Rise of Crypto Lending: Should Traditional Lenders Worry?
Innovations within the decentralized finance (DeFi) space have already shown how the use of blockchain technology for financial services can offer an alternative to conventional financial products. From insurance to savings accounts and securities trading, DeFi technology has opened up a variety of services that fintech startups can offer.
One of the fastest growing areas of DeFi is cryptocurrency-backed lending. Much like traditional financial institutions offer fiat currency loans secured against a car or house, a crypto loan is secured using cryptocurrency as collateral.
Unlike conventional lending products, cryptocurrency-backed loans use blockchain smart contracts to govern the lending and cannot be modified by a third party.
“Crypto investors are often praised for taking the HODL (hold on for dear life) approach to investing. But how a HODL works can vary significantly,” says Nicole DeCicco, founder of cryptocurrency advisory firm CryptoConsultz.
“Hodlers often consider and participate in crypto lending and staking platforms in order to earn interest on their investments. While not without risk, the benefits of such platforms are unquestionably impressive, that is the less we can say.
It’s not hard to see why borrowers are increasingly interested in crypto loans, thanks to the ability to access relatively low interest rates, virtually instant funding, and no credit checks. Data from CoinMarketCap shows that the global market capitalization of all crypto assets, including Bitcoin and Ethereum, is close to $1.8 billion, illustrating the major market potential for crypto lending.
For crypto whales (people who have millions and millions of crypto in their digital wallets), lending their crypto through online platforms can provide them with fiat currency from interest, not facing the same level taxes that the sale of their crypto could incur.
However, like many financial products, taking out crypto credit is not without risk. Bitcoin and other cryptocurrencies are well known for their high volatility and can rise dramatically or crash within days. Due to this inherent instability, crypto loans typically have an extremely low loan-to-value (LTV) ratio and require borrowers to provide additional capital if the price of crypto falls below a predefined value.
“It is imperative that those wishing to use crypto loans understand the smart contract rules and review the fine print as one would for a traditional loan,” DeCicco adds.
Crypto lending faces regulatory hurdles
Although many regulators around the world are beginning to establish cryptocurrency regulations, the lack of clear and comprehensive guidelines has created a difficult operating environment for many crypto lending platforms. In February this year, a subsidiary of leading crypto platform BlockFi called BlockFi Lending LLC was accused by the United States Securities and Exchange Commission (SEC) of offering an illegal lending product.
According to the SEC, BlockFi Lending LLC has not registered the BlockFi Interest Account Lending Product as collateral, nor has it accurately represented the risks of the product. Although the crypto platform did not agree with the allegations presented by the SEC, it approved the payment of a settlement fee of $ 100 million, which is the largest penalty ever imposed for a action of applying cryptography.
“One of the main reasons why scrutiny is focused on lending rather than transactions in general is that lending is multi-faceted. Without clear regulations, crypto credit companies are not held to the same reporting standards. There’s very little disclosure about what’s going on behind the scenes,” DeCicco adds.
From a regulatory standpoint, more is needed for these platforms to thrive. Currently, crypto lending platforms are not required to follow certain banking regulations and are also not covered by any form of deposit protection or financial services compensation scheme. This leads to customers having little recourse if the platform fails or faces liquidity issues.
Is it a disruptive platform?
A number of companies have sprung up in recent years to offer crypto loans through a central company. Companies like BlockFi, Celsius, YouHodler, and CoinLoan provide loans in the centralized finance space (CeFi) and offer customers similar benefits to DeFi but with the customer experience and enhanced security of conventional financial companies.
In a short time, many platforms have seen extremely high growth in crypto lending. For example, CoinLoan saw crypto loans increase by 2000% in 2021, reflecting the good year for crypto in general. As these platforms continue to grow, are major financial institutions at risk of losing customers to innovative crypto lending?
For Ilya Volkov, CEO and co-founder of cryptocurrency exchange and lender, YouHodler, the rise of crypto-based lending poses no risk to traditional lending markets.
“Technically speaking, crypto-based lending is a form of traditional pawnbroking, where crypto is used as a form of collateral [pledge]. That means we’re not talking about disruption or competition with legacy businesses, but kind of an extension of them,” he says.
Compared to traditional financial organizations that often date back hundreds of years, there is no doubt that crypto lending is still a new industry. But as crypto adoption grows, with a survey of Piplsay research firm seeing that 49% of millennials own cryptocurrency, it may not be long before customers and major banks are considering crypto loans.
“Right now it’s hard to borrow money from a bank,” says Alex Faliushin, CEO and founder of crypto lending platform, CoinLoan. “Crypto lending allows anyone with funds to lend money instantly and also be a lender, giving healthy returns compared to holding cash in the bank.”
The process of opening an account on a crypto exchange or lending platform is also generally simpler and more innovative compared to bank accounts.
It may be some time before crypto lending reaches its full potential and people feel comfortable embracing a relatively new financial product. However, the benefits for crypto owners by getting a loan against their stake might be too enticing to turn down.
“Over time, we will see more and more ways to use crypto lending platforms to get the best use for your money and the use cases will grow along with the industry,” Faliushin concludes.