Crypto Lending Is A Paradigm Potent Enough to Topple Convention

The crypto landscape is a multifaceted world where individuals and organizations implement blockchain-based solutions that will rid themselves of the heavy reliance on centralized systems. Since this is the narrative spurring the crypto market, it, therefore, rings true for an emerging crypto sector that promises to disrupt the banking industry and offer solace to the unbanked. Throughout 2019, the crypto lending market performed above expectations, as it continues to stand out as one of the core contributions of the popularly acclaimed Decentralized Finance Defi.

In this article, I will put a spotlight on the crypto lending sector, discuss its successes and frailties, and project what the future holds.

What Are Crypto Lending Platforms?

The concept of crypto loans stems from the need to infuse elements of blockchain and decentralization to an overly centralized banking system. Unlike the conventional banking industry, the crypto loan paradigm provides a trustless and fairer financial empowerment scheme that is void of intermediate processes found in traditional lending platforms.

To achieve this innovative feat, networks incorporate the decentralization-based functionalities that abound in blockchain technology to create an ecosystem where users can access transparent and fairer loan infrastructures. In other words, a crypto lending platform is an initiative that enables lending services with cryptocurrencies being the only accepted form of collateral. As such, this solution is peculiar to crypto holders who see the importance of bypassing restrictions often encountered when trying to request loans from traditional banks.

As straightforward as the purpose of crypto lending platforms seems, the business model is far from simple. For one, there are different variations of crypto lending solutions. That said, the most distinguishing factor of crypto lending solutions is the degree of decentralization they incorporate into their ecosystem. It is worth noting that a DeFi system eliminates all forms of intermediate processes and lets participants communicate and transact directly. Defi is a blockchain-based solution, which adopts smart contract, consensus mechanisms, and an immutable ledger to create a self-sustaining peer-to-peer financial network.

While Defi is the ultimate form of crypto lending facilities, a majority of the platforms we have today are currently running a model that incorporates just one or two elements of Defi. Hence, there are platforms whose only attribute carrying some sort of semblance to the above-stated standard is their decision to accept digital assets as collateral. These platforms are run by central authorities, which autonomy over all of the processes involved in lending or borrowing crypto. Then there are platforms fractionally running Defi-based lending systems, as they enable a p2p network with smart contract functions. In this case, lenders might get to have autonomy over their dealings with potential borrowers.

Having surmised the goal as to what a crypto lending platform should embody, let’s discuss the types of operations that a typical crypto lending solution could enable.

An Infrastructure for Borrowing

In this scenario, the crypto lending solution functions solely as a platform where crypto holders can borrow funds. As you would expect, interested borrowers must have the right amount of collateral in the form of cryptocurrency before they can access loans.

A Crypto Lending Infrastructure

Lending out cryptocurrency generates more return than stashing it away in a hardware wallet in hopes that long-term market trends generate favorable price swings. Hence, some lending facilities invite crypto holders to capitalize on the demand for crypto loans and make extra profits off their holdings by loaning crypto to borrowers with interests. While this is a given, the platform governs the matching process and sets interest as they wish. In this variation, borrowers could be individuals or institutions.

P2P Network

Peer-to-peer networks combine the functionalities of the other two variations to create an ecosystem where lenders and borrowers can initiate loan agreements without little or no inputs from the governing entity. Unlike the two types mentioned above, a p2p lending network offers a competitive landscape for the borrowing and lending of crypto, albeit with negligible transaction fees.

What Are the Benefits of Crypto Lending Platforms?

Crypto lending solutions provide competitive interest rates, which without question is the most attractive perk of using one. Apart from low rates, users get to enjoy low processing fees and access loans almost instantly, as there are no unnecessary hold-ups associated with traditional loaning facilities. Likewise, utilizing crypto lending solutions entrenched in blockchain technology avails a transparent system where all the moving parts behind the scene is visible to participants.

Furthermore, crypto holders, who need to raise funds for one reason or the other, can simply opt to borrow funds instead of selling their assets. With this possibility, holders can avoid tax obligations governing crypto transactions. Note that converting crypto to fiat currencies triggers capital gain tax in some regions, as crypto practitioners must calculate the difference in the value of their assets when it was originally purchased and the moment it was sold. In light of this, opting for the services of crypto loan facilitators appears to be the wise thing to do.

Are Crypto Lending Platforms Better Than Their Traditional Counterparts?

If you choose to look at this argument objectively, you will discover that crypto lending platforms have some advantages over the traditional alternatives. The reason being that they circumvent the high-handedness peculiar with banks or traditional platforms. Thus, participants are not susceptible to human errors and emotions that often frustrate the operations of traditional lending solutions. Instead, a trustless and fully-automated mode of operations, brought about by the incorporation of smart contracts, is sure to enable a fairer and error-free loan processing infrastructure. Needless to say, low-interest rates, widely celebrated in the crypto lending market, is another eye-catching feature of these establishments.

However, these perks do not take anything away from the fact that traditional lending facilities are free from price volatility that affects the operations of crypto-based loan facilitators. It is common practice in the crypto lending sector for service providers to require borrowers to monitor the value of their collaterals and deposit more coins whenever price slumps cause their security to fall below an accepted range. Not to forget that the conventional lending market is a closely regulated sector, which is enough reason why it will take some real convincing for the mainstream to entirely ditch traditional lending facilities for the crypto-based ones.

