Why Crypto Interest Rates Are So High
How interest rates work and why they have hit a record high right now.
Crypto has become the new gold as everyone wants to own it for its promising monetary future. Holding (hodling) a cryptocurrency such as Bitcoin for a few years can generate some handsome profits. However, that’s not the only way to make money in the crypto market, as you can now earn through lending.
If you are here, you probably heard about this enticing concept and got curious. Well, this article will answer your questions. Today’s post will discuss how interest rates work and why they have hit a record high right now.
What Is Crypto Lending?
To help you understand this concept better, we’ll first discuss what lending is in the traditional market. In traditional financial markets, a lender is a financial institution such as a bank that loans you (the borrower) money to be repaid with interest. The bank sometimes also asks you to secure the loan with some collateral. That way, if you default on the interest payments, it can sell your collateral to recover the money.
How Does This Apply in Crypto Markets?
This concept works the same way in the crypto market, but crypto’s volatility makes things different. The high price volatility forces lending platforms to demand more collateral because your digital assets could lose or gain value in no time.
Borrowers can put up collateral and easily borrow loans, which have to be paid back at the agreed interest rate. The lender remains the asset’s owner.
Therefore, if you have assets you plan on holding, you could lend them to borrowers and earn interest. This is an easy way to generate passive income through interest on your crypto assets.
How Does Crypto Lending Work?
Borrowers and lenders use a third-party crypto lending platform to facilitate this process. Crypto lending platforms are usually responsible for connecting many borrowers and lenders and handling their transactions. So, there must be a crypto lender, borrower, and platform for lending to occur.
Here is what the process looks like:
A borrower approaches a lending platform and requests a loan. The borrower then submits the required collateral for that amount of loan.
The platform approves the request and holds the collateral.
The lender releases the crypto, cash, or stablecoins to the borrower via the platform.
Why Are Crypto Interest Rates High?
High interest rates are a great way to convince people to lend their crypto and earn interest and there are a few ways to maximize this interest. These rates are currently high right now, which is for different reasons.
Demand and Supply
There is currently more demand than supply for some coins. So, lenders charge high interest rates because they have something borrowers are willing to pay generously for. However, many lenders are now entering the markets, which might balance the demand and supply, thereby lowering the rates over time. For now, the lending market is definitely in the favour of lenders, hence the high yield opportunities across many crypto assets.
Platforms like BlockFi have raised lots of money from venture capital. This allows them to offer high interest rates, even if they make some losses, to attract more customers. They use their vast capital reserves as a competitive advantage over those without the same means. They’re effectively using the venture funding to fund an acquisition strategy by providing abnormally high interest. This is great for consumers, as they’re effectively being handed venture capital money for being an early adopter.
New lending platforms can offer better interest rates than banks and more established platforms. An established company will likely have more expenses due to insurance, sophisticated custody solutions, and huge customer service teams. So, they are left with inadequate funds to share with their customers. Smaller crypto lending platforms, on the other hand, have smaller teams and generally fewer expenses. Therefore, they can easily offer bitcoin and other cryptocurrencies at lower fees and pass on more yield margin to their customers.
Although the lending industry is growing, it has a long way to go. Luckily, many people are now becoming aware of it, which might significantly increase the demand for crypto loans in a few years. This will balance borrowing and lending in the market, thus keeping interest rates healthy.
Digital Assets Range Vary
There is a notable difference in the variety of supported digital assets available on lending platforms. In the case of decentralized finance, this can be due to technical constraints, and for other platforms, it’s usually an issue of supply and demand.
Once all platforms offer the same assets, it should ensure a much healthier, more competitive borrowing and lending market. The industry is still relatively new, having only really started in 2019. The growth has been exponential, so we expect conditions to change in the near future as more liquidity enters the market.
Should You Use Your Savings to Invest as a Crypto Lender?
High-interest rates are undoubtedly attractive, which could tempt you into investing all your hard-earned money. However, that would be unwise. The crypto market’s unpredictability increases the chances of finding yourself in a bear market, thus lowering your crypto’s worth, if they’re not stablecoins. Therefore, the asset you had lent out would be worth less than the invested amount. Or, if you had borrowed crypto, it would be worth less than you received it.
There is also the risk of you or the lending company, especially if it’s not well established, being hacked and your assets stolen. Some companies specify that they wouldn’t be responsible for any loss caused by cyber-attacks, technical issues, or volatile market conditions. So, understand that you take responsibility for whatever happens in the market. It’s important to always use secure, well-insured platforms, like Nexo or BlockFi.
You should only invest money you don’t plan to use soon. Your risk tolerance should also be pretty high due to the high volatility. Additionally, get a lending platform that uses cold storage since that guarantees tighter security as the crypto is stored offline.
Using secure crypto lending platforms will allow you to feel safe, which is always the most important thing.
If a platform offers significantly higher interest rates than others, then always check if they’re regulated, insured, and what their security practices are. Sometimes rates that are too high are too good to be true.
Are Higher Interest Rates Good for Crypto?
Interest rates are usually a huge factor that investors in every sector consider to determine whether an opportunity is investment-worthy. Crypto interest rates have been quite high recently. Fortunately, there are signs of a more stable and competitive market in the future that’ll allow rates to remain high without pushing clients away. We hope this article has helped you understand the high crypto interest rates in the market today.