What Is Crypto Lending?

Cryptocurrency enthusiasts are often encouraged to hold on to their crypto holdings for the long haul. But if you need money, you might be considering cashing some of your cryptocurrency to cover a major or an unexpected expense.

Depending on how much you need, though, you may be able to use your cryptocurrency as collateral for a loan. Additionally, many crypto platforms allow consumers to lend their digital assets in exchange for a hefty return , compared with the traditional high-yield savings account. Find out the different ways your crypto assets can work for you.

What Is Crypto Lending?

Cryptocurrency is growing as a payment method and a speculative investment opportunity. But for enthusiasts who plan to HODL — an industry acronym for hold on for dear life — their assets with no plans to sell, there are opportunities to get more value out of their digital currencies.

One way is to use your digital assets to borrow money when you need it. Another is to lend your cryptocurrency and earn interest instead of paying it.

Borrow Using Cryptocurrency

A crypto-backed loan is a collateralized loan that you can get through a crypto exchange or some other crypto lending platform. The loan functions similarly to a mortgage or car loan in that you’re using an asset — in this case, your cryptocurrency — to secure your loan funds.

[Read: Best Mortgage Lenders.]

Here are some of the key features of crypto-backed loans that you need to know about:

Interest rates are relatively low. Cryptocurrency lending platforms generally offer crypto-backed loans with annual percentage rates in the single digits, which is less than a credit card and even many unsecured personal loans.

However, crypto loans are not as cheap as mortgages and auto loans, so think twice before using funds from a crypto loan to make a major purchase.

You’re limited on how much you can borrow. Many platforms allow you to borrow up to 50% of the value of your cryptocurrency — though some go as high as 90%. You can receive your loan funds in the form of U.S. dollars or select digital currencies.

There’s no credit check. There’s typically no credit check involved when you apply for a crypto-backed loan. For consumers with less-than-stellar credit, this is a significant advantage over traditional financing options, which can get expensive for poor- and fair-credit borrowers.

Funding is fast. Crypto loans are typically funded the same business day, sometimes within a few hours. If you need cash fast, using a crypto-secured loan is one of the best ways to do it.

Lend Your Cryptocurrency

On the flip side, many crypto platforms allow you to earn interest on your digital assets when you lend them to institutional borrowers. The arrangement is similar to using a savings account, where you stash your cash and the bank or credit union pays interest on the balance in exchange for using it to issue loans to other customers.

[Read: Best Savings Accounts.]

“This lending is mutually beneficial to both borrowers and lenders as it generates yield for the lender and liquidity for the borrower,” says Jennifer Liu, head of lending at Anchorage Digital, a digital asset platform.

Here are some of the key things to know about lending crypto:

Crypto savings accounts offer much higher returns. As of June 2021, the average online high-yield savings account annual percentage yield was 0.45%. In contrast, crypto interest-bearing accounts currently go as high as 12.7% APY. That’s even higher than the average return of the S&P 500 (more than 7% since 1957).

The space is new. Many crypto exchanges and lending platforms have only been created recently. “What you’re seeing is basically the disintermediation of the large cost structure associated with retail banks,” says Brock Pierce, chairman of the Bitcoin Foundation and co-founder of Tether, a popular cryptocurrency. “It’s less clear what the long-term sustainability is of them. It’s definitely more of the wild, Wild West, where you’re seeing very high yields, but it’s not without risk.”

You don’t have to lock in your assets. You don’t need to commit your money for a certain amount of time, as you would with a certificate of deposit or bond. While there may be some limitations, you can generally get your funds back shortly after you request them.

The best rates are on less-volatile assets. The best interest rates are typically reserved for stablecoins, which are digital assets that peg their value to an external source, such as a traditional fiat currency or gold.

For example, USD Coin, TrueUSD and Binance USD are all stablecoins that tie their value to the U.S. dollar at a 1:1 ratio. The price per coin is roughly $1 and doesn’t fluctuate much, so there’s a lower risk of losing money to volatility.