What Is The Current State of The Crypto Lending Industry?

Already, we have several lending solutions targeting the budding crypto community. As stated earlier, a majority of these facilities have introduced one of two unique features to retain their appeal in a keenly contested market. While some have fallen by the wayside, others have been able to ride the crypto wave and establish a thriving business. More impressive is the rate at which established institutions, venture capitalists, and investors are taking to the idea of investing in crypto lending platforms.

In 2019, Blockfi raised $18 million in an investment round led by Valar Ventures, a venture funds affiliated to Peter Thiel, the co-founder of PayPal. Likewise, the Celsius Network claimed to have onboarded 100 institutional clients and have processed over $2.2 billion worth of loans since July 2018. Nexo, on the other hand, purported that it has facilitated $700 million worth of loans and has provided services to over 200,000 clients since it started operation.

Recently, Genesis Global Capital, an affiliate of Genesis Trading, which lends cash and cryptocurrencies to its clients, recorded an uptick in revenue in the fourth quarter of 2019. According to reports, the lending platform saw an increase in the demand for loans by almost 21 percent in Q4 alone. Remarkably, this feat dwarfs the output of traditional lending firms like New York-based JPMorgan, which recorded a mere 2 percent surge in the value of loans processed, a growth percentile close to what the global lending market recorded during the same period.

Needless to say, these highlighted successes are evidence that the crypto lending market is pushing new narratives that might see it topple its counterpart deeply rooted in a rigid system. However, before this could become a reality, stakeholders must look for ways to circumvent challenges native to the crypto lending market.

What Are the Limitations of Crypto Lending Platforms?

Even with all of the benefits and successes credited to the emerging market, there are still issues plaguing its efficacy. One of such shortcomings is the unrelenting volatility of cryptocurrencies. Volatility could make the entire process a bit tricky, as borrowers have to track the effect of price fluctuations on the value of their collateral. Whenever the value of the deposited asset drops below the accepted valuation, borrowers have to deposit more coins to eliminate the effect of price swings on the validity of their collateral.

For example, if borrower A deposits 1 BTC as collateral for a $10,000 loan he plans on repaying for the next 6 months, and the price of BTC suddenly drops to $5,000, he or she has to deposit more bitcoin to cancel out the impact of bitcoin’s price slump. The same sort of price calculation and tracking requirements apply to lenders who must reconcile the original value of their assets and the expected amount of crypto they would eventually earn.

Another limitation has to do with the perceived security frailties associated with crypto platforms. Crypto lending platforms often incorporate custodial services, which exposes them to all sorts of threats. As such, it is advisable to take precautions and research the efficacy of a crypto lending platform before depositing your crypto in its wallet. While this is a given, we have begun to see crypto platforms take extra measures to boost the security of their systems. The move by some solutions to secure their wallets via partnerships with institutional custodial services has suddenly elevated the security standards of the nascent terrain. Hence, it is becoming glaring that the crypto lending market will stand as one of the beneficiaries of the new order of custodial solutions designed to cater to the crypto industry.

Then there is scalability and its ripple effect on the burgeoning blockchain industry. Ethereum, which remains the most popular application-based blockchain network suitable for Defi-based lending apps, has continued to battle with congestion and high transaction fees. The blockchain’s transaction validation system can verify only 15 transactions per second. Thus, the prevailing narrative regarding the impacts of scalability on the current struggles of the blockchain industry also applies to the crypto lending paradigm. In light of this, the current push for scalable blockchain solutions will advertently pave the way for even more sophisticated and viable crypto lending facilities.

In August 2019, a worrying revelation emanated, as a report claimed that lenders had only made 2% profit on their activities on crypto lending platforms. Graychain, a credit assessment firm, asserted that the high demand for crypto loans had not necessarily had the desired effect on the profits generated through lending out digital assets.

The report reads:

“From our quarterly analysis, you can see the number of loans originated grew faster than the new addresses and the total origination amount. That means that people are making more small loans, rather than borrowing millions at a time.”

In an interview with Coindesk, Neil Zumwalde, the chief technical officer of Graychain, reiterated that a majority of the loans requested on lending platforms have short-term schedules. Zumwalde explained: “Generally these companies that are doing really huge originations are originating really short-term loans.”

What Does the Future Hold for The Crypto Lending Market?

There is no doubt that crypto lending’s prospect is tied to the long-term viability of the crypto and blockchain industry as a whole. If developers finally solve blockchain’s three-pronged challenge that includes security, decentralization, and interoperability, then it will immediately establish the global appeal of crypto lending platforms. The same also applies to the long-heralded mainstream status of crypto. The establishment of crypto’s mainstream status will push new fronts where crypto lending will experience unprecedented hype.

When all these start falling into place, I expect the conventional landscape to pay more attention to what is brewing in the crypto lending market. Hence, it won’t surprise me if conversations relating to the introduction of regulations for crypto lending markets come to the fore. Besides, there is no way traditional lending platforms will stand by the sidelines and watch all these unfold. Therefore, I believe that we will see an influx of reports detailing how conventional solutions incorporate one or two components of crypto lending to their existing business model.