending on the demand for the asset that has been lent.
Using the example above, a protocol such as Yield Yak on the Avalanche blockchain may choose to offer a branded staking token to their investors but then may offer the ability to stake the liquid token (in their case yyAVAX) directly through other protocols, either providing liquidity or directly loading it out. Doing so would open up further investment opportunities, however, it does also open the user up to riskier ventures. As with most things, investors should always manage their risk profile and only invest what they’re comfortable investing or losing.
There is no definitive answer as to which option is better for investors, as it depends on each individual investor’s goals, preferences, and risk tolerance. In my opinion, they’re both great options but in the current environment, staking is the better option. No smart contract risk. Higher APY. Yield is paid in the native currency such as AVAX or ETH which is great if you’re bullish on a particular chain’s future. In the end, it’s all up to how you want to invest and the risks you’re willing to take, but if you’re looking for a safe path to earn a much higher return than you ever could at a bank, staking is most likely the best bet for you.
