How crypto lending works for investors and borrowers

Cryptocurrency’s popularity has led to a range of innovative financial products to help you leverage your crypto holdings, including high-yield deposit accounts and crypto-backed loans. But these products aren’t insured by the FDIC and carry higher risk than traditional finance products, like savings accounts and personal loans. Here’s what to know about crypto lending.

What is crypto lending?

Crypto lending is when an individual lends crypto or fiat currency to borrowers on an exchange or peer-to-peer (P2P) platform, who then secure loans with their own crypto assets. It offers a solution to both investors who want to earn yields on their crypto holdings and to borrowers who want to access cash.

There are two sides to crypto lending: investing in a crypto-backed loan, and borrowing against your crypto assets:

1. Investing to earn income. With this option, you loan out crypto or fiat currency to earn returns on the loan — similar to a high-yield savings account. Do this by opening a crypto savings account or by loaning out funds directly to an individual on a peer-to-peer lending platform.
2. Borrowing for cash needs. With this option, you borrow against your crypto with a crypto-backed loan that pays out in fiat or stablecoin. There’s no credit check required, and most loans are processed on the same day your crypto collateral is received.

This is the typical crypto lending cycle: Lenders deposit fiat or crypto into a crypto lending platform account, which the platform loans out for borrowing and investment purposes. Borrowers deposit crypto as collateral for loans and pay interest to the lender.

Here’s a closer look at how crypto lending works for both investors and borrowers, the pros and the cons and the risks involved.

For investors: Crypto lending

Investing in crypto goes beyond buying and holding on — or, as some say, “hodling” — for future gains. You can also earn passive income on your crypto by investing in crypto lending. Here are some of the most popular lending products available to crypto lenders.

Types of crypto lending accounts

Crypto lending platforms are eager for you to use their services and hold assets with them. Many offer a range of crypto lending accounts — often called “earn” products — to entice you to make deposits or lock up your crypto or stablecoin in exchange for higher yields than you’d find on a traditional savings product.

Common types of crypto lending accounts include:

1. Crypto savings and deposit accounts. Although they’re advertised as similar to deposit savings accounts at banks, crypto savings accounts are more like securities lending. You deposit your crypto assets with a lending platform, which then loans out those assets to borrowers. This process of loaning out your deposits is called rehypothecation.
2. Fixed-term crypto deposit accounts. Similar to a CD, this option involves depositing crypto or fiat currency into an account that is locked until the end of a fixed term — usually 30, 90 or 180 days. You can typically withdraw interest during this time, as it accrues. Like with the savings account, the platform rehypothecates your funds.
3. P2P crypto lending accounts. A peer-to-peer lending platform allows you to directly loan out your cryptocurrency to a borrower who wants a crypto-backed loan. Because you’re lending directly to the borrower, there’s no rehypothecation of your assets.

Compare a range of crypto savings accounts and features to find the right one for your investment.

Pros of crypto lending

There are a wide range of benefits to investing in a crypto savings or deposit account.

• High yields. Crypto lending products typically offer much higher yields than you can get at a traditional financial institution, typically offering rates at 9% or higher.
• Options to withdraw as needed. Some platforms offer high yields on deposits without requiring a minimum deposit or locking up your assets for a set amount of time.
• Crypto not required. Crypto lending accounts sometimes allow you to earn returns on US dollar deposits — though those returns are still subject to the same taxes as any other crypto asset. This allows crypto skeptics to earn relatively high yields without having to buy volatile coins like Bitcoin (BTC) or Ethereum (ETH).
• Bonuses. Many platforms offer cash or crypto bonuses for signing up and making a deposit. Some offer higher yields for larger deposits.

Cons of crypto lending

Weigh these risks and drawbacks to crypto lending before you sign up for one of these products.

• Not FDIC-insured. Crypto assets held by exchanges are not insured by the FDIC, and so aren’t as safe as deposits held at traditional financial institutions. Never invest more than you’re willing to lose.
• Potential speculation of assets. Unlike cash deposits, crypto deposits may be used to take a speculative position on the asset itself. This can be riskier than lending for loans, which are collateralized by borrowers. As such, it’s important to understand how your crypto deposits will be used by the platform.
• Transfer of ownership. You’re required to turn over ownership of your crypto to the company and trust that it’s kept safe for you. If the company becomes insolvent, there’s a good chance you could lose your funds.
• Insurance may not be adequate. Many platforms advertise cyber insurance to cover hacking events, but the coverage may be far less than the value of customer deposits in reality.
• Changing regulations. The federal and state governments are still figuring out how to regulate crypto platforms, which could affect your ability to earn returns on your deposits.

