Crypto lending is part of crypto fixed income. It’s a fast-growing business. There is a lot of supply from the lenders – it allows them to earn interest in cryptocurrency. And there is a growing demand from borrowers who can use the funds for trading, tax optimization, or crypto payments.
We have published on our blog several articles about fixed income and crypto fixed income. We have analyzed specific behaviors and details of several platforms. However, in this article, we will connect the dots – this article will give an overview of the crypto lending platforms.
The following topics will be analyzed:
- Top crypto lending platforms
- Classification of crypto lending platforms
- Benefits for the users – what would be the best crypto lending platform
What is the crypto lending market?
We will look at the following on the market dynamics.
Crypto lending market segmentation
There are 3 main channels for crypto lending:
- Crypto Borrowing / Lending via the Crypto Exchanges for margin trading
- Custodial Lending Platforms (Nexo, Celsius, Genesis Capital) – they control your private keys (i.e. they control your assets)
- Non-Custodial Lending Platforms (Maker, Compound, Ethlend, SmartCredit.io) – the do no control your private keys (i.e. they do not control your assets)
Crypto exchanges are the biggest player in this market. They are offering the margin lending – that’s for the traders, which can leverage their positions via the margin lending. For example, the trader puts down 1 Bitcoin as collateral, he borrows 3 Bitcoins against this collateral and he has to pay daily interest for these 3 Bitcoins. This will take a long position with these 3 Bitcoins. When the market goes up, then the trader will earn a profit. However, when the market goes against his trades, then the traders’ positions can be liquidated.
Our analysis does not include Crypto Exchanges. It’s because there is no data available, except Bitfinex, which publishes their lending statistics regularly. Although the crypto lending is the side business for the crypto exchanges – the interest rates will be set on the crypto exchanges. See more in the article Why is the DAI Interest rate at 10% in DeFi? Our focus below is on the Custodial Lending Platforms and Non-Custodial lending platforms. For details about their differences see the article “Risk Analysis of Crypto Lending Platforms“.
Key use cases for crypto lending
- Using loans for trading – ca 80% of the market will feed into the crypto exchanges. Traders use their collateral to get the loans, because either the crypto exchanges do not support these collaterals or traders get better terms via crypto lending
- Liquidity creation – instead of selling crypto, which in most countries would be a taxable event, the users would rather monetize their crypto-assets via using them as collateral for the loans. This is approximately 15% of the market
- Crypto economy – borrowing crypto for using it in the crypto- sphere – 5% of the market
We estimate the market size of custodial and non-custodial lending platforms as 10-15 Billion USD.
- Graychain estimated in Q2 2019 the crypto lending market size as 4.7 Billion USD (Source: https://reports.graychain.net/TheCryptoCreditReport-q2-2019.pdf)
- Celsius has originated loans for 4.25 Billion USD in 2019 (Source: https://www.prnewswire.com/news-releases/celsius-hits-4-25-billion-in-originated-crypto-loans-setting-the-bar-for-crypto-lending-industry-300956493.html)
- Genesis Capital did loans of 3.1 Billion USD in 2019 (Source: https://genesiscap.co/insights/q4-insights-2019/)
For custodial lending platforms we need to refer to the self-reported numbers; for the non-custodial platforms, the data is available via the Blockchain.
Our analysis shows a 25%-35% quarter to quarter growth of the market. This is understandable because during the hype period investors were not looking at the interest income (they made their 10x anyhow). However, as the market turned and as more of traditional investors enter the crypto markets, then there is a shift to the fixed income.
Custodial lending platforms
- Genesis Capital had Quarter to Quarter Growth 34% from Q3 to Q4 2019 (Source: https://genesiscap.co/insights/q4-insights-2019/)
- Genesis Capital loan book growth 38% from Q2 to Q3 2019 (Source: https://genesiscap.co/insights/view-q3-insights-2019/)
Non-custodial lending platforms
Data is available for the DeFi platforms (part of the non-custodial lending platforms). The growth was 140% per year, which is 25% quarter to quarter.
This is based on the DefiRate report for 2019 (Source: https://defirate.com/market-report-2019/)
Classification of crypto lending platforms
Here are the key parameters for the classification of the crypto lending platforms:
Here is the explanation of these parameters:
Custodial Crypto Lending – in this case, the user has to give the control of his assets to the platform. Users can transfer their assets away from the platform, but while on the platform the user’s assets are not under the user’s control. When the platform will be hacked or when it’s making bad investments, then the user has to take a “haircut” or will lose all his assets.
Custodial crypto lending platforms have the “honey pot risk” – when the asset concentration on the platform is growing, then the motivation of the platform hackers is growing as well. The biggest custodial lending platforms are insuring their platforms against the loss of the client assets. However, one needs to keep in mind that these insurance contracts are capped at a fixed level.
Custodial platforms do not always communicate to whom they are lending their funds. They refer often to the peer to peer lending. That’s not always the case – the custodial platforms are often pooling together client assets and lending them via the OTC (Over The Counter contracts) to the trading desks, crypto exchanges for margin trading or hedge funds. This contains two risks – one doesn’t know the terms of these OTC contracts and one will have the counterparty risk. See more in the “Risk analysis of Crypto Lending Platforms“.
Non-Custodial Crypto Lending – this is the opposite of the custodial crypto lending. The users and only the users are controlling their assets. There is no “honey pot risk” and there is no risk of non-transparent OTC contracts. However, there is a risk of smart contracts hacking, but as the experience in the sector is continuously increasing, then this risk is decreasing.
