How to explain crypto (Part 5 of 7)

Figuring out how to explain crypto to your parents – or any older relatives – in a way they’ll understand can be difficult. After all, many people still see crypto as either a fad that will eventually go away or as a complex subject that only techy people can understand.

That’s the purpose behind this series: to learn how to explain crypto in a way anyone can understand, particularly older generations who weren’t raised in the digital age.

Previously, we looked at how you can use your coins through crypto banking. But there’s one subject related to banking that deserves a more in-depth explanation: crypto lending. 

How to explain crypto lending

Crypto lending has become an in-demand service in the decentralized finance (DeFi) world, with popular platforms like BlockFi, Nexo, and Aave rising to meet users’ needs.

But what is crypto lending exactly? In short, crypto lending uses crypto as a type of secured asset in exchange for financing. Crypto lending covers both borrowing funds and lending out your own. 

So those looking to borrow will put up their crypto as an asset in order to secure fiat currency, more of the same crypto, or a different type of crypto. 

Those looking to lend their crypto to borrowers generate interest in return, allowing them to earn an income with their crypto.

Why should you consider crypto-backed loans?

If you’re wondering how to explain crypto lending to your parents, you should first tell them what benefits it has. 

The main advantage of crypto lending over traditional loans is that crypto loans use smart contracts, which means the entire transaction is trustless. There’s no need for a third party to get involved and handle sensitive information. Instead, everything is controlled by computers, and data is stored on the blockchain.

In addition, crypto lending services are accessible worldwide, without a bank – all you need is an internet connection. This gives the unbanked, those who don’t have bank accounts, the ability to take out loans.

Another advantage of a crypto-backed loan is they’re available without a credit check. This allows people with poor credit history to access important financial services they otherwise couldn’t.

Crypto loans have fast approval times, as well as a fast transfer of funds once you have been approved. They also typically come with lower interest rates than mortgages or car loans. 

Also, repayment schedules are often more flexible with some platforms not even requiring a fixed time period to pay back your loan.

How does crypto lending work?

Taking out a loan

When you’re figuring out how to explain crypto lending, you should start with crypto-backed loans. To take out a crypto loan, you must open an account on a lending platform of your choice and then decide how much crypto you want to put up as collateral.

Depending on how much you are looking to borrow, the platform will calculate how much collateral is necessary. But all crypto-backed loans are overcollateralized, meaning a prospective borrower actually has to put up more in collateral than they will be borrowing. 

So why would a borrower put up more than they want to borrow? The main reason is because they aren’t ready to sell off their crypto to get the necessary funds.

A crypto loan allows the borrower to retain ownership of their crypto the entire time. Once they repay their loan, they will have control over their funds again. 

And if the market value of the crypto had gone up during that time, they wouldn’t miss out on those gains. Another reason borrowers wouldn’t want to sell their crypto is to avoid paying capital gains tax.

Once the collateral is put up, it will go into a smart contract on the platform. The platform will then match the borrower with a lender, at which point the borrower will receive their funds. The smart contract will self-execute the terms of the loan from there.

Lending out your crypto

Lending your crypto works much the same way as a savings account with a traditional bank. To get started, you open an account on the platform of your choice and then deposit the crypto you want to lend. 

The platform will take care of the rest so the only thing you need to do is sit back and collect the rewards from the interest, which can often be as high as 15%, depending on the platform and which coin you are lending.

If you’re wondering how interest rates can be that high, just consider how volatile crypto is and how the market value for the coins you lend could drop overnight.

But despite the risks, if you plan on holding your crypto over the long term, lending might be a good option to make some passive income with your crypto. If you decide you don’t want to lend out your crypto anymore, you can always withdraw it from the platform.

Are there downsides to crypto lending?

When you’re deciding how to explain crypto lending to your parents, you should be upfront about the potential risks. Crypto lending is safe, but there are some inherent risks that traditional lending doesn’t have. 

Perhaps the biggest risk is crypto’s price volatility, which can affect both borrowers and lenders. If you put your crypto up as collateral in a loan, it won’t be immune to these price changes. 

In fact, if the value of your crypto falls beneath a certain amount, you’ll need to put up more to maintain the loan-to-value ratio. Otherwise, some platforms liquidate their user’s collateral to repay the loan.

Other platforms also have borrowing minimums. Because crypto-backed loans are over-collateralized, if you don’t have enough collateral to qualify for the borrowing minimum, you won’t be able to get the loan. 

Another risk is that regulations become more likely as the DeFi and crypto lending industries have grown. As DeFi platforms try to develop rules that satisfy government regulators, it could significantly impact the future of crypto lending.

Finally, it’s important to only choose trusted platforms with good reputations because if you don’t, you could risk your collateral. If the company you choose goes under or your funds end up stolen in a hack, there is no guarantee that you’ll be reimbursed.

What’s next in the series?

Crypto lending is still in its early stages, though the industry has grown to be worth billions of dollars. Crypto enthusiasts are drawn to the ability to quickly get loans in a currency of their choice with no credit check.

As more people turn away from traditional finance and discover DeFi, the number of crypto lending platforms will keep growing to meet the demand for crypto-backed loans. 

Now that we’ve taken a look at how to explain crypto lending to your parents, what will we cover next? The fourth use case for crypto we’ll go over is gifting your crypto to others.