High Interest Rates on Cryptocurrency Loans are not Sustainable (The Merkle)
One peculiar trend in the cryptocurrency industry is how crypto loans can become very lucrative. A lot of platforms and services now offer interest rates of up to 10% for specific currencies and assets. Although this gets many people excited, one has to openly question how sustainable this business model really is.
Establishing Interest Rates
The cryptocurrency lending business model is not that different from a bank loan. People are looking for funds and need to put up some form of collateral before they receive the money. Based on the amount of funds being lent, as well as the duration of the loan, an interest fee will be added to the total. In this industry, it appears the current rate for some assets is close to 10%, which is vastly superior to any other way of making money passively.
That being said, these rates of 10% are not necessarily all that sustainable in the long run. Services such as dYdX and DeFi pool deposits from their lenders, from which borrowers can then take money at a steep interest rate. Once the money is being returned to the pool, the interest rates are divided among all lenders who contributed funds accordingly. As popular as this model is, some service providers are already looking to reduce the interest rates to as low as 3%. That figure is more in line with what seems sensible.
The Risks Involved
Cryptocurrency lending remains a very risky business model, especially for those willing to offer loans to others. For users depositing funds into such a lending pool, there are many things that can go wrong in quick succession. Virtually all of these service providers use smart contracts. It has become more than apparent those contracts can be subject to some serious bugs. Although this has not happened on a large scale yet, smart contracts have proven to be exploitable in numerous other instances.
There is also the risk of a borrower simply not paying back the funds. That aspect created a ton of problems in the early stages of cryptocurrency lending services. These days, borrowers need to put up collateral equal to the amount of money they borrow. Failure to pay back the funds will see that collateral being liquidated altogether. It is a sensible business model although there could always be loopholes regardless.
Should you Lend Money?
That decision is entirely up to the individual. These lending rates are incredibly appealing if people are borrowing money from you. Although the highest interest rates only apply to certain coins – mostly DAI, the stablecoin – it is not necessarily useless to lend money through these services. A passive revenue stream is always welcome, albeit no one will get rich overnight from extending a loan this way. It is also ill-advised to spend a large portion of one’s portfolio on this lending business, as one never knows if these services will stick around for long.
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