What is cryptolanding and how do I earn interest?
Bogdan LashchenkoDeFi and cryptolending
The world of cryptocurrencies never stops evolving and every year there are some interesting features in the digital asset industry. Since cryptocurrencies were invented as an alternative payment system, it is not surprising that the world of digital assets is also becoming equipped with the same tools that are found in the world of conventional finance. For example, in 2020, a whole offshoot called decentralised finance (DeFi) emerged.
The father of the DeFi industry, André Cronje, surely wanted digital assets to evolve into something more in the future, and to be able to provide people with credit opportunities. Cronje's actions changed the world of cryptocurrencies forever. This is exactly the kind of phenomenon we are going to talk about today.
Many people have heard what cryptolending is, but not everyone understands the specifics of this trend in the world of digital assets and do not always have the right idea about it. Cryptolending is, in other words, the field of cryptocurrencies, which is an analogue of lending. In the economic system of digital assets, cryptolending creates full-fledged markets with two important categories of users: lenders and borrowers.
Through such decentralised finance protocols, users who own some digital assets can borrow other cryptocurrencies against their existing capital. For example, a user has BUSD Stablecoin and wants to borrow a more volatile digital asset, such as BNB. He would then temporarily exchange his assets for Binance Coin, after which he would pay interest to the lender. The BNB could end up rising and the deal would thus be ideal for the lender and the borrower. The lender will receive the interest and the borrower will then be able to earn money from having borrowed the increased asset.
What is the interest of cryptocurrency lending?
What is noteworthy about these platforms is that there is often no fixed percentage rate charged to lenders from borrowers. It all depends on the market situation and how the lenders feel. Special loan pools are set up to implement such deals, where acts of lending are carried out.
Apart from this possibility, users can not only borrow, but also lend themselves, which is quite interesting. It is this possibility that has brought great popularity to DeFi-protocols in the past years. Thanks to this possibility, lenders represented by ordinary users can make a good profit by lending their money, and the process of making money is similar to coin-stacking, but has slightly different features.
How exactly do credit pools work?
Previously, we briefly talked about how credit pools work and what they are. Now it's time to talk about the more technical aspects. In the field of cryptocurrency lending, there is a specific pool where lenders and borrowers come together to make a mutually beneficial transaction. Lenders, as in the case of staking, give their tokens to the pool, in which borrowers can borrow coins at interest. For transactions to take place between users, there are smart contracts. They are also responsible for regulating interest rates, loan repayment periods, withdrawals and so on.
The cryptocurrency lending industry has gained quite significant momentum, and the daily volume of such transactions amounts to tens and hundreds of millions of dollars. It is worth noting that in 2022, this sector of digital assets suffered in the same way as the digital asset world as a whole, but cryptocurrency loans continue to function, although not with the same turnover as in 2021.
So, how do smart contracts sell acts of credit after all? On the lenders' side, it looks like that by adding their funds to the Liquidity Pool (LP), users receive LP tokens, which are the equivalent of their funds at a 1:1 ratio. These LP tokens then begin to increase in value as other people use their funds. When creditor users want to withdraw their money along with whatever they have accumulated over time, they need to go to the pool and execute a corresponding smart contract to exchange their LP-tokens for real tokens.
On the part of users who borrow in digital currencies, there is a provision of available coins in exchange for the token they want to borrow. Just as with lenders, the coins being lent are converted into LP tokens via smart contracts. While the lender can exchange his LP tokens at any time on a cryptocurrency exchange and get the coins back, the borrower will have to prove that he is able to pay back the funds he borrowed with interest before a reverse exchange can take place. Otherwise, liquidation will occur. The lending platform will intervene to repay the loan and take back the collateral from the borrower with interest.
How does the disposal ratio work?
We mentioned earlier that how much users disburse their funds during a loan depends on the state of the market. In order to protect lenders' funds, to charge a fair amount to borrowers and to properly balance borrowed and lent funds, the recycling ratio is used with a special formula. If it is greatly simplified, the formula is as follows:
utilisation ratio = borrowed capital/total capital.
The values have a floating value and the ratio varies depending on how much capital has been borrowed and how much total capital is observed on the lending cryptocurrency exchange. If the amount of capital borrowed exceeds the total capital available, then the utilisation ratio will have a value above one. In such a case, new borrowers will not be able to access the services of the DeFi platform. If the borrowed capital will have a lower ratio than the total capital, the ratio will then have a value below unity, indicating that it is possible to carry out acts of borrowing and lending.
