Despite increasing pressure from regulators, the crypto lending field is growing faster than ever. Crypto holders can generate revenue from their holdings in various ways. While some are related to the modern DeFi (decentralized finance) schemes, others are connected to traditional finance. Several hedge funds have figured out that they can make large profits by using leveraged bets on many crypto tokens and the derivatives of crypto. The crypto borrowing market is in high demand because investors can make a large sum of money using their trading strategies. These market players can afford to pay huge interest to the lenders without losing much profitability. These interests paid by borrowers minus handling fees go in investors' pockets as yield, which is exponentially higher than bank deposits.
Lending Bitcoin can generate up to 13.01% annual yield, and some tokens can give yields higher than 100%. But the rewards don't come free for investors; there is a risk of asset price plummeting overnight and the middleman company defaulting. The industry of lending and borrowing crypto is growing into a big business. Companies like BlockFi, Celsius, and Nexo manage billions of dollars in lent and borrowed crypto. The El Salvadorian government is also pushing for crypto-backed loans. So far, we are lucky not to have witnessed any high-profile crypto lending scam. But there can be cases in the future where you lend your crypto and not get it back. Issues like these can cause a chain reaction of fear and failure in both DeFi and the traditional finance systems. The high financial risk posed by crypto lending is why regulators are increasingly trying to subdue it.
What are the Safety Issues With Crypto Lending?
1. Your Deposits are not Insured.
Lending your crypto tokens on a CeFi platform is very different from keeping your money in a bank account. Your bank deposits are insured in most developed countries, but you can't say the same for CeFi crypto deposits. You pay for security to guarantee that your deposits will be refunded if a bank goes broke. However, no jurisdiction ensures CeFi crypto deposits. You risk losing all your assets once the platform provider goes bankrupt. You can avoid these scenarios by keeping an eye on your crypto lending platform provider's economic health and only using established platforms. Or you can use DeFi platforms, where there is no risk of insolvency. DeFi platforms are not under any private limited company and can not file for bankruptcy.
2. Cyber-attacks on Your Stored Crypto
The crypto lending platforms have high-security measures nowadays to prevent attackers from stealing your crypto tokens, but it is still a target for cybercriminals. The top platforms employ professional service providers, like Bitgo, for storing your crypto assets securely. But even these service providers can not guarantee 100% safety of your assets no matter how safe they are considered according to IT standards. With some CeFi platforms, you get private insurance policies covering technical risks and asset theft. However, DeFi platforms don't have any such insurance policy as you manage your crypto assets in your wallet that you connect to the DeFi platform.
3. Smart Contracts can be Faulty
Smart contracts are not legal bindings but lines of code that govern a course of action on the blockchain. If the developer behind the smart contract makes a mistake, the smart contract can be vulnerable to operational and security risks. These smart contracts form the building blocks of any DeFi platform. When you put your cryptocurrencies in a DeFi platform, smart contracts govern everything that happens with it, like interest payments and collateral liquidation. Unlike CeFi platforms, in DeFi, there is no human involvement in the background, so you can not hold anyone responsible if the smart contract fails and you lose all your cryptocurrencies. But the good news is the smart contracts used in the DeFi platforms are available to the public. With the necessary technical knowledge, you can check the smart contracts yourself or trust the developers and the community behind the platform.
4. Lack of Proper Crypto Regulations
Unlike most mainstream asset classes, there are no proper crypto-assets regulations. While a lack of rules is suitable for decentralized systems, investors lack legal certainty. In DeFi platforms, these legal challenges are more evident as there are no legal contracts to bind them in today's legal framework. So if you lose your assets on a DeFi platform, who can you sue? The answer is you won't be able to take any legal actions in most cases. However, the situation is slightly different regarding CeFi, as you can hold the platform provider legally responsible if it doesn't fulfill its contractual obligations.
5. Crypto is Volatile
The crypto market is highly volatile, primarily based on market emotions. Suppose you have lent your Bitcoins on a DeFi or CeFi platform and the price suddenly plummets; your asset value would be affected severely. However, you can easily avoid such volatility by investing in stablecoins in your portfolio. Specific platforms even offer a higher interest rate on stable coins, and you can also opt to receive interest payments in stablecoins. The value of stablecoins is tied to an underlying stable value asset, like the US dollar (USDT and USDC). Unlike Bitcoins, you do not have to face the same volatility risk with stablecoins, as their value fluctuates only as much as the assets they are tied to.
The entire crypto market has surpassed the $3 trillion mark at its peak, but currently, we are looking at a bull run. The crypto lending platforms like Nexo are built to withstand the volatility associated with cryptocurrencies. But if the entire market falls by more than 30%, it would be very challenging for these platforms to keep up. There is significantly less transparency in the crypto lending market as your assets are reloaned multiple times. If anyone borrower in the middle defaults, your assets come under colossal risk. While the regulators are still uncertain with crypto lending and borrowing, you should go in with eyes wide open without any delusions. At Bitcompare, we got you covered with reviews of all significant crypto lending platforms and their comparisons to help you choose the one that suits you best.