Fiat loans – lending platform would give fiat loans based on the crypto collateral. This is possible only with custodial lending. In this case, the platform would use crypto as collateral to the loans and would lend out the fiat money
Instant fiat loans – this is a sub-category of the fiat loans – borrowers can immediately receive the fiat loans (therefore they are called “instant fiat loans”). Users crypto is used as collateral against the loans.
Variable interest rate daily loans – these are short term loans with variable interest rates, which are set every day. Variable interest rate bears the risk for the borrower – the interest rights might spike. Or they bear the risk to the lenders – the interest rate might fall. The alternative is to use fixed-term loans, where the interest rate will be fixed for the loan term.
Large choice of collateral – in DeFi – Decentral Finance – platforms are usually 5-8 different types of collateral. But what’s then when the users have other tokens in their wallets? Then they have to find the platforms with a larger collateral choice.
Low collateral ratio – crypto lending is collateralized lending. If the borrower has low collateral ration, then the borrower can borrow more on his given asset basis. See more in “Why borrowers need low collateral ratio?“. A low collateral ratio makes the crypto loans more attractive for the borrowers. As the market is driven by the borrowers, then this is the key feature for the borrowers. See more in the “Why is the collateral ratio so high in DeFi?“
API – Crypto lending API allows integration in other platforms. However, only non-custodial lending platforms can offer an API. Otherwise, in the case of custodial platforms, the integrating platforms have to transfer their funds to the custodial platforms, which defeats the purpose of the API. Therefore crypto-lending APIs can be only non-custodial.
Loan Transferability – Usually the loans are not transferable. This means, when the lender lends out his money, then the lender’s funds are locked until the loan term is finished. However, what’s if the lender will need liquidity before the loan term will finish? In this case, the lender can use either variable rate daily loans. These loans can be canceled at any time, however, the interest rate on the variable rate loans is less than fixed-term loans. The alternative would be a bond-like structure of the loans, which would make the fixed term loans transferable.
Crypto Credit Score – this refers to the capability to separate good borrowers fro the less good borrowers. A good borrower can receive a better interest rate and have a lower collateral ratio for his crypto loans.
Fixed Income Fund – this refers to the automated investment engine, where the users will define their investment rules. The platform will execute based on these rules.
Crypto lending platforms will develop into a crypto fixed income market. More details about what is required for this are in the article “Compound. finance review and Crypto Fixed Income“.
Risks in the platforms
Crypto exchanges based lending is facing general hacking risks (MtGox, Bitfinex, …). They are responding by using the hot wallet / cold wallet strategies. 90%-95% of the crypto assets will be kept in cold wallets, where access is possible only with operational procedures. In the hot wallets, multi-signature technologies will be used. Additionally, they do have operational risks, mainly the “employee risks”, where the employees might use the private keys or other data for their advantage.
Custodial lending platforms are with their risks similar to the crypto exchanges – they face hacking risks and operational risks. The hacking risks will be mitigated with the multi-signature wallets (BitGo has established himself as a standard in this sector). The risks are smaller in the case of fiat lending – the crypto assets would not leave the platform in this case. In the case of crypto-to-crypto lending, the risks are higher, because the coins are just moving more around.
Custodial lending platforms do not face operational risk because the assets will be kept in the smart contracts, where the entry and exit criteria are described via the source code. There is the hacking risk for these smart contracts, but, as there is a multitude of security scanning systems available, and the experience of the developers is growing, then the respective risk is continuously reducing.
What would be the best crypto lending platform?
The short answer to this question is – there is no best crypto lending platform. It depends on what you are looking for. One needs to look at the client’s needs and to create the best offering for them.
Here the key recommendations:
- If borrowers need instant fiat loans, then they should go with Nexo (custodial platform)
- In case of variable rate daily loans, one could use Celsius (custodial platform) or Compound.finance (non-custodial platform)
- If other platforms need integration needs via API – SmartCredit.io offers non-custodial “Credit As A Service API“. If one wants to use custodial lending platform API’s, then he would need to transfer funds first to this custodial platform, which defeats the purpose of integrating platforms
- In case a borrower needs a low collateral ratio, then the choice is very limited. However, SmartCredit.io is the only one with a low collateral ratio
- If a borrower needs a wide choice of collateral, then one could use custodial platforms (Nexo or Celsius). In the case of non-custodial platforms, SmartCredit.io offers a wide choice of collateral
- If lenders need transferability, then one could use Compound.finance for variable rate loans or SmartCredit.io for fixed-term loans
- If one needs a passive income, then one could use Compound.finance for variable rate loans or SmartCredit.io for fixed-term loans via the “Private Fixed Income Funds“
Our analysis shows, that the traditional financial system is nearing to the end. See more in the “Coronavirus crash versus 2008 financial crisis – Where is the difference?” or “Bitcoin and upcoming recession” or “Coronavirus crisis – where to invest now?“.
Crypto lending is the key capability of the alternate blockchain-based financial system. See more about this in “Coronavirus and Blockchain-based financial system – Are we ready?“. The more the traditional financial system will de-stabilize, the more important the alternate blockchain-based financial system becomes. This results in the importance of the emerging crypto lending business.
To answer the question from the beginning – there is no “best crypto lending platform“, but recommendations are depending on your needs. However, as this very fast-growing business, then there is more than enough place for multiple crypto lending platforms.
For more information check out the related articles from the SmartCredit.io blog: