The Pros (and Cons) of Crypto Lending
Almost a decade and a half after Bitcoin was invented, cryptocurrencies are reaching a crossroads. Enter crypto lending, an emerging practice in the growing world of decentralised finance (DeFi).
DeFi lending vs traditional lending
As you know, lending and borrowing are key elements of the financial system.
Lending as you know it
At some point in their life, most people need to borrow, usually by taking a student loan, a car loan, or a mortgage. The process has been around for centuries, and little has changed.
- Lenders provide funds to borrowers in return for interest on their deposit
- Borrowers pay interest on the amount they borrowed in exchange for having a lump sum of money available immediately
- And this process is facilitated by a financial institution, such as a bank or, more recently, a peer-to-peer lender.
DeFi lending allows users to become lenders — or borrowers — in a completely decentralised and permissionless way while maintaining full custody over their coins. One of the main beliefs (and promises) of DeFi is self-custody of your assets, whether they be coins or newer forms of digital assets, such as non-fungible tokens (NFTs).
- DeFi lending is based on smart contracts that run on open blockchains — a distributed ledger that accurately and instantly records all transaction data.
- This is also why DeFi lending is accessible to everyone without providing personal details or trusting another party to hold your funds.
The question remains - what does the world of DeFi mean to the future of lending?
The opportunities and limitations of DeFi loans
It may be too early to tell. But so far, the promise of decentralised finance may not be best proved by crypto lending. So here are the pros and cons of the space, which companies looking to offer these products should be careful to weigh up.
Pro: Rapid origination
Crypto loans have a major advantage over traditional loans. They are very fast and accessible. Often, no credit checks, or even credit histories, are required. Many DeFi lenders offer flexible terms and low fees compared to what borrowers may have come to expect from the traditional finance world.
Pro: More credit access
Typically, borrowers do not need a traditional bank account to borrow or lend crypto. With almost a third of the world’s population unbanked, this could be a novel solution to opening up credit access to people in developing and emerging markets.
Con: Alternative collateral
But there is no such thing as a free lunch, despite the claims of some cryptocurrency companies. In DeFi at the moment, many of the loans could be described as ‘over-collateralised. People who want to borrow funds have to supply tokens that are often worth more than the actual loan.
That trade-off allows crypto lenders to offer their loans with such favourable terms. However, the new approach to collateral may be a steep learning curve for lenders looking to forge stronger connections between their traditional finance roots and the world of DeFi.
Con: Limited regulation
Crypto loans are not insured in the way traditional bank loans are. As a result, if something goes wrong — or if something illegal or unethical occurs — it may be impossible for borrowers to retrieve their assets. It does not help that many DeFi products are complicated to use, leading borrowers and investors to make genuine mistakes caused by poor user experiences.
With regulators and tax authorities beginning to assess measures to manage the industry seriously, lenders must be careful not to risk damage to their brand or customer satisfaction.
Navigating new worlds of lending
Whether you view crypto lending as a great possibility or a potential pitfall, it is clear that it is just one part of a broader world of DeFi that will grow and mature in the years ahead. Talk to a credolab expert today to learn how we can help you understand your customer data to explore whether DeFi services like crypto lending are right for your business model.
To learn more about crypto lending, download our latest ebook here.