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Crypto has become the new gold, as everyone wants to own it for its promising monetary future. Holding a cryptocurrency such as Bitcoin for a few years can generate profits. Yet, 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 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.
What Is Crypto Lending?
To better understand lending, let us discuss what it means in a traditional sense. In traditional financial markets, lenders are financial institutions that loan borrowers money.
Under this setting, borrowers must repay their loans with interest. The bank sometimes also asks borrowers to secure their loans with collateral. If they don't pay the interest, the loan can be paid back with the money from the sale of the collateral.
How Does This Apply to 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. The demand exists because digital assets could lose or gain value in no time.
Apart from that demand, borrowers can put up collateral to access loans. The loans must be paid back at the agreed-upon interest rate after expiration. Throughout the process, the lender remains the asset’s owner.
If you have assets you plan on holding; you could lend them to borrowers and earn interest. With this method, lenders generate passive income from their crypto assets.
How Does Crypto Lending Work?
Borrowers and lenders use a third-party crypto lending platform to ease this process. Crypto lending platforms are usually responsible for connecting many borrowers and lenders.
They also handle transactions for all platform users. So, there must be a crypto lender, a borrower, and a platform for the lending process to function. 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. There are a few ways to maximize this interest. These rates are currently very high for a variety of reasons.
Demand and Supply
There is currently more demand than supply for some coins. So, lenders charge high-interest rates. Lenders do this because borrowers are willing to pay for the loans.
Many lenders are now entering the market. The development might balance demand and supply. It may also help to lower rates over time. The lending market is in favor of lenders. Hence, there are high yield opportunities across many crypto assets.
Venture Capital
Some crypto platforms have raised a lot of money from venture capital. This allows them to offer high-interest rates to attract more customers.
The platform uses its capital reserves as an advantage over other platforms. This tactic is very effective against platforms without the same resource.
With their venture funding, lending platforms fund their acquisition strategy. The strategy provides abnormally high interest. It is excellent for consumers. Thus, customers receive venture capital money for being early adopters.
Lower Costs
New lending platforms can offer better rates than other known platforms. An established company will likely have more expenses due to insurance. They also incur expenses for sophisticated custody solutions and large customer service teams.
So they may not have adequate funds to share with their customers. Smaller crypto lending platforms have smaller teams and generally fewer expenses.
Thus, they can offer bitcoin and other cryptocurrencies at lower fees. They can also pass on higher yield margins 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. That factor will increase the demand for crypto loans in a few years. It will also balance borrowing and lending in the market. thus keeping interest rates healthy.
Digital Assets Range Vary
There are differences in the variety of digital assets available on lending platforms. In the case of decentralized finance, this can be due to technical constraints. For other platforms, it’s usually an issue of supply and demand.
Once all platforms offer the same assets, it will ensure a healthier lending market. The industry is still relatively new, having only really started in 2019. Despite its exponential growth, we expect to see more growth soon. This growth will become more evident as more liquidity enters the market.
Should You Use Your Savings to Invest as a Crypto Lender?
High-interest rates are undoubtedly attractive. Excellent rates could tempt you into investing all your hard-earned money. Such actions would be unwise.
The crypto market’s unpredictability increases the chances of ending up in a bear market, thus lowering your crypto’s worth if they’re not stablecoins. So, the asset you lent out would be worth less than the invested amount. Or, if you had borrowed crypto, it would be worth less than you paid for it.
There is also a chance that investors or the company doing the lending could be hurt. Such a situation can cause investors to lose their assets.
Some companies specify that they won’t be responsible for losses from cyberattacks. Most platforms also apply this rule to volatile market conditions or technical issues.
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 YouHodler.
You should only invest money that 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. That feature guarantees tighter security as the crypto is stored offline.
Using secure crypto lending platforms will allow you to feel safe. A certain sense of security is the most important thing an investor can have.
If a platform offers higher interest rates than others, conduct checks. Ensure they’re regulated and insured. Also, verify their security protocols. Sometimes the rates are too high to be true.
Are Higher Interest Rates Good for Crypto?
Interest rates are usually a huge factor that investors in every sector consider. Examining interest rates can help investors 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. Such a situation will allow rates to remain high without pushing clients away.
Disclosures
Content is given solely for informative reasons, does not constitute tax or financial advice, and does not endorse any particular investment plan. Every investment has risk, including the possibility of a cash loss. Past performance does not guarantee future results.
Bitcompare does not guarantee good investment outcomes. The previous performance of a security or financial instrument is not indicative of its future performance. Before investing in options, clients should carefully assess their financial goals and risk tolerance. Due to the significance of tax concerns in all option transactions, a customer contemplating options should consult a tax professional to see how taxes impact the outcome of any option strategy.
