Crypto lending is a fairly new practice that appeals to many investors for its relatively simple procedures and attractive returns. Some crypto lending sites allow investors to earn annual percentage returns (APR) at rates as high as 25 percent—much higher than the annual returns traditional financial institutions typically offer. Crypto lending also doesn’t typically involve challenging verification processes like building a good credit score, so crypto traders can lend or borrow coins quickly and easily.
Crypto lending isn’t limited to the ever-popular Bitcoin, either. In the last few years, many crypto lending platforms have emerged to provide investors with a safe and convenient way to lend a wide variety of coins. If you own Monero (XMR) coins, for instance, there’s no need for them to simply sit in your XMR wallet as you wait for the token price to peak. Instead, you can connect with a borrower through a secure peer-to-peer lending platform, set up a loan, and earn a substantial amount of interest in return.
Despite the many benefits of crypto lending, however, it’s worth remembering that this lending method is still young and highly experimental, especially when compared to more established, more rigorously regulated methods. Investors interested in crypto lending thus need to be aware of the various risks and uncertainties associated with it. Read on for an in-depth look at a few of the most salient risks related to borrowing crypto, as well as some advice on how to mitigate them:
Ever-Changing Crypto Lending Regulations
Crypto regulation is the subject of heated debate among politicians all over the world, especially in the United States.
As digital currencies grow more popular, the cryptocurrency sector is likely to attract greater attention from government institutions and other regulatory bodies. Each will likely have their own ideas about how to tax crypto and what the tax rates should be. At present, it’s impossible to predict whether changing legislation in a particular jurisdiction would affect investors’ profits for the better or worse.
Depending on where you’re located, taxes on cryptocurrencies will likely impact your earnings as a crypto lender. Crypto earnings in the US, for example, are typically taxed either at capital gains tax rates or regular income tax rates.
The best way to deal with highly changeable crypto regulations is to monitor developments in your jurisdiction closely. It’s also wise to read up on smart contracts and crypto taxes before making any significant investments.
Volatile Crypto Prices
Crypto prices tend to fluctuate rapidly and without warning, and this volatility is a major concern in crypto lending and other financial activities involving digital currency. Indeed, many cryptocurrencies experience drastic price swings in only a matter of days, and lenders who don’t account for this risk may face much-diminished value on their returns. To be specific, lending out a particular amount of crypto at a high value may come back to bite you later if your borrower pays off their loan after the value has fallen.
Managing this risk effectively involves familiarizing yourself with your chosen cryptocurrency’s recent price fluctuations, understanding market trends, and planning your investments wisely. It may also help to study financial markets and identify factors that lead to dramatic spikes or drops in certain crypto prices.
Security Breaches and Cyber Attacks
Cybersecurity and custody concerns have been hot-button topics in the cryptocurrency sector since the inception of Bitcoin. As with any platform on which crypto is stored and traded, crypto lending sites aren’t immune to security breaches and attacks from cybercriminals.
Thus, it’s important to read a particular exchange’s terms of use thoroughly to understand how the platform intends to protect your investments from cybercriminals and other adverse events. For instance, reputable crypto lending platforms may take out private insurance policies to cover theft and other technical risks.
In short, it’s in your best interest to do careful research and invest only with credible lending sites. You should also look for high liquidity rates and substantially sized markets as proof of legitimacy.
Platform Insolvency Risk
Bank deposits in most developed jurisdictions come with insurance protections that ensure that they’ll be refunded up to a particular limit in the event of the institution going bankrupt. Hence, the risk of a lender losing the money they’ve deposited with a bank for loans is very low overall. Lenders are also guaranteed at least some compensation if the bank fails.
Crypto lending, however, doesn’t afford lenders federal deposit insurance or any similar safety nets. Lenders thus face the risk of losing their whole investment if the lending platform they’re using goes insolvent for any reason. This risk is wholly out of investors’ control to prevent or mitigate. The only way you can manage it is by loaning out only a portion of your crypto assets rather than going all in.
Due to the many risks involved, particularly at such an early stage of its development, crypto lending isn’t a financial undertaking you should enter blindly. Take time to understand which risks are endemic to the cryptocurrency space and which are more manageable. Both borrowers and lenders must research potential platforms thoroughly, prepare for risk, and choose only the most trustworthy providers to work with.