Thousands of years before the appearance of
fiat currencies, loans were lent and repaid
in the form of seeds and cattle stocks. Today,
digital lending is one of the fastest growing
industries in the crypto space.
I have a very substantial amount of my net
worth in cryptocurrency. Any time I have an
opportunity to help move our industry forward,
I'm going to do so.
This is Brock Pierce. He is a cryptocurrency
investor and philanthropist.
We've been suffering in the two year bear
market. We are going to keep holding, at least,
I am.
And this is Chris, he is a YouTuber and a
Bitcoin hodler. Both Brock and Chris ask themselves
the same question. How can I unlock the value
of my crypto without selling it? Last year,
Brock was offered a 1.2 million dollar loan
on lending platform Nexo to buy a house in
Amsterdam. He used that loan as one of the
first ever Bitcoin-backed mortgages. Nexo
said we'd be down to do a crypto-backed mortgage
for you, I said awesome, great. This way I
could, you know, conceivably keep my Bitcoin,
get access to the fiat to be able to close
that euro based transaction.
Meanwhile, Chris found out that cryptocurrency
exchange Binance was offering interest income
on crypto savings accounts. For a hodler to
earn interest on your crypto, you would be
holding your crypto in your wallet anyway.
So, you know, being able to earn money on
that. It just sounded like a very good idea.
Earning passive income on crypto. Taking out
crypto-backed loans. All this became possible
thanks to one of the most explosive industries
in the crypto space - crypto lending.
Prior to this, holding digital currency was
no different than holding a bar of gold in
a safe, right. There's no utility in that.
And so by lending it out, they can actually
unleash the value of that digital asset. Purchasing
traditional investments, stocks and bonds,
paying down higher cost debt and financing
major life events. So, you know, I'm getting
married or I'm remodelling my kitchen or buying
an engagement ring and being able to do all
of those things without selling your Bitcoin
or selling your cryptocurrency.
But how does a crypto lending platform actually
work? Think of it as a sort of bank. Users
lend out their crypto funds to the platform.
The platform gives out loans to borrowers
at a certain interest rate, and it uses part
of that interest to pay yields to lenders,
keeping the rest as a profit. Besides lending
cash to hodlers, crypto lenders provide crypto
loans to traders institutions who meet liquidity
for margin trading operations.
Every time you go on an exchange and you want
leverage, like let's say you want to buy your
one Bitcoin, you want to buy a second Bitcoin.
That means leverage. Somebody has to provide
that leverage. Somebody meaning someone is
giving the exchange alone. Today Celsius is
one of the largest lenders to these exchanges.
A key difference from legacy lenders is that
crypto lending is not based on the borrower's
credit history. Instead, borrowers are required
to stake their crypto as collateral, which
will be returned once the loan is repaid.
The crypto lending industry is growing at
an impressive speed, according to research
company Credmark. The total value of crypto
loans increased seven times last year, reaching
8 billion dollars. Experts say the lending
business will enhance the liquidity of the
crypto market, thus reducing its volatility
and attracting more investors into the space.
If you are an individual or a business that
wants to do something but don't have the capital
to do it right now, if lending weren't an
option, if borrowing weren't an option, that
work wouldn't happen. So the system would
lose all of that productivity.
So you can think of lending as this just incredible
grease that just pushes everything forward
at a much faster rate.
However, the high volatility of digital currencies
makes lending and borrowing crypto a risky
practice. During a Bitcoin flash crash last
year, crypto lender Poloniex lost 13.5 million
dollars of lenders' money. When the market
drops by more than 50 percent, and you're
in a collateralized margin type of trade,
you can lose all of your principal.
When money is cheap, then people who think
they can do something interesting with it
might borrow more than they really should
or more than would be prudent given the dynamics
of the market. Volatility is just part of
the problem.
As of today, crypto lending largely relies
on third party custodians.
This raises the problem of trust as the common
crypto adage goes, "not your keys, not your
Bitcoin."
You don't know anything about what's going
on behind the scenes. All you have is the
trust for these platforms. And that is why
you're getting these high interest rates,
right? Because there are risks involved with
it.
If all of a sudden a borrower who borrows
coin is undercollateralized, you as the lender
have no way to know that you're relying on
a third party, another lender to do that.
A more transparent alternative, decentralized
crypto lenders is offered by DeFi lending
platforms. In decentralized finance, smart
contracts enable peer to peer lending operations
with no third party involved.
Public crypto lending platforms are completely
governed by smart contracts. Anybody participating
in the contract - anybody who gives crypto
to these contracts knows exactly what is going
on.
because they can read the code.
However, DeFi lending platforms are often
complicated to use, and their technical constraints
can sometimes work against the user. For example,
in a massive market crash on March 12th, the
Ethereum network became heavily congested
due to a spike in transaction activity. As
a result, millions of users funds were unfairly
liquidated on major DeFi lending platform
MakerDAO.
Trusting smart contracts is a bit like trusting
self-driving cars. The majority of the public
would not want to get into the car without
a driver. And that's a bit what it's like
to deal with a public lending, right. You're
just trusting this code that's out there on
the Internet and you're literally giving this
code your money on the assumption that you're
going to get it back with interest. Because
of the security and usability issues, most
users still prefer to entrust their funds
to centralized custodians. That is why DeFi
lenders occupy a small portion of the crypto
lending market.
What would I rather do? Would I rather trust
a smart contract that I have to lock up my
funds into or a centralized entity?
Well, right now it's a centralized entity.
If someone can build a product that has more
utility that may have centralized components
to it, I'm going to most likely use that versus
the fully decentralized version that has risks
in it.
How is the crypto lending industry going to
evolve? Will the centralized model eventually
win the trust of the wider public or essentialist
lenders here to stay?
There are plenty of people for whom the values
that the decentralized versions provide are
worth dealing with the user experience downside.
And then I think the user experience will
get better over time.
A model that will prove to be very popular
is this hybrid model where you have centralized
entry points into the decentralized finance
protocols. So maybe even you will have a custodian
that you trust as a user and then that custodian
interacts with the DeFi protocols for you.
Crypto lending introduces an additional risk
factor to an already highly volatile asset
class.
At the same time, it expands the utility of
digital assets, which now can be used to earn
yields and borrow capital. Finally, lending
and borrowing provide the liquidity needed
for a developed market economy.
These are the services that will help propel
the crypto market to full maturity.