Risks of crypto lending for investors

While the returns on crypto lending products are enticing, bear in mind crypto lending isn’t free of risk. In return for the high yields lending products promise, you:

• Must be willing to tolerate a moderate to high level of risk. Crypto exchanges can be the target of hackers and scams, and insurance may not cover exchange failures. Crypto assets are not insured by the FDIC, which means you could lose your assets in a hack or if the lender becomes insolvent.
• Must forfeit the right to your assets. When you deposit funds to an exchange, you’re turning over ownership of your assets to the exchange and trusting it or its third-party partners to keep them safe for you.
• May not be able to get your funds back quickly. If you choose to lock up your crypto assets in exchange for higher yields, you can’t cash them out to take advantage of market swings. You must wait until your contract expires.
• Might see changes to your account subject to regulation. New federal and state government rules could cause crypto lending platforms to temporarily close accounts to new borrowers, as BlockFi did in February 2022, or hastily recall loans in “excluded countries,” as Crypto.com did a month later.

As with all crypto investments, carefully evaluate the platform you’re doing business with and determine if risk is worth the potential returns you can achieve. And talk with a trusted financial professional if you’re not sure.

5 ways to find a safe crypto lending platform

Research the platform or exchange you’re interested in to make your crypto lending a positive experience:

1. Does the company have proof of reserves? While not an ironclad guarantee of safety, a company offering professionally audited proof of reserves of customer deposits signals it could theoretically pay back all depositors with the reserves it has on hand.
2. Does it have a good track record? Choose an exchange that employs industry best practices in data security and rehypothecation – meaning it invests customer assets with reputable institutions and doesn’t gamble with your funds.
3. What does insurance cover? Many exchanges advertise cyber insurance, but it can be useless in practice. If a company offers it, check how much coverage is available and for what type of events. Many times, it’s not nearly enough to cover all the customer deposits on hand.
4. What do previous customers say? Customer reviews are an excellent source of information. They can tip you off to serious problems with an exchange or a mobile app — before you transfer funds and discover you can’t as easily transfer them off the platform.
5. When can you withdraw your funds? Every exchange is different, so check its policies on when you can withdraw your funds, if needed. Some may not release deposits for up to 30 days, even after transfers have cleared your bank.

Not all companies are created equal. Perform your due diligence to ensure you understand how your assets are used after you transfer them to the platform and how easily and quickly you can transfer funds off the platform when you want to.

How to make money lending crypto

Crypto investors make money lending crypto by receiving returns based on the interest that borrowers pay. There are a couple ways to make sure you receive the highest returns possible.

Typically, the highest yields are only available to lenders who stake the platform’s native token while they’re lending out the funds. This can be a little risky because native tokens are often even more volatile than other types of crypto and you could easily lose the funds that you invested.

Another way to earn higher returns is to fund loans in stablecoin. Many lenders fund loans with stablecoins, which are in high demand, and therefore offer higher yields for deposits in that currency, compared to other types of crypto. Because the value of stablecoin is typically tied to the US dollar, it’s less volatile than most cryptocurrencies.

But practicing your due diligence when choosing a provider is key to making money by lending crypto. Take steps to ensure it’s a company that you trust to keep your crypto safe before signing up. Sometimes an offer that seems too good to be true is just that.

Best crypto staking and rewards platforms

For borrowers: Crypto loans

Crypto loans offer a way to tap into your crypto’s value without having to sell it, incurring capital gains tax and losing out on future appreciation value. With a crypto loan, you can pledge your crypto in exchange for a loan in fiat currency like US dollars or stablecoin.

To get a crypto loan, you need to pledge more crypto than the loan is worth. This is called the loan-to-value ratio — or LTV. For example, if a platform requires a 50% LTV on loans, you’ll need to pledge $2,000 worth of crypto in exchange for a $1,000 USD loan.

Crypto loans are turned around more quickly than traditional loans. After pledging your collateral, some lenders fund in minutes, but more often, within 24 to 48 hours.

Stay on top of your collateral’s value when you have a loan. If the price of your crypto drops, you could lose it unless you can add more collateral within short notice.

Guide to crypto loans

Why take out a crypto loan?

Among common reasons to take out a crypto-backed loan instead of a traditional loan is to invest in more crypto. Receive the loan in fiat currency or stablecoin to purchase another crypto asset — like Bitcoin — using the lending platform’s exchange.

Some people also invest their crypto loan funds into a crypto lending account that offers a higher APY than the interest rate they’re paying on the loan. But this can be risky if deposits are locked into a fixed term. If you need to pay down the loan quickly due to changes in regulations or market fluctuations, you may not be able to access enough crypto assets to avoid default.

Many also use it like a personal loan to consolidate high-interest debt or fund a down payment on real estate. In these cases, a crypto loan can offer more savings than a personal loan if you have a credit score below 670 — what lenders consider to be good credit.