It is noteworthy that this rule does not work if the borrowing capital is 0. If there is no borrowing on the lending platform, then it would not make sense for the platform to allow people to send in their funds for lending. In other words, if there is no demand for the service, there will be no supply either, because otherwise the lenders will not be able to make any profit and therefore there will be no point in giving their money to the general pool. In that case, the interest rate will be almost minimal, because the cryptocurrency platform benefits from having as many people as possible using its services.
At the same time, the opposite is also true. If a lot of people come to the platform to borrow digital assets and there are not many offers, then the creators of the platform will raise the interest rate to motivate users to give their funds to the pool. The higher the demand for the service, the higher the interest rate.
This is why the value of the utilisation rate is important, which for the most part determines the current status of any given crypto platform providing lending services. Despite the fact that lending rates are always floating and have no sustainability, it is still one of the good ways to make money in digital assets.
An additional reason is often the receipt of bonuses in the form of management tokens for using lending protocols. In addition to the fact that creditor users receive a percentage of the profits for using their tokens, these same users become members of a community that is able to make various management decisions in the creditor cryptocurrency platform.
However, before users want to borrow or lend their funds on DeFi-platforms, it is worth keeping in mind what exactly the dangers of the cryptocurrency world are and keeping in mind the ongoing collapses in 2022. Last year, several lending platforms suffered bankruptcies.
How stable is the earning power of credit?
Consequently, several questions arise regarding the stability of this type of earning. All users who want to make money on such cryptocurrency lending platforms can do so, but firstly, there will be a demand and secondly, the percentage of money earned will be highly dependent on the current market situation and the formula we discussed earlier.
Notably, the LP-tokens you get from one platform can be universal and can be exchanged on other similar DeFi-platforms. So if you have received such tokens and for some reason are generating a rather low income on the cryptocurrency lending platform you are using, you can go to some decentralised exchange and put your assets under stacking there so that they can continue to generate income if you wish.
This can be implemented because credit platforms occupy most of the decentralised finance niche and other venues can accept the same LP-tokens. If the user would regularly capture profits and create new liquidity tokens and then send them to the platform, this would then be called compounding. In other words, lenders will make a profit consisting of compounded interest. The very process that allows compounding to take place is called compounding.
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Although users can make profits with compounding interest, which many investors call the ultimate miracle, no one is immune to the volatile loss that lies in the specific nature of LP-tokens. It involves the delivery of two equal amounts of a particular cryptocurrency asset and the possibility of one of them falling in value. In the event that one of the two assets, or maybe even two assets at once, rise in value, then investors' profits will increase nicely accordingly.
How much can I earn from cryptocurrency lending?
There is no clear answer to this question either. It all depends on which cryptolending platform was chosen, what state the market is in right now, how often you are campaigning, how the currencies you hold will grow, and so on and so forth. On an average, you can assume that your earnings can start from 3% and go up to 10-15% per annum on average. Nevertheless, these are only conservative numbers. It may be that you will send LP-token, consisting of BTC and USDT, for example, and leave it for 2 years and will do monthly campaigning. In that case, when BTC will grow from $24,000 to $69,000, and you'll add your percentage to your existing amount once a month, you may even be able to triple your deposit in 24 months. It also works the other way around. If you send some SHIBA into cryptolanding, which may lose in value, not only will you not be able to earn, but you will also go into deficit. So in the world of digital it is quite difficult to name approximate earnings.
If you completely abstract away from the notion of volatility and pay attention only to coin stacking rates, then everything is in the region of 5%. For example, if you take one of the top platforms from the cryptolending sector, AAVE, there crypto-loan rates are between 0.01% and 4% per annum.
But that's as far as the Ethereum network is concerned. If we switch to the Avalanche blockchain for example, then we can see more pleasing numbers. The most pleasing of these would of course be Frax Stablecoin, for which a reward of 33.91% p.a. is promised. It's worth noting that this is a flexible figure, and therefore this percentage will fall as money comes in, but nevertheless, if you invest your money in it, the earnings will obviously be much higher than that for the other coins, even if this figure drops quite well.
All other digital assets also have rates that can change to one extent or another, but the rate of change in the rate will not be as active as in the case of Frax. The predictable range of rewards that will be given out to users for staking LP tokens will give more or less an idea of how much can be earned from this type of passive income.
On another cryptolending platform, the figures are even more modest. There they are in the region of 2%, which, to put it mildly, cannot be called good earnings.
Another platform we want to refer to to get a rough understanding of earnings is Solend from Solana. There as well as in the case of AAVE, there are enough different cryptocurrency tokens that you can send under the stacking and get financial earnings from them.
It varies quite a bit on Solend, ranging from the 0.13% p.a. mark to 100.25%. In order to earn a flexible 100.25% p.a., Solana offers to create LP tokens from SLND coins.
All blockchains will be available to some extent on various cryptolending platforms for LP-token staking, but the more popular the blockchain, the lower the reward for staking will be. Thus anything related to Ethereum will have a rather low reward. That is why LP tokens from the Ethereum sector will yield the lowest reward, and a coin from Solana could yield up to 100% p.a.
Risks in cryptolending
Before you begin your journey into cryptolending and start lending your digital assets, it's worth knowing first of all the risks that such an activity contains. Such lending protocols are a major part of the economic system of decentralised finance. It is the cryptolending sector that accounts for a large proportion of the support of the entire DeFi ecosystem.
Because of this high importance of tokens from the cryptolending sector, there can be big problems with composability. If any digital assets suddenly start to succumb to problems, it's not just those cryptocurrencies that are at risk, but in some ways the entire DeFi-protocol system as well. Composability risk is a fairly well known problem in the world of decentralised finance, and so this factor will not be big news for people who are involved in cryptolending. Despite such high-profile claims about the close relationship between DeFi platforms and digital assets, so far there have been no such events that have led to the collapse of the entire field of decentralised finance.
In addition to all of the above risks, there is also the trivial risk of profitability. As we said before, every asset that will be chosen by this or that investor can lose its value in the course of the loan, which not only will not bring people any profit, but will leave them with a loss. Of course all APY counts for tokens and it is up to investors to decide how much to sell them at, if they don't take a loss then they can sell at a higher price and make additional profit if the asset starts to go up.
Let's talk about the peculiarities of APY yields, which directly affects the profitability of investors who stack LP-tokens. Because the APY is calculated using the formula utilisation ratio = borrowed capital/total capital, this value cannot be constant and is constantly subject to change. If the market goes into a deep dump, the capital borrowed along with it will be lower in volume and as a result, the cryptolanding platform may leave investors with no earning capacity at all. In that case, they will have no choice but to wait for the situation to improve or exchange their LP-tokens for conventional digital assets.
If the situation picks up exactly the opposite and the cryptocurrency market starts to grow, a lot of users will be willing to take out a crypto-loan. Thus the APY will start to rise and the interest rate will also rise accordingly. As we could see earlier in the case of Solend, one of the assets there had an APY of over 100% p.a. All this is due to the high demand for cryptocurrency services and a specific cryptocurrency.
Nevertheless, as good as 100% p.a. sounds, there is a big risk in that. If 100% of the assets have been borrowed, you then the lenders will not be able to get back their capital that they left as collateral. To prevent this from happening, along with the rise in popularity, cryptolending platforms should raise the interest rate so that people who have borrowed can pay back more money, so that such platforms do not lose their liquidity. All of the above changes and processes are carried out by smart contracts.
Another type of risk, which among all the risks can be called the most unpleasant, is liquidation. It occurs when the value of the borrowers' collateral decreases in relation to when they posted their digital asset as collateral.
Here's an example. If you took a loan and posted 5 BNB as collateral, and at that moment the market began to fall and your collateral also lost 10% of its value, then it would be considered that you have not posted 5 BNB but 4.5 BNB as collateral. But logically, the smaller your collateral, the smaller should be the amount borrowed, but in the case of cryptolending, this is not how it works. In such loans, according to lending and borrowing protocols, there are excessive collaterals. In simple words, if the collateral amount is higher than the loan amount, then a liquidation initiation act will occur. If the collateral amount is severely reduced, the liquidator will get the right to redeem the borrower's funds at a reduced price. Thus the borrower's money will be withdrawn and the loan will be liquidated. Such cases can happen on DeFi-platforms, but they are quite rare because such cases discourage lenders and borrowers from continuing to use the services of cryptolending platforms.
Is it worth making money in the field of cryptolending?
This is a question that everyone has to find the answer for themselves. If you are in search of passive income, you are willing to take risks and you don't want to engage in conventional investing, then this sector of activity might suit you. It is worth keeping in mind that in the case of cryptolanding, you can expect a lot of risks, and earning here is only available if you are willing to accept the risks.
If you don't like the idea that you might hypothetically face liquidation, or that the APY is floating and you can earn no more than 5% annually in most cases, then you should refrain from this kind of activity.
Still, the decentralised finance sector and cryptocurrency exchanges are one of the best ways to make passive money in the world of digital assets, when you consider what goes beyond cryptocurrency exchanges.
If this interests you, then it's worth understanding what platforms exist for this type of earning. In the following piece, we will talk in more detail about such cryptolending platforms where you can earn money.
Bogdan Lashchenko – content manager at EgamersWorld.Bogdan has been working at EGamersWorld since 2023. Joining the company, he began fillin the site with information, news and events.
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