Blog Podcast The pros and cons of crypto-backed lending

The pros and cons of crypto-backed lending

date May 25, 2021 time 10 min read 1689 views

On this episode, you’ll discover how crypto-backed lending improved the peer-to-peer lending field. You’ll also find out why crypto-backed platforms can offer you much better interest rates than banks. Listen now to learn how crypto-backed lending could be a beneficial addition to your diversified investment strategy.

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Remember: All investing involves risk. The content of the podcast is for informational purposes only and is not investment advice. Please always use caution and diversify.

TREVOR:

Hello and welcome to the 13th episode of Alternative Investing with MyConstant. I’m Trevor, Content Manager at MyConstant. And with me today is…

CHRIS:

Chris Roper here, Head of Communications. 

TREVOR:

Chris, our frequent listeners might be wondering why I’m the one opening this episode today. Would you care to fill our listeners in as to why?

CHRIS:

Sure. So, usually I’m the lead presenter for the podcast but I’m actually going to be leaving MyConstant in a couple of weeks. So sadly this will be my last episode with you all, but I’ve had a great journey with you all and thank you for your support so far.

We’re still amateurs, but we do try to give you valuable information in your investing journey in a half hour segment so you have something to put into practice in your life. 

So yea, this is the last one. So what are we going to talk about today? 

TREVOR: 

Well, we are continuing our series on interesting alternative investments. So, last week we covered wine and in this episode we’re diving into crypto-backed lending. 

CHRIS:

Our listeners might be wondering why it took so long to get here. I know we did speak about peer-to-peer in the beginning. But crypto-backed lending is a specialized alternative form of P2P lending. 

TREVOR:

Our frequent users of MyConstant probably know what crypto-backed lending is. But for people who don’t know, would you like to give a little summary?

CHRIS:

So, crypto-backed lending is P2P lending. It’s when an investor lends funds to a borrower in return for interest. But there is a big difference and that is the use of cryptocurrency as collateral. At MyConstant for example we ask our borrowers to put at least 150% of the loan amount in cryptocurrency.

That way, if they default (don’t repay) or if their collateral falls too much in value — such as a flash crash — then we can always sell their collateral to repay the investor.  

And that’s what’s really cool about crypto-backed lending is that cryptocurrencies make great collateral. 

Other platforms that take collateral — it’s usually something like property or a vehicle. 

TREVOR:

And those can take a while to sell. 

CHRIS:

Yes, you could be waiting months or years to get your money back. But with cryptocurrencies it’s a very liquid market. Cryptocurrencies are a liquid asset. It’s easy to buy or sell these assets which means it’s great for collateral. 

We can sell cryptocurrency at a moment’s notice. 

You’re probably wondering, well, if cryptocurrencies are so liquid, why don’t people just sell them instead of borrowing against them? 

TREVOR:

Well, we can’t touch them.

CHRIS:

No, my question is, if crypto is a liquid asset, why would you borrow against that asset? Why wouldn’t you just sell it to do what you want to do?

The answer is — most people hold crypto for the long term in anticipation of the price rising. So there are millions of people holding these digital assets — cryptocurrency — hoping for the value to go up. 

TREVOR:

In the crypto world they say, hold on for dear life (HODL). 

CHRIS:

You’re right. These people hold on to these digital assets for a long time, then they may occasionally want to use these assets to unlock some value. Maybe they need to fix their car or pay for a wedding or what have you. So, crypto backed lending allows them to unlock the value of their crypto without having to sell them. 

Because if you do sell them, you might want to buy again and the price will be a lot higher. 

TREVOR:

Just to give people a bit of background, crypto backed lending is fairly new. It actually just came about in 2018. And before that the P2P industry didn’t have the greatest reputation. And when crypto backed lending came in, it cleaned things up. 

Before this, there were a lot of negative stories surrounding P2P lending. One of the most notorious was Ezubao, which was a P2P lending company in China. And in 2016 they were shut down because the entire operation turned out to be a Ponzi scheme. 

CHRIS:

There were quite a few of these stories. Peter and I covered them in an earlier podcast. There was a massive P2P craze in China and there wasn’t a lot of regulation around it at the time. And the companies would just take their investors’ money. 

But in reality, they were just taking the investors money and running. So it was a scam industry for a long time. But they’ve tightened regulations and it’s better now. 

TREVOR:

Right. If we’re talking about scams, what’s a way that we can avoid being scammed with crypto backed lending?

CHRIS:

At the moment it is easy to get tricked into putting your money into something that might not be legitimate. So it’s important that before you even start looking at crypto-backed lending companies, you look at the reviews. Are they transparent? Do you know who the CEO is or where they’re based? What protections do they have in place? Do they do KYC checks? There are many different things you can look at and I think once you’ve done that research, you should probably only invest a small amount to begin with. Maybe just $50 dollars and then maybe $100 and then as you become more familiar with the platform, then you can start looking at investing large amounts. 

A lot of the risks around crypto-backed lending are not unique to crypto-backed lending. This is the same for all investment platforms. It’s always crucial to do your research, do your homework on any financial platform before you put your money in and even when you’ve done all the due diligence, there’s still some risk that you could lose money.

TREVOR:

What are some of the risks that people have when putting their money on a platform?

CHRIS:

Yea, there are a number of risks with crypto backed lending that could cause problems. One of them being that when a borrower needs a crypto backed loan, they want $1,000. They need to put down $1,500 in bitcoin for example, then they get their $1,000 loan. Then that crypto is held by the platform. 

So there is a custodial risk aspect to it. If the platform is hacked and the crypto is stolen, then nothing is backing the loan anymore. 

And problems with market volatility. Crypto is very volatile as our listeners know. So you need to make sure that if you’re investing in a crypto-backed loan, that the collateral backing it is at a sufficient enough level above the loan amount that it gives the platform time to liquidate. Because the price can change within minutes — seconds in some cases. 

TREVOR:

And we just had a crypto crash that affected our customers. 

CHRIS:

You’re right. And on MyConstant we have a liquidation threshold at 110%. We won’t liquidate it until it falls at that point. That extra 10% is a buffer. That 10% gives us extra time to cover — 

TREVOR:

And gives people time to top-up.

CHRIS:

Well, once it falls to 110%, the loan is liquidated. You can’t top-up. 

The crypto is liquidated and the funds go back to the investor. That 10% — if at the point of liquidation, if the price falls further, MyConstant will still cover the difference so we can give the investor back their principal and earned profit. That’s their interest they earned to date. 

So if we can’t do that, if our model were any different and we couldn’t always give principle + profit back, then there would be no investors. No one would use the platform. So we’re lucky. We’re had a number of flash crashes and no investors have ever lost a cent on our platform. 

TREVOR:

On average, when people are lending their crypto out now, one average, what can they expect to get as a return?

CHRIS:

It depends. For example, on MyConstant, we offer up to 7% on a 180 day fixed-term. But you can get higher rates on other platforms, but normally they are higher because the platform will pay you in their native token. 

TREVOR:

Nexo does that — right? 

CHRIS:

Yes, Nexo does it. Celceus does it too. 

Nexo advertises higher interest rates, but the reality is that the interest paid is not all in USD. In fact, most crypto backed lenders do not handle fiat (USD). They’re mainly for people who have stablecoins which are USD backed digital assets with a 1 to 1 value ratio with USD. 

So what people usually do is they invest their stablecoins in crypto backed lending and they make a return either in stablecoin or in the platform’s native token. So the well funded crypto backed lending companies, they can afford to pay higher rates in their own tokens. But at MyConstant, we don’t have a token that we pay interest on. We use fiat. You can put in USD and take USD out. 

So that makes MyConstant pretty unique in the space. There are not many crypto-backed lenders that let you do that. So to answer your question you’re looking at between 5 and 12% is about how much you can make. 

TREVOR:

That’s a strong rate.

CHRIS:

Yea, it’s a really strong rate when compared to inflation or what a bank would pay you. 

TREVOR:

You’re at least trying to maintain the value of that crypto.

CHRIS:

It’s just another way of putting your money to work.

TREVOR:

And now, where do you see the future of cryo-backed lending going? Are rates going up or down?

CHRIS:

It’s a tough one. There are so many undecided things. It seems the technology is progressing at a rapid pace. regulation is coming in much slower. So we don’t know how that balance will play out. 

At the moment, you have a new type of crypto backed lending — yield farming. What that is, is you put your money into a yield farming platform and then they will move your funds through different crypto backed lenders to get the best rates at all times. 

These are digital asset lending pools. So you can move your stablecoins for example — 

TREVOR:

Like MakerDAO?

