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Crypto Daily Topic

Should You Invest in Cryptocurrency Loans? 

Cryptocurrencies have generated a variety of opportunities for investors to make money. Perhaps the most common one is the commercialization of mining, which by itself is rewarding, but the overhead costs can sometimes exceed the rewards. 

Apart from mining, investors can engage in other profitable operations either linked to the dynamic crypto market, or those that are similar to the conventional economy. 

A good example is the crypto lending concept, which is similar to traditional lending, only that it has the potential to generate higher interest rates. So, how is this concept beneficial to the lender and borrower? Before we answer that, let’s understand how cryptocurrency lending works. 

The Basics of Crypto Lending 

Essentially, crypto lending is a practice of lending digital assets to borrowers who then pay back at a predetermined interest rate. It’s usually done in a peer to peer platform where the borrower must put up some collateral, either fiat currency or digital assets, in order to be approved for a loan. The borrower will then repay the lender using their own tokens or fiat currency after a specific duration of time set by the lender. 

More often than not, crypto-based lending is done for margin trading purposes. In this case, a borrower can either take a long or short position. With a long position, the borrower believes that the price of a certain crypto asset will certainly go up. As such, they’ll request to lend some of your funds through the platform to increase their capital and enjoy bigger profits. It should be noted that the interest rate and payback period is set by the lender. 

For example, say, you are a borrower with $2,000 worth of Bitcoins, which is currently priced at $20,000. This means that you have 0.1 BTC. Now, let’s say you take a long position and borrow $500 against your $2,000 holdings. You’ll now have 0.15 BTC. If the BTC price indeed increases by say 10% to $22,000, your total holdings, including the borrowed amount, will be $2,750. Once you pay back the loan, you’ll have earned more profit – about 25% – than you could have earned with your initial amount. 

Taking a short position works pretty much the same way, only that now you’ll be betting on the falling prices. As such, you borrow the coins when the price is high and sell them when the price is still high. Once the price has fallen, you buy back the coins and refund them to the lender plus the interest. The price difference is your profit, while the interest paid back is the lender’s profit. So, both parties win. 

Is Crypto-lending Safe? 

Like any other form of peer-to-peer lending, crypto-lending comes with its risks. The biggest concern arises from whether there is a guarantee of lenders getting their money back or not. 

To solve this, crypto lending platforms require all borrowers to put up collateral worth more than the amount they intend to borrow. Typically, this concept is referred to as the loan-to-value ratio, which ranges between 60 to 70%, meaning a borrower can only take an amount worth less than the set percentage limit.

Also, if the prices go contrary to what a borrower anticipated, and the loan amount is lower than the margin limit, all their holdings will be liquidated to ensure the lender receives their full lent amount. This goes a long way toward protecting the lender from market volatility. 

Other safeguarding measures put in place include lending the platform your holdings directly. This way, you’ll have peace of mind since you’re lending the exchange and not an individual. 

Advantages and Disadvantages of Cryptocurrency Loans 

In an ideal scenario, cryptocurrency loans are profitable to both the lender and the borrower, but they still come with their own pros and cons. Here’s a look at some of them;

One of the biggest advantages of crypto-lending is that it’s easy to set up an account and get started. As such, there are no skill-sets required, unlike mining or trading. 

Also, compared to mining, lending, and borrowing crypto-asset loans is a more affordable way of earning returns. Also, it doesn’t require you to check on your funds regularly since there aren’t any fast actions involved. In fact, as a lender, some platforms allow you to automate your lending account, such that you receive the paybacks without necessarily monitoring your account. 

On the downside, however, there are no unified taxation and regulatory policies governing the lending process. This makes it hard for individuals to know the tax implications of their lending activities. In the same vein, should there be any dispute, it will be solved according to the regulations of both users and the platform’s jurisdiction. 

Besides the regulation hurdle, some platforms tend to charge high commission rates out of the interest rates paid back by the borrower. What’s even worse is that the commission amounts are set daily and not over the full course of the loan. As a lender, this means that your profit amount is never guaranteed. 

Choosing the Right Platform

Generally, there are two types of crypto-lending platforms to choose from – centralized and decentralized. 

  • Centralized Lending Platforms

Centralized crypto lending platforms are similar to traditional fintech companies that deal with digital assets. This means that they operate under regulations set by a central intermediary who also manages the loan matching process as well as keeps the custody of all assets. 

The platform usually sets the interest rates which are favorable to both the lender and borrower. 

  • Decentralized Lending Platforms

As the name suggests, these platforms aren’t controlled by an intermediary or central authority. They don’t follow the Know Your Customer (KYC) processes, nor do they keep custody of the digital assets. 

Also, except for a few, most decentralized platforms have variable interest rates, depending on the demand and supply of the asset on the platform. So, it would be safe to assume that decentralized crypto-lending platforms can be more profitable to a lender than their counterparts. 

Key Takeaways 

If you hold a substantial amount of cryptocurrencies but don’t have immediate intention to use or sell them, investing them in a crypto-lending platform can be a sound investment. This way, you’ll earn passive income while still holding your initial crypto amount. Well, the earned interest may not be much but think of crypto loans as a diversification investment tool. More so, you can leave the interest to accumulate to significant amounts or re-invest it to earn more returns.  