The risks are higher. Even with less volatility, though, digital currencies remain more risky than traditional ones. “You take on greater risk than market risk by lending your crypto,” says Liu. “But if you’re planning to hold it long term anyway, it means you’ll generate yield while keeping your position.”

What to Consider Before Engaging in Crypto Lending

There are some clear benefits to cryptocurrency lending, either as a borrower or as an individual lender. However, there are also some significant drawbacks to keep in mind before you decide to proceed.

Crypto Loans

You may be subject to a margin call. Cryptocurrency remains one of the most volatile assets you can buy. If you borrow against a large chunk of your holdings and the price drops, you may be required to deposit more crypto to increase your collateral. Alternatively, the crypto lending platform may sell some of your holdings to reduce your loan-to-value ratio. “If you’re going to be collateralizing a loan with a volatile asset, you better make sure that you’re wise in how much leverage you can use,” says Pierce, “because it can cost you dearly.”

Collateral is locked in. If you’re using a cryptocurrency to secure a loan, you can’t use it for payments or trades until you’ve paid the loan in full. If you end up needing to liquidate your holdings in an emergency, you can’t. And if the price of your crypto drops, you can’t sell to limit your losses.

Some loans are relatively short term. Repayment terms vary widely, depending on where you look. With some platforms, you can pay back the loan on your own schedule. But with others, you’ll have as little as 12 months. Depending on how much you plan to borrow, make sure you can afford to repay the debt within the time allotted.

Not all coins are eligible. You can’t use just any digital currency to secure a loan. Some platforms only accept a few options, which means you might need to exchange a currency you want to keep for an eligible one. Other platforms allow you to use dozens of currencies, so shop around.

Crypto Savings

Funds aren’t insured. Before you decide to move all of your savings to a crypto savings platform, keep in mind that these accounts aren’t insured like accounts held with a bank or credit union. If the company fails, you could lose all of your money with no recourse. Keeping your digital assets with a reputable platform can help keep your crypto safe, but even that’s not a guarantee.

Withdrawals aren’t always instant. Crypto platforms typically say you can withdraw your crypto whenever you want. But in some cases, it can take several days to release the funds to you.

Interest may not compound. While your balance will grow in a crypto savings account, the interest may not compound with some platforms as it does with a traditional savings account or investment portfolio. In other words, the simple interest rate is only applied to the principal balance, not the principal balance plus any interest you’ve earned. However, there are exchanges that offer compound interest, so make sure you check before opening an account.

It’s a bit more complex than a savings account. There’s greater complexity around secure storage and transfer of digital assets, says Liu. While crypto platforms can help streamline this process, it’s still something to keep in mind.

Alternatives to Crypto Lending

If you need money but don’t want to deal with the risks associated with crypto loans, traditional financing options like personal loans and credit cards may be more expensive, but they also carry fewer risks to your financial security. That’s especially the case in the event of a price crash.

[Read: Best Personal Loans.]

If you have investments with a traditional broker, like stocks and exchange-traded funds, you may also consider a securities-backed loan. The concept is similar in that you use your portfolio as collateral for a loan, but because stocks tend to have less volatility than cryptocurrency, there’s not as much risk.

Alternatively, if you’re looking for an opportunity to earn money as an individual lender, traditional peer-to-peer lending platforms can give you that chance without all of the risks associated with digital assets. You can also invest in traditional securities for the opportunity to achieve investment gains over time.

If you are considering crypto lending in either of its forms, though, Pierce recommends crawling before you walk and walking before you run.

“Go buy a hundred dollars’ worth of Bitcoin, learn how it works, go watch some YouTube videos, go read the Satoshi white paper,” he says. “Then go make a very small loan using one of these platforms. As you become more comfortable, then you can create greater investment exposure for yourself. But I encourage everyone to invest in their education first.”

More from U.S. News

How to Get a Personal Loan With a Co-Signer

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What Is a Loan Origination Fee?

What Is Crypto Lending? originally appeared on usnews.com

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