Cryptocurrencies are forcing us to rethink how we view the finance industry.
A decade ago, the idea of a loan without a credit score check would have been considered absurd. Today, the power of smart contracts and cryptocurrencies has revolutionized the traditional lending business. Crypto loans do not require credit checks. They are instantaneous, borderless, and open to everyone.
The crypto lending sector is evolving at a quick pace. Technology upgrades are pushing for innovative, efficient, and safer lending practices.
This article looks at the emerging trends in crypto lending and borrowing.
Liquid Staking Token (LST) Lending and Borrowing
Ethereum‘s move from proof-of-work (PoW) to proof-of-stake (PoS) has given birth to a new sector – liquid staking tokens (LST).
When token holders stake their ETH on staking platforms like Lido and Rocketpool, they receive a secondary token – stETH on Lido and rETH on Rocketpool – representing ETH staked on the platform. This process is also known as liquid staking. Stakers, who have locked up their ETH for staking rewards, now have LSTs that can be used freely for trading and lending.
Currently, LST lending and borrowing is arguably the most dominant trend in the crypto lending and borrowing space. To put things into perspective, the total value locked in LST stands close to $19 billion (as of 5 July) on the top three liquid staking services – Lido, Coinbase Wrapped, and Rocketpool.
That’s $19 billion that can be borrowed and lent.
Top crypto lending platforms Aave, MakerDAO, Curve, and Summer.fi (formerly Oasis) already support LST lending. The ability to borrow crypto against stETH, rETH, and cbETH has given rise to new LST strategies to maximize returns.
An Example of an LST Lending and Borrowing