Crypto lending explained (and how to invest in it)

Cryptocurrency investing has exploded (again), and with it, another phenomenon: crypto lending.

This form of peer-to-peer lending for digital currencies is a new way for borrowers to take out loans without credit checks or banks, and to optimize their investments and minimize taxes; and for investors to passively earn money.

Here’s everything you need to know about borrowing and lending cryptocurrency loans.

Cryptocurrency lending is a way for crypto investors to borrow against their crypto assets, like Bitcoin or Ethereum, from other investors who can earn money on interest from the loans.

Crypto lending is a form of what’s called “collateralized” lending — a loan with some asset to back it up in case the borrower doesn’t repay for any reason.

Traditionally, collateral is something like your home, in the case of a mortgage, home equity loan, or business loan requiring collateral; or your car, in the case of an auto loan or title loan. If you stop making payments on the loan, the bank or lender can take your collateral and sell it to recoup its losses.

In the case of crypto lending, the borrower uses cryptocurrency assets in a crypto investing account as their collateral, and they borrow money specifically to invest in more crypto.

Crypto loans are a form of peer-to-peer lending, where borrowers request loans, and investors buy portions of loans with the promise of earning back their money plus interest in the near future.

Crypto loan contracts are managed on the same blockchain technologies as cryptocurrencies themselves, so they’re decentralized, i.e. not managed by a particular entity, like a bank or government.

Most run on the Ethereum blockchain, which hosts Ether, the second-most popular coin after Bitcoin; as well as the newly en vogue NFT.

Lending in cryptocurrency

Investors usually purchase loan portions with cryptocurrency or stablecoins, not regular money, a.k.a. “fiat” currency. On a cryptocurrency platform, crypto loans are generally just one more investment option — you don’t have to become a banker to be a crypto lender.

Stablecoins are unique cryptocurrencies designed to match the value of a fiat currency; for example, Tether (USDT) and USD Coin (USDC) track the value of the U.S. dollar (USD). Lending in stablecoins helps eliminate some of the volatility inherent in cryptocurrencies, keeping your investment more secure.

Crypto loans are typically extremely short-term, as short as seven days and no longer than about six months.

Borrowing for investing

Many borrowers request crypto loans specifically for the purpose of crypto investing.

So, they’re not using them like personal loans or business loans — they’re borrowing assets to buy more assets with the hope that what they buy will grow in value to a greater degree than what they’ll pay in interest.

Borrowing to reduce taxes

Another reason U.S.-based borrowers might borrow a crypto loan is to effectively cash out their investment accounts without paying capital gains taxes on the cash.

In this case, borrowers take a loan in fiat currency (U.S. dollars), which gives you cash flow even while your crypto assets are locked up as collateral. You don’t have to pay taxes on the loan amount, because it’s a loan, not income.

If you simply cashed out and withdrew funds from your investment account, you’d have to pay taxes on any gains your account has made. Instead, borrowers who use loan funds for business or investing can actually deduct the loan interest amount on their taxes.

Overcollateralization

Because cryptocurrency values are so volatile, even collateral on crypto loans could be risky.

When you borrow a mortgage with your home as collateral, the bank safely expects your home to maintain its value or, more likely, rise slowly in value over the years. 

Crypto, by contrast, changes in value fast. And often unexpectedly. If someone borrows the value of two bitcoins (BTC) and they put up two BTC from their portfolio as collateral, the collateral could lose tens of thousands of dollars of value in the time it takes to repay the loan, making it less valuable than your loan balance.

To address that risk, crypto loans are overcollateralized, meaning borrowers usually put up more in collateral than the value of their loan. To borrow the value of two BTC, for example, you might have to let a platform hold four BTC from your portfolio until you repay the loan.

Can you lose money lending crypto? It’s definitely possible.

Crypto lending is an investment option, and as an investment, it comes with risk, just like any other. Platforms are aware of the risk, though, and they build in protections to reduce it, including:

• Overcollateralization. Depending on the historical volatility of the currency a borrower puts up as collateral, they may have to put up more than the value they borrow.
• Margin call. If the value of collateral drops significantly, some platforms require borrowers to add more collateral to their accounts, or they’ll automatically sell some collateral, to maintain a required proportion to their loan balance.

How are crypto loans taxed in the United States?

For U.S.-based borrowers, crypto loans aren’t taxed as long as you pay them back. Whether you receive fiat or cryptocurrency, you receive the money as a loan, not as income, so you don’t have to report capital gains and pay income tax on the cash you receive.

If, as a borrower, you don’t repay the loan and the lender sells off the cryptocurrency assets you put up as collateral, you’d have to claim the balance of the loan as capital gains and pay income tax on the amount. Borrowers are also subject to taxes if the platform liquidates any collateral in the case of a margin call.

For investors, the interest you earn from investing in crypto loans is taxed as ordinary income.

Pros & cons for borrowers

Pros:

• No credit check to receive funds.
• Increase crypto holdings without selling your assets.
• Improve cash flow without liquidating and paying taxes.

Cons:

• Risk of margin call with currencies.
• Pay high interest rates on loans.

Pros & cons for investors

Pros:

• Earn interest as loans are repaid.
• Interest is usually higher than with typical peer-to-peer lending.
• Diversify your crypto investment portfolio.

Cons:

• Risk losing money if borrowers default on loans.
• Some platforms are vulnerable to bugs and hacks.

You can take out a crypto loan with any cryptocurrency platform that offers the service. Here are some of the best platforms for crypto lending:

BlockFi

BlockFi is a cryptocurrency platform that acts like a “crypto bank.” It offers a cash back rewards debit card, an interest-bearing savings account, and cash loans — all in crypto.

BlockFi lets you borrow crypto loans in USD, USDC, or Gemini Dollar (GUSD); and put up collateral in Bitcoin, Ether, or Litecoin. You can take the cash to use as a personal loan to pay down debt, make a major purchase, or make a down payment; or reinvest it to grow your portfolio.

BlockFi charges a 2% origination fee to borrow, and interest rates range from 4.5% to 9.75%.

BlockFi Interest Account (BIA) Disclosure – BlockFI Interest Account (BIA) are no longer offered to new clients who are U.S. Persons or persons located in the United States. Existing clients that are U.S. persons or located in the United States will be unable to transfer new assets to their BIAs. “ The BIAs have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States, to U.S. persons, for the account or benefit of a U.S. person or in any jurisdiction in which such offer would be prohibited.

BlockFi Bankruptcy Notice -On November 10, 2022, BlockFi announced that it had to suspend withdrawals from its platform due to the FTX liquidity crisis. As a result, consumers should not be using the BlockFi platform. As of November 28, 2022, BlockFi officially declared bankruptcy.

Binance

Binance is one of the largest worldwide cryptocurrency platforms, with a U.S.-specific platform called Binance.US.

Binance lets you borrow money in dozens of digital currencies, including both stablecoins and other cryptocurrencies. For collateral, you can choose among 15 coins, which include mostly stablecoins but also a few popular cryptocurrencies, including Bitcoin and Ether.

Interest is calculated on the hour, and rates are adjusted at the same interval, depending on the currency you borrow.

Crypto.com

Crypto.com is a platform for crypto trading and banking that offers a cash back Visa debit card, an interest-bearing savings account, mobile payments, and NFTs; as well as its own currency, Crypto.com Coin (CRO).

Through Crypto Credit, the platform lets some users borrow money in stablecoin: TrustToken (TUSD), Paxos (PAX), USDC, or USDT. Users can repay the loan on any schedule within 12 months — no monthly deadlines or minimum payments.

Loans through Crypto.com aren’t yet available to citizens or residents of France, Germany, Hong Kong SAR, Malta, Singapore, Switzerland, the United Kingdom, or the United States.

CoinLoan

CoinLoan is a crypto lending platform for borrowing and swapping cryptocurrency assets. It’s not a typical exchange, so you can’t buy and sell through the platform like you can on most. Instead, it lets you grow your crypto assets through lending.

To invest in loans through the platform, simply deposit funds in any currency into your CoinLoan account, which works like a high-yield savings account. Accounts pay interest in APYs set by currency, including fiat, cryptocurrency, and stablecoins.

For example, USDT assets in your account earn 12.3% APY, while Bitcoin earns 7.2%. CoinLoan supports 18 currencies.

YouHodler

YouHodler — named for the crypto community idiom “HODL,” an encouragement to hold onto crypto assets instead of selling impulsively — is a cryptocurrency exchange, lender, and banking platform.

Users can borrow from the platform using any of the market’s current top 20 coins as collateral, putting up collateral at a value of 110% of the loan. Loans come in euro, U.S. dollar, Swiss franc, and pound sterling, and you can cash out to a credit card or bank account.

To earn from the lending platform, investors simply need to put assets into a YouHodler wallet to earn up to 12.7% APY on stablecoins and up to 8% on other crypto assets.

Celsius

Celsius is a crypto banking platform that boasts competitively high APY on accounts and competitively low APR on loans.

Celsius lets you borrow in seven currencies: USDC, GUSD, PAX, USDC, MCDAI, USDT, and USD. Interest rates are set based on the loan-to-value ratio (LTV), the value of the loan compared to the value of the collateral:

• 25% LTV = 1% APR.
• 33% LTV = 6.95% APR.
• 50% LTV = 8.95% APR.

In other words, the more collateral you put up, the lower your interest rate. You can choose among loan terms of six months to three years.

Investors earn interest through Celsius by moving assets into a Celsius account, which bears up to 17% interest, depending on the currency.

To invest in crypto loans, you have to use a cryptocurrency platform that facilitates crypto lending (see above). Through the platform, you’ll follow these basic steps:

1. Deposit fiat currency into your account to fund investments.
2. Purchase cryptocurrencies on the exchange.
3. Buy loans through the lending platform with some of your investment assets.

Borrowers work through the platform to request and repay loans, and you earn interest into your account as loans you’ve invested in are repaid. The platform determines interest rates based on the value of currencies used in the loan.

Depending on the platform, you might instead make full loans directly to borrowers (though most platforms now facilitate lending, so you just put your money into a pool and purchase fractions of loans).

In that case, you set the interest rate and loan term. You receive bonds through the blockchain as a guarantee of repayment, and the lender repays you in the agreed-upon timeframe, plus additional bonds as interest. You cash out bonds in exchange for crypto.

Crypto lending is a tool for cryptocurrency traders to maximize their investments without selling assets, for borrowers to bypass banks and credit checks, and for investors to passively earn interest with a diversified portfolio.

These peer-to-peer loans come with much of the volatility and risk associated with crypto investing, but platforms that facilitate lending have built-in many features to mitigate risk for both borrowers and investors.