Crypto Lending Disruption

Market Insights Mar 19, 2021

Crypto lending has grown massively over the last few years. Lenders and borrowers connect to an online platform with crypto-assets as the currency of the loan.

Lending crypto-assets is an easy way to get a passive income while cutting the risk exposure without triggering a taxable event: some countries might tax at a higher rate short term sales. On the other side, borrowing digital assets not only contain the risk exposure on their assets but also allow to obtain funds to use without selling their other holdings. Crypto-asset lending tends to outperform the average saving account, mostly because blockchain is still an experimental and risky technology. According to Defirate.com, crypto lending yields are usually in the range of 2% to 20% APY (Annual Percentage Yield), with an average at around 8%.

Crypto lending can be considered as both centralised and decentralised platforms.

Centralised platforms run all operations and they may need to comply with regulatory processes (such as Know-Your-Customer and Anti-Money-Laundering checks). Once on-boarded, centralised lending clients are offered to maximise the yield of their crypto assets safely and easily, with favorable interest rates. Centralised exchanges like Binance or Okex offer some lending and borrowing features on top of trading activities. Some other platforms like Blockfi, Nexo or Celsius offer crypto loans as their core service.

Decentralised platforms, also called non-custodial protocols, consist of a series of smart contracts that automatically execute lending and borrowing programmes without the need to transfer funds to a third party. With decentralised yield farming programs, borrowing can also carry a 10%+ APY, as decentralised lending protocols provide incentives to borrowers and early users by giving away their own native token. Borrowing comes with added risks, such as asset liquidation, which happens frequently in volatile cryptocurrency markets.

Like any other Decentralised App (Dapp) the user would need to connect their DeFi Wallet, in a few clicks lenders/borrowers deposit their crypto-assets/ collateral. As of March 2021, there is around $20bn locked in lending protocols on the Ethereum blockchain only as per DeFi Pulse.

We will dig deeper into two successful examples of decentralised lending.

Aave is one of the biggest success stories of the past few months, the price of its native token has grown tenfold in 4 months (from $31 on 31 October 20 to $372 on 17 March 21, source CryptoCompare). Volumes have been multiplied by more than 100x. Lending smart-contracts which had $30m in Total Value Locked (TVL) in March 2020, now have $5bn+ in March 2021 (Source: Defipulse).

In short, Aave allows its customers to see their digital holdings grow in number from day to day. It runs on the Ethereum blockchain as a decentralised open source and non-custodial liquidity protocol.

In practice, lenders deposit their crypto-assets into a lending pool and receive a reward in ‘aTokens’ and the corresponding share of the interests paid by the borrowers.

On the other side, borrowers deposit their collateral, they receive AAVE tokens in exchange and pay the interest at the end. Any collateral in AAVE gets discounts.

Aave also allows uncollateralised flash loans where the loan is received and repaid within the same transaction. This is used for example, by traders who make an arbitrage transaction of the same asset between two exchanges.

MakerDAO is like a credit facility that issues loans of the stablecoin DAI out of Ether, the loan would be paid back at the end with an interest called stability fee. If the rate is low, people are encouraged to borrow more DAI (lock up more ETH). If the rate is high, the cost of capital is high making it less attractive to borrow DAI. In the end, Maker aims at stabilising DAI price at 1USD.

In practice, users deposit Ether to Maker’s smart contracts creating Collateralised Debt Position (CDP) to borrow a number of DAIs. The user shall make sure the ratio (collateral amount out of the number of DAIs) is always above a predefined level. This ratio follows real time price changes of ETH/USD.

If the ETH/USD price is moving up, the ratio is growing, the user might withdraw more DAI as long as the ratio is well above the minimum required.

If the ETH/USD decreased, the user might need to add collateral or pay back some DAIs.
If the ratio goes below the predefined level, the user’s position is liquidated with a penalty.

At Trakx, we offer a thematic crypto instrument on Lending that replicates the performance of the leading tokens in both centralised and decentralised Lending. The allocation is determined by market capitalisations and is rebalanced every month to include the latest trends in the crypto lending space.

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Carole Laizet

Senior marketing manager with 15+ years of experience in the Financial Industry (traditional Banking as well as Crypto Assets). Responsible for market research @trakx.io