The risks involved with Bitcoin lending and how to reduce or eliminate them.
Crypto lending comes with attractive perks. It allows you to take out personal loans without letting go of your crypto holdings. Aside from that, crypto-backed loans usually have lower interest rates and can be funded faster than traditional loans.
However, it is not all good. As with almost anything that has benefits, there are some risks attached to cryptocurrency lending. Some of these risks come from the crypto lending platforms, and some come from the crypto assets themselves.
This article will focus on a specific type of crypto lending: Bitcoin lending. We will discuss how it works, highlight the risks involved, and show you how to reduce or eliminate such risks.
Bitcoin lending is a type of cryptocurrency lending that involves the use of Bitcoin. It could mean using Bitcoin as collateral for the crypto loan you take out or taking out a Bitcoin loan using other crypto assets as collateral.
Most crypto lending platforms offer Bitcoin as one of their main lending products because it is one of the most stable cryptocurrencies.
As with other aspects of the crypto industry, Bitcoin lending is largely unregulated. Many crypto lending platforms say that their products are not securities and do not need to be registered with the government.
However, governmental authorities do not seem to agree with that. For example, BlockFi (now insolvent), a popular crypto lending platform, was slapped with a $100 million fine by the SEC for failing to register its lending products with the US government.
This is likely to show other Bitcoin lending platforms how to meet government rules, which is good news for investors.
How secure is Bitcoin lending? In most cases, this has to do with the lending platform you choose to use.
Most of the time, centralized crypto lending platforms like Nexo are safer, but they have more rules and identity checks. On the other hand, decentralized platforms like Aave and Compound do not require identity checks but are generally less secure than their centralized counterparts.
Now, let's talk about some of the risks that investors may face when they lend bitcoin.
Unlike traditional lending platforms, many Bitcoin lending platforms do not come with deposit insurance. So, there is no guarantee that you will get your money back if the platform goes out of business.
Centralized crypto lending services, like Nexo, protect their users in some way because they have insurance. For example, Nexo has total insurance of at least $775 million.
However, this cannot replace the type of security that comes from government-approved insurance corporations like the FDIC and similar institutions with a proven legal framework.
So, if you're looking to start crypto savings accounts with a Bitcoin lending platform, check out what type of insurance policy it has and whether you're comfortable with it.
This risk is more common with DeFi crypto lending platforms because they use smart contracts, which hackers can easily take advantage of. A typical example is a flash loan attack.
A "flash loan" is a type of loan that doesn't require collateral. The only condition is that you need to pay it back in a flash, within seconds, before the transaction ends. If you can't pay it back, the transaction reverts as if it never happened.
Because flash loans make it easy to borrow large amounts of money, some hackers use them to make illegal money by changing the prices of crypto assets. They then return the loan and disappear into thin air with the profits.
Rug pulls and temporary losses are two other examples of Bitcoin lending scams.
Most Bitcoin lending platforms use third-party services to store your bitcoins. Some even lend them out to other crypto lending platforms or invest in them with some crypto investment platforms. That is how some of them make profits.
It's all good and fine as long as you get paid, right? But what happens when those third-party platforms can not repay the loans? In such cases, your crypto lending platform may go bankrupt, and that will affect you.
Even though most centralized crypto lending platforms try to reduce this risk by putting up too much collateral for the crypto they lend, your capital is still at risk, especially when the market is moving a lot.
Most decentralized platforms for lending crypto don't lend to third parties, so this risk may not apply to them.
This is an ever-present danger with Bitcoin and other cryptocurrencies. Even the best crypto lending platforms can't protect you if the market moves in the opposite direction of what you thought it would, leaving your collateral open to being sold.
That is why you need to watch out for the interest rates and the loan-to-value ratio before signing up on a Bitcoin lending platform. Also, you should have some extra cash on hand in case you get a margin call on your Bitcoin loan.
This goes without saying. When you put down your collateral with a crypto lending platform, you trust that you'll get it back when you're ready to repay. That is why you should verify how legitimate the platform is before starting with it.
How do you know if a Bitcoin lending platform is trustworthy? Well, is it regulated? Does it have reputable partners? Does it have sound security practices like two-factor authentication and encryption? What about the interest rates it offers? Are they reasonable?
Also, check out whether or not it has insurance coverage and how deep such coverage goes. Lastly, try out multiple platforms to reduce your exposure if something goes wrong with one of them.
An example of a trustworthy Bitcoin lending platform is Nexo. It is licensed in the United States as well as Canada, Switzerland, Lithuania, etc. It also stores its cryptocurrencies in cold wallets and has robust insurance coverage.
If you're just starting out in Bitcoin lending or just trying out a new Bitcoin lending platform, it may not be wise to lend out your whole portfolio and hope for the best. You should start small and then progress according to your risk tolerance.
That way, you can better assess the security of the platform, its response to customer queries, and what kind of profit potential you stand to gain.
Decentralized Bitcoin lending platforms come with more flexibility than their centralized counterparts. Therefore, it may be tempting to favor DeFi over CeFi regarding crypto lending.
However, keep in mind that Bitcoin lending scams are more common with DeFi platforms. There is no need for regulation, nor is there a need for insurance with these platforms. If they suffer an attack, there is no one to hold; your money is simply gone.
In this article, you have learned that while Bitcoin lending has its advantages, it also presents certain risks. Uninsured deposits, Bitcoin lending scams, volatility, and third-party services may lead to the loss of money for investors.
To mitigate such risks, you should use trustworthy crypto lending platforms, start with small amounts, and steer clear of DeFi lending platforms as much as possible. That way, you will tread as safely as possible in the sometimes tumultuous world of Bitcoin lending.