CHRIS:

Yearn.finance 

Compound finance is an example of a lending pool. What Yearn does, is they search the market for the best rates, for the best lending pool rates and then they move your money there. And as soon as it’s better in a different lending pool, they move it elsewhere. So there’s stuff like that going on for people who invest stablecoins. 

There’s not a lot happening for people who only invest USD. But we don’t know what’s going to happen in the cryptocurrency industry. 

And that’s a threat. What’s going to happen to cryptocurrencies? If governments decide to crackdown on them, fewer people will own the assets and many will sell. So there wont be borrower demand. And if there is no borrower demand, then the investors can’t get — no one to lend money to or match with. 

I think that’s the biggest threat. What happens in the cryptocurrency industry. Because volatility seems to be handed well — especially if you have the right collateralization model then volatility can be managed. But it’s the other aspects in the industry like regulation. Climate change and the electricity usage too could kill crypto.  

I mean, not every crypto relies on a high amount of electricity usage. Bitcoin uses as much electricity as Argentina does. But it is an exciting time for the crypto industry. 

Just make sure you do your research first. 

TREVOR:

And personally, have you done crypto-backed lending before?

CHRIS:

Yea, I do. I put money on our own platform. I invest quite regularly. And some other platforms I invest in too.  

TREVOR:

When you did this, was there a goal in mind? 

CHRIS:

For me, the goal at the moment was just to try these platforms out and just to see how easy it was. How easy it is to put money in and take it out. 

See if there were any issues with borrowers defaulting and so on. But if you’re new to this, then I think, if you want to test different platforms, that’s fine. 

Read up, do your due diligence, and understand the technology and how it works. Some of these companies are automated and they might use smart contracts which are little bits of code on the blockchain. It’s like a program on the blockchain.

It carries out, or performs a function once certain criteria are met, so smart contracts handle the lending model for a crypto backed lender. But these smart contracts are only as good as the code they’re written in. 

Make sure those smart contracts are regularly audited and are robust. 

TREVOR:

Well, I think that covered everything. Chris, is there anything you’d like to add? 

CHRIS:

Have you tried crypto backed lending Trevor? How was your experience? 

TREVOR:

I have. I’ve had great success on MyConstant. I’ve put it into a fixed term loan. And I’ve laddered my loans. Ending at different time periods. 

CHRIS:

Many people do that on our platform with short term, 30 day loans. So they put it in and after that 30 days they reinvest. So they reinvest with the interest they earned. 

They just do that over and over. Because you get a better rate than our instant access option. But if you put your money in for 30 days you get 6% APR and if you need your money, you know you only have to wait 30 days to get it. So it’s a nice middle ground. 

TREVOR:

And you know when it’s coming out. 

CHRIS:

And you compound your earnings too. 

So each 30 days you’re putting in more and more from the interest earned. 

So let’s just summarize with a checklist for our listeners. 

TREVOR:

I think, first, look at the company’s profile — the people running it. Look out for any red flags. Put in a little bit of money first and make sure you can withdraw easily. Read the reviews during the company vetting stage. 

CHRIS:

Read up with customers’ reviews. Research any case studies too. Any crypto backed lended would be happy to show a case study. 

And most should post statistics as well. The performance of the loan, how many defaults, how much has been recovered. 

TREVOR:

And read terms and conditions. Something that many people skim over, but if you have your money on a platform, check that with a fine-tooth comb. 

CHRIS:

And one other thing, the first thing you should do, decide what you want to get out of crypto-backed lending. If you just want to test it as an investment, that’s legitimate — that’s fine. But if you want to get a return, you should sit down and work out an investment plan. 

TREVOR:

And when you have a plan, you tend not to touch the money, because you know you need the money from this point to that point. 

CHRIS:

Yea, with new investors, many new investors throw their money in and expect huge returns from day one and it just doesn’t work like that. It’s rare to make that kind of money. 

Choose a good investment and wait. Just let your money work for you. And I suppose I should say thank you again. It’s been a lot of fun with you and Peter when he was here.

TREVOR:

Thank you! I’ve enjoyed working with you as well. And listeners, if there’s a topic you want discussed, feel free to send me an email at [email protected] 

CHRIS:

Thanks a lot listeners for all your support. And we recently hit 500 listeners for our podcast. It might not sound like a lot, but to us it’s a big deal. Every number counts. 

Take care everyone!

TREVOR:

Thanks a bunch. Bye bye. 

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Trevor Kraus

Trevor Kraus

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