Unlike personal loan providers, crypto lenders don’t check your credit or personal finances. Instead, the rate is based on factors like your loan term, the type of collateral and the value of your collateral compared to the amount you borrow. In some cases, the interest rate may be lower than the capital gains tax you’d pay by selling your crypto to pay for these expenses.

Pros of crypto borrowing

• Fast funding. Get your funds in 24 to 48 hours in most cases, and sometimes minutes.
• No capital gains tax. Unlike selling crypto, taking out a crypto loan doesn’t incur a capital gains tax hit.
• No credit check. Because crypto lending is secured by collateral, crypto loans don’t consider your credit score, income or debt.
• Choose from many types. Crypto loans range from $100 to $1 million or more, with terms of 30 days to 12 months and either monthly or lump sum repayment options.
• Investment opportunities. While speculative and risky, crypto loans can be used to buy more crypto. For example, some investors are willing to borrow at 10% to buy more crypto if they believe returns will significantly exceed 10% in the future.

Regardless of the purpose for borrowing, the main benefit of crypto loans is the ability to tap into its value now without having to sell it, incur capital gains tax and forfeit any future appreciation in value.

Cons of crypto borrowing

• Volatility and margin calls. If the price of your crypto drops too low and your LTV rises too high, you need to add more crypto to your collateral account or you’re at risk of losing your crypto.
• No FDIC insurance. Unlike a traditional secured loan, crypto collateral isn’t insured against exchange failure. If the platform is hacked, or it or its partners goes out of business, you may lose your assets.
• No access to your assets. Once you pledge your crypto as collateral, you can’t trade, cash out or earn interest on it. But you may be able to pay off the loan early and get your collateral back, if necessary.
• Not available in all states. New York and a handful of other states have regulations that restrict who can trade and lend cryptocurrency. Make sure the platform you choose is legal in your state before signing up.
• Changing regulations. Changes in regulations may result in crypto loan providers requiring full repayment with little notice if authorities consider the crypto loan product illegal.
• Loans may not be in USD. Not all crypto lending platforms fund loans in fiat currency like US dollars. You may need to convert your crypto from one coin to another multiple times, waiting and paying fees in the process.

Risks of crypto loans for borrowers

Taking out a crypto loan is not as safe as taking out a traditional secured loan. The main risk is that most lenders require you to transfer ownership of your crypto collateral to its custodian.

Unless the company offers a multisignature wallet — often called a multisig wallet — that lets you keep ownership of at least one of your private keys, you’re fully trusting the exchange or its custodian to keep your assets safe for you. Should the company go under, you may not get your assets back.

Evaluate each lender on its own merits and safety, as some are riskier than others. To help make sure your crypto loan is a positive experience, research the platform or exchange you’re interested in:

1. Does the lender offer multisig wallets? A multisig wallet lets you control one of your keys, which means you retain sovereignty of your assets during the loan term. Unchained Capital is a lender that offers multisig wallets.
2. Does the company offer proof of reserves? While not an ironclad guarantee of safety, a company offering audited proof of reserves of customer deposits offers peace of mind that you’ll get your money back if an unpredictable, potentially severe event occurs.
3. How is your crypto stored? Is your crypto collateral held in cold, offline storage, or is the company loaning it out? Loaning out crypto is called rehypothecation and increases risk.
4. Does it have a good track record? Choose a lender that offers strong security protocols, industry best practices and positive customer reviews. Don’t be lured by low interest rates and slick marketing copy with few details on how the company operates.
5. Is insurance cover, if any, adequate? If the company advertises insurance for assets, check how much coverage is available for customer deposits and for what type of events. It may not be enough.

Crypto loan alternatives

Crypto loans may be a good option if you want to access cash or stablecoin without having to sell your cryptocurrency. If you don’t already own collateral — or don’t own enough to get a low rate — you may be able to secure financing through more traditional methods:

• 0% APR credit cards. Top cards allow you to transfer debt or make new purchases without accruing interest, usually for 12 to 18 months.
• Unsecured personal loans. Choose from a range of lenders, including direct online lenders, banks, credit unions and peer-to-peer (P2P) platforms.
• Home equity line of credit. Leverage a HELOC to tap into your home’s equity like a revolving credit line to use as you need and pay off later.
• Personal loans. Borrow or consolidate debt with online lenders offering loans up to $50,000 or more.

Bottom line

If you own cryptocurrency, crypto lending and borrowing products offer a novel way to leverage your crypto assets for a range of needs – whether it’s to earn cash or borrow cash for unexpected needs. But due to crypto’s high risk and volatility, consider other options if you don’t have the money to lose.

Learn more about crypto loans, credit cards, trading accounts and other products designed to help you to get the most out of your crypto assets in our guide to crypto banking.