What is Crypto Lending?

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What is Crypto Lending?

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Not long after Bitcoin’s creation in 2008, the DeFi ecosystem started its work in the crypto town, launching a massive playground of innovative financial products and services. For the first time, we could get a good sense of financial freedom as DeFi allowed us to run our financial lives without relying on banks or financial institutions.

Decentralized Finance (DeFi) gained its place among the crypto users quite fast, with billions of dollars changing hands on a daily basis! This ecosystem is full of financial applications, most of which offer a transparent and open version of the services or products that traditional banks usually offer;

We mainly know these financial applications as Decentralized Applications or DApps.

Decentralized Applications in DeFi

Generally speaking, DApps aim to connect users in need with other users who are willing to provide a solution for a fee. Users’ needs can vary from content or money to specific services, like ads and promotions.

In the context of DeFi, A DApp simply brings borrowers and lenders together; Borrowers can get the money they need with (and sometimes without) collateral and have to pay a small fee as interest to the lenders.

Aside from DApps, some centralized crypto exchanges or lending platforms deliver these services as well.

Crypto Lending: How Does It Work?

As we mentioned above, there are different ways for you to lend your crypto and gain a new source of income. Generally, you’d have to choose between a centralized platform, like a conventional crypto exchange, or a decentralized lending application, like Compound.

In a crypto exchange, the platform is responsible for getting your funds, lending them to the proper borrowers, and eventually, paying back the interest to you. In a DApp, on the other hand, a smart contract handles all this work which is essentially a piece of code that runs on a blockchain system.

So basically as a lender, all you need to do is give your funds to the lending platform and wait till the end of the lending period to get them back with interest. But as with other aspects of the crypto world, things tend to get complicated and sometimes out of hand if not managed properly.

Crypto Lending: Know The Risks

Crypto lending can be quite rewarding, but you can’t ignore the risks. Let’s go through some of them together:

  • DApps’ security strongly depends on the smart contract they rely on. Any simple bug in the contract’s code may cause you to lose all your funds.
  • The crypto market is highly volatile and your loaned funds could go through sharp price movements. In other words, your ability to manage your funds in these times is limited as you have limited to no access to your funds during the lending period.
  • A sharp market crash may lead to the loss of your funds as the borrower may not be able to pay back; defaulting on their loans.