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Cryptocurrencies

What are Pegged Cryptocurrencies? 

The violent price swings witnessed in the crypto market is part of the reason why virtual currencies haven’t found favor in the public’s eye. While the volatility can result in quick gains, unexpected losses are also inevitable. This explains why digital currencies are more speculative investments than a store of value. It’s even harder for merchants to accept cryptocurrencies as payment due to their dynamic prices. 

However, the recent entry of pegged cryptocurrencies is proving to be a solution to the crypto market’s volatility. In fact, they have the potential to win more investors into the virtual currency space, making digital assets acceptable across the world. But what exactly is a pegged cryptocurrency? 

Pegged Cryptocurrency Overview 

Pegging is a financial concept whereby an unstable asset is tied to a more stable asset to mitigate volatility. 

Similarly, when a digital currency’s value is tied to that of some other medium of exchange, it is said to be pegged. Usually, the coin is tied to a stable fiat currency such as the US dollar, gold, or any other bank-issued currency. Tether is an ideal example of a pegged cryptocurrency whose value is tied to the US dollar. 

In addition to being an alternative store of value, pegged cryptocurrencies help compliment the typical cryptocurrency trading.

If, for instance, you made huge gains from trading volatile cryptocurrencies but fear that the gains might evaporate soon, you can safeguard your gains by trading them for Tether tokens, usually denoted as USDT. This way, even if the dollar loses its value, the price decline won’t be as huge as that experienced in the digital currency market. 

Also, in a bearish market, pegged cryptocurrencies can be used to increase the number of tokens/coins in your portfolio. This is especially true because a pegged currency’s value isn’t affected when the market dips. But since it’s still available in the crypto market and has not been exchanged into fiat currency, you can leverage on the dip by making more purchases to increase your coin/token holdings. 

How Crypto Pegging Works

Cryptocurrency developers wishing to peg their tokens to a stable asset must at all times have the actual asset in reserve as proof of pegging. This is to say that if a cryptocurrency is backed by gold or the US dollar, the project developers should have vast amounts of gold/dollars in vaults to guarantee the pegged value of their tokens. 

In the case of Tether, each token of the coin is tied to the value of one US dollar. Should the coin fail for some reason, investors can then go to developers to claim a refund that is proportional to the number of tokens that they held.

Benefits of Pegged Cryptocurrencies

There is more to pegged cryptocurrencies than just being an alternative hedge against market volatility. 

  • Improved Liquidity 

Compared to typical cryptocurrencies, pegged tokens can be liquidated easily and faster. This is especially true for coins pegged to a fiat currency. They serve as a liquidity vent through which other digital currencies can be swapped for more stable assets. 

  • Offer Affordable Remittance Transaction Cost

Sending remittances overseas is characterized by high transaction costs. If you are sending the funds in the form of digital currency, for instance, Bitcoin, the process is overly slow and sometimes expensive. It becomes even more expensive when you factor in the volatility of the coin, which may result in the recipient receiving less than the amount expected. At the same time, sending fiat currencies overseas has its own challenges, such as an amount limit which you can send at any given time, as well as accumulating transaction costs. 

Pegged cryptos, on the other hand, offer the best of both worlds. First, they are less affected by the market movements, which helps minimize transaction fees. Also, since they are virtual currencies by nature, they aren’t affected by remittance transfer limits.

As such, they can be transferred to various jurisdictions in an affordable process compared to money transfers. Once you consider the foreign exchange-swapping hurdles that plague fiat currency transfers, it becomes even clearer as to why pegged cryptocurrencies are the most viable option. 

Risks Associated with Pegged Cryptocurrencies

One of the biggest risks associated with pegged cryptocurrencies is investors can never be sure if a coin is backed up by real funds. For this reason, before investing in a pegged cryptocurrency, note that it is not enough for a developer to simply claim that their coin is pegged. They must be transparent with their reserves by providing physical proof that the backup funds are available. Ideally, the developers should be open to third-party audits of their financials to verify that indeed the coin is backed up by a stable medium of exchange. 

Also, the fact that a coin is backed up by physical funds stored in large amounts is a problem in itself. It means that the funds are prone to theft and can even disappear for some other reason, causing a decline in the token’s value. Such cases mainly affect gold-pegged cryptocurrencies. Therefore, investors should examine the credibility of who stores the gold of a particular coin and where it is housed. 

For coins pegged to a fiat currency, the government doesn’t take kindly to developers linking a product to the value of a central bank currency. To successfully peg their currency, the developers are required to obtain the necessary paperwork and license as well as maintain a public record of their holdings. So, be sure to check the whitepaper of a pegged crypto to ascertain whether it maintains compliance. 

At the same time, it is pretty hard to make profits from a pegged cryptocurrency. This is because the buying and selling price of the digital coin has the same value as that of the fiat currency. It’s probably the reason why developers fail to convince investors to store their assets in digital tokens instead of fiat currency. 

Conclusion

Unfortunately, there have been only a handful of successful pegged cryptocurrencies in the market. Nonetheless, it’s undeniable that they play a vital role in bridging the gap between the crypto-space and the traditional economy. With time, as more developers continue to launch pegged cryptos, their role will be appreciated and eventually bring in more investors in the market.