What is crypto lending?
Crypto lending is a broad term used to describe various mechanisms that exist for lending digital assets to other parties in return for interest. In the modern financial system, banks and institutions facilitate the vast majority of lending activity. Individual account holders receive an interest fee on funds they hold with a bank, which represents a share of the interest the bank makes from lending those funds out to other account holders in the form of loans or other types of credit.
In some cases, crypto lending is like a bank since centralized exchanges like Bitstamp or lending platforms operate systems where they lend out customer funds and share the interest among the customer base. These services may be regulated by financial authorities. For this reason, crypto lending may not be available to people in all jurisdictions and is typically offered subject to KYC checks.
Borrowers must also demonstrate they are sufficiently creditworthy for a loan – for example, by undergoing a credit check or providing income statements.
If a borrower defaults on a crypto loan, the lending institution can take legal steps to recover their losses.
Decentralized lending
Decentralized or DeFi lending has emerged to facilitate loans between peers on a blockchain. Since blockchains operate pseudonymously, decentralized lending is set up differently from traditional credit arrangements facilitated by a bank or lender. In decentralized lending, there are no intermediaries – all activity is channeled through lending pools managed by smart contracts.
Most DeFi lending platforms require that loans be collateralized to manage the risk of defaults. However, cryptocurrencies are also volatile, so the value of the collateral can easily fall below the loan's value. For this reason, decentralized loans tend to require overcollateralization, so the user must deposit more crypto than the value of their loan is worth. Should they default, the smart contract will liquidate their collateral.
What is crypto staking?
Crypto lending always involves credit transactions between two parties, a lender and a borrower, even if the mechanisms vary. In contrast, staking effectively involves loaning crypto funds to a proof of stake blockchain network. Cryptocurrency holders lock up their funds to participate in network security and earn rewards. The type of participation can vary – it may involve validating transactions as a network node or simply delegating funds to a validator for a share of their rewards under a variation of the delegated proof of stake model.
Since it is a blockchain-based activity, cryptocurrency holders can stake their funds in a decentralized, non-custodial way via a supported wallet.
Many centralized exchanges and companies, including Bitstamp, also offer crypto staking by pooling funds and distributing rewards. These services are more accessible than self-custodial staking, but they may come with a fee.
Considerations for crypto staking versus lending
If the goal is simply to earn a return from investment, there may not be much difference between crypto staking and lending. It may be possible to get a better interest rate or reward ratio by shopping around different providers and platforms. However, both can vary frequently according to supply and demand, so maintaining the best rate over time may involve ongoing efforts to reallocate funds.
Centralized versus decentralized providers
A significant consideration in deciding whether to lend or stake crypto could be whether to opt for decentralized, non-custodial services or centralized services via a provider. DeFi lending platforms and staking via self-custody wallets can offer higher rewards than centralized alternatives and the assurance of transparency since funds are always held in smart contracts on the blockchain.
However, the user is fully responsible for their funds. Blockchain protocols and wallets can be targets for scams and hackers, and the underlying code may be vulnerable. Users should be aware of the risks.
Conversely, centralized providers can incur fees. However, they are generally easier to use and don’t require a self-custody wallet. Even so, it’s important to choose a reputable lending or staking provider with a track record for security and reliability.
Volatility and lockup periods
Volatility is a risk for both staking and lending since funds are inaccessible while lent or staked, and cannot be sold in the event of a market downturn. Lockup periods may also be a consideration, particularly when staking directly, as many staking networks impose an unlocking period that can further delay access to funds.
Regulatory intervention
Regulation could pose a risk to the continuing operations of lending and staking providers. The practices have already been ruled unlawful by authorities in some countries, and providers have been forced to close down operations. While such an event should pose no risk to staked funds or the loan principal, it will involve finding another way to generate returns on those funds.
Participation and contribution
Finally, supporters of blockchain networks may prefer staking over lending since it allows them to participate in network security and contribute to the longevity of the platform. Lending doesn’t necessarily offer the same “feelgood” factor, but some lending platforms may focus on issues such as financial exclusion by offering credit to those unable to obtain it via traditional means.
Crypto lending vs crypto staking essentials
- Crypto lending and crypto staking both involve loaning funds in return for interest or rewards.
- Lenders provide credit to borrowers, while stakers loan funds to a blockchain network to support network security.
- Returns from lending and staking may not vary much, but factors such as choice of provider, volatility, and the value of participation may help to decide which suits the individual’s preference.