What is crypto lending?

How does crypto lending work?

Crypto lending is when you loan your cryptocurrency to someone else through a platform and earn interest in return.

"In many ways, crypto lending works similarly to traditional finance,” said Ron Levy, CEO of The Crypto Company. “Borrowers can use their crypto as collateral to secure a loan, while lenders can earn interest on their digital assets without selling them.”

The lender deposits cryptocurrency onto a crypto lending platform using its lending protocol. “Generally, lenders deposit their tokens into a lending platform or protocol. Those deposited funds are pooled and made available to borrowers,” explained Levy.

In return, lenders receive interest, or crypto dividends. The interest generated from the loan is held on the platform until the investor removes the crypto from the lending protocol.

“Crypto lending gives people a way to access liquidity without selling their digital assets,” explained Andrei Poliakov, CEO of APX Lending, a crypto-backed lending platform.

How do crypto loans work?

On the borrower’s side, crypto loans work similarly to traditional loans. The borrower still pays interest and makes regular payments until the loan is paid off in full. However, crypto loans differ in that they use crypto instead of cash or property as collateral, and they’re usually issued by third-party lending platforms instead of traditional banks.

To get a crypto loan, borrowers must pledge a portion of their own holdings as collateral. You can use a crypto loan for nearly any purpose, including debt consolidation, home renovations and even vacations.

Types of crypto lending platforms

There are two main types of crypto lending platforms: decentralized and centralized.

Decentralized crypto lending platforms

Decentralized crypto lending platforms combine blockchain technology with smart contracts to execute transactions. Smart contracts are programs on the blockchain that automatically enforce the terms of a loan, removing the need for a third party. Using blockchain networks like Ethereum and Solana, they automate the lending process, using an algorithm to set interest rates and manage the loan.

“There is no central company or person that can go in and change the rules,” Levy explained. “Users interact directly with the protocol, supplying or borrowing assets peer-to-pool. Rates are usually algorithmically determined by supply and demand.”

Because decentralized platforms are more technical, they’re usually better suited for experienced investors who can handle a complex system.

“On decentralized platforms, everything runs on smart contracts, which can create flexibility but also expose users to code risks and volatile interest rates,” Poliakov said.

Centralized crypto lending platforms

Centralized platforms are similar to traditional banks in that they act as an intermediary between the lender and the borrower. They provide the platform to unite lenders with borrowers and can be offered as either a dedicated platform or as a product offered by a crypto exchange. Either way, they take the crypto from the lender, make it available to the borrower and then create and oversee the loan.

Centralized vs. decentralized platforms

If you’re new to crypto lending, centralized platforms are usually easier to use. Decentralized platforms can offer higher returns but come with more complexity and risk.

“They operate like traditional financial intermediaries,” said Levy. “A user typically deposits crypto into an account managed by a company, and the company lends it out. In this case, the platform manages custody, sets interest rates and assumes the counterpart risk.”

These platforms are often better suited for newer investors who appreciate a user-friendly interface with easy access to customer support.

Risks and benefits of crypto lending

Crypto lending comes with potential rewards, but also carries significant risks.

Benefits of crypto lending

There are several advantages of crypto lending that can be very attractive to the right investor.

• Passive income: Through crypto lending, investors can earn passive income from the interest that borrowers pay. Investors can earn anywhere from 1% to 20% annual percentage yield (APY), according to Coinbase.
• Overcollateralization for added security: Overcollateralization requires borrowers to put up more collateral than they borrow. It’s a practice common with many lending platforms. For lenders, the collateral provides extra security for the loan, just in case market values change.
• Flexible loan terms: Crypto loans tend to be more flexible than traditional loans. Borrowers can often opt for shorter terms or early withdrawals, making crypto loans more attractive to borrowers and helping investors retain liquidity.
• Little management needed: Crypto loans are managed by smart contracts that handle the loan process, including repayment, so you don't have to manage the loan yourself.

Overall, Levy said, crypto lending is beneficial to the financial ecosystem as a whole, noting that this type of lending provides “efficient capital markets and greater liquidity.”

Risks of crypto lending

Although earning interest on crypto can sound tempting, there are real risks investors need to weigh before moving forward with crypto lending.

• No regulatory protections: While traditional banks and credit unions have federal protections, crypto lending doesn’t. This means your investment could be lost if the platform fails or runs into trouble.
• Security vulnerabilities: Crypto platforms, particularly centralized platforms, are prone to security issues. They could potentially be hacked or compromised, leaving your funds vulnerable. There’s also always the fear that the platform will go bankrupt.
• Potential margin calls: There’s always the risk of prices plummeting, causing your investments to lose value. This could result in an unanticipated margin call.

Because the crypto market can be highly volatile, it’s critical that you never invest anything you're not prepared to lose. “If the centralized company managing the platform fails or mismanages funds, users may lose deposits,” warned Levy.

» MORE: Benefits and drawbacks of traditional loans

How to get started with crypto lending

If you’ve researched the risks and still want to try crypto lending, here’s how to get started:

1. Find a platform: Before you can loan your crypto, you need to set up an account with an appropriate platform. Be sure that the platform offers crypto loans and also supports the type of crypto you have.
2. Add your holdings: Deposit your crypto assets onto the platform.
3. Set your terms: When you make your crypto available for lending, you’ll get to set the conditions for your crypto, including the loan term and your desired compensation. Remember that while higher interest rates can provide greater earnings, they may also discourage potential borrowers.
4. Start earning interest: Once a borrower accepts a crypto loan with your holdings, you’ll begin earning interest, according to the terms of the loan.

After the loan is paid off, you can decide whether to withdraw your crypto or keep it on the platform for future loans.

» MORE: Explore personal loan options for flexible financing

Popular crypto lending platforms

Some of the best platforms for crypto lending include these popular lenders.