Among the decentralized financial services that have appeared in recent months, credit secured by crypto is starting to appeal.
To better understand the mechanisms behind crypto loans, the players who position themselves and the regulatory issues, the JDN answers the ten big questions that arise.
What is a crypto loan?
A crypto loan, in English crypto-backed loans, works like a traditional loan. Except that you have to pledge crypto-currencies. It is therefore essential to have guarantees to borrow. In some cases, borrowers must provide more collateral than the value of their loan to protect lenders from risk against losing money. To take out a loan, simply go to a dedicated platform, request the desired amount (in fiat currency, crypto or stablecoin ) and indicate the cryptocurrencyto be sent as warranty. On the most decentralized platforms, there is no need to enter your identity to set up a loan file. A smart contract (stand-alone program that runs automatically following predefined conditions) is designed to escrow the crypto and obtain the loan instantly. If the borrower does not repay the loan , the smart contract is liquidated and the money returns to the lender. Interest rates are generally set either by algorithms or by the platform.
What are the different types of crypto lending platforms?
Not all lending platforms are alike. Some are more decentralized than others. Kyle Kistner, founder of the bzX lending protocol, has identified seven types of platforms , which correspond to seven bricks (the protocol, the custody of crypto-currencies, the definition of the interest rate, the development of the platform, etc.).
What are the advantages of crypto loans?
Since there is no credit score and file review, every crypto holder can take out a loan. The transaction is transparent because the necessary information is entered into a smart contract, which is audited in order to reduce the risk of flaws and bugs (even if zero risk does not exist). The borrower has control of the funds lent to him because he has his private key (a sequence of numbers and letters that can be compared to the signature of a check). Obviously, the criteria for granting a loan are less drastic than those of traditional players, since only a crypto guarantee is requested. A specificity that is not necessarily a quality:
Who are crypto loans for?
Technically, crypto loans are for anyone who can access the internet. They are advantageous for those whose files are refused in the traditional circuit. It is also a good alternative for those who have difficulty accessing traditional financial services. Provided you are able to over-guarantee your loan. But these natural targets are not the current users. “One of the problems with open finance (decentralized finance, editor’s note ) is indeed that this system, which is supposed to target in particular populations with difficult access to the traditional financial system, is mainly used today by individuals who already have access to this one”, tempers the firm Blockchain Partner in his study “Understanding Open Finance: definitions, uses, challenges, perspectives” .
It is a good alternative for those who have difficulty accessing traditional financial services
For now, retail investors active in the crypto sphere are using these loans for leverage. “Decentralized finance is used by people who are not bothered by the current user experience and who know how to make profit with these instruments”, summarizes Albert Dessaint, analyst at Blockchain Partner.
Are crypto loans only for speculation?
According to Max Bronstein, marketing manager at the Dharma protocol , crypto lending volumes are mainly driven by speculative trading activity and the need for short-term cash. In its quarterly report , Genesis Capital indicated that the majority of its crypto hedge fund clients are doing crypto lending to position themselves in assets and profit from their evolution. Brokers also use it to arbitrate on price differences between the current bitcoin price and the bitcoin futures market (commit to a future price to buy or sell). Genesis Capital also notes that some companies use it for short-term liquidity.
What are the crypto lending projects?
There are about twenty crypto loan projects that fall into two categories: protocols, more or less decentralized and on which it is possible to build products, and centralized platforms. The three most used protocols today are Maker Dao, Compound and InstaDApp, as shown in the table below. They are all based on the Ethereum blockchain.
|Protocol name||Amounts retained (in dollars)||Number of ethers kept (in millions)||Cryptocurrencies as collateral accepted|
|Compound||113.2 million||1.05||ETH, DAI, REP, ZRX, BAT|
|InstaDApp||32 million||0.3||DAI, ETH, MKR, REP, USDC, ZRX|
|dYdX||21.3 million||0.2||ETH, DAI|
|From Network||12.6 million||0.12||BAT; DAI, ETH, MKR, USDC, ZRX|
|Dharma||9.2 million||0.09||Ether; DAI; USDC|
Source: Defipulse.com (data from September 12, 2019)
Maker Dao is far ahead of the others. At the beginning of July 2019, nearly 1.6 million ethers were kept by the system, which represented more than 1.5% of the total ethers in circulation. Maker Dao is both a stablecoin system ( cryptocurrency whose price is stable) and a decentralized lending protocol. Compound allows both to earn interest by placing cryptocurrencies on its protocol and to borrow crypto (with a supply balance equal to 1.5 times the borrowing balance as collateral). The interest rate is set by an algorithm , which fluctuates in real time depending on supply and demand. Dharma allows to generate, issue and manage debt in the form of a tokenon Ethereum. Beyond that, there are many other protocols: Colendi, Lendroid, Marble, Ripio Credit Network… .
If I don’t trust a protocol, what are the centralized crypto lending platforms?
Here is a non-exhaustive list of decentralized crypto lending platforms.
|Platform name||Creation||Interest rate||Warranties|
|BlockFi||Aug-17||From 4.5%||bitcoin, ether, litecoin|
|Celsius||Jul-18||From 4.95%||bitcoin, ether, bitcoin cash, dash, litecoin, XRP et DAI|
|EthLend||nov-17||Depending on the market||More than 150 coins|
|nexus||2017||From 8%||20 crypto|
|Salt||2016||From 5.99%||bitcoin, ether, litcoin, dash|
In addition, the world’s largest exchange, Binance, signed a partnership with a lending platform in July 2018 that allows holders of its token (BNB) to use it as collateral on the platform.
What are the disadvantages of crypto loans?
Most of the existing platforms, especially the less decentralized ones, don’t have a good user experience. They suffer from a lack of liquidity like decentralized exchanges . “A new financial system is an exciting idea, but is useless without liquidity. To encourage liquidity, it must be fair, easy, economical and fast to trade in every market. Today, financial markets based on blockchains don’t meet most of these criteria,” notes Pantera Capital’s Joey Krug.. Another disadvantage: the difficulty for institutional investors to obtain insurance. For Max Bronstein, “one of the biggest obstacles today is the lack of insurance products, especially the inability to insure against the risks associated with smart contracts. Institutional investors are not comfortable with the idea of putting money in escrow if there are no indemnities linked to technical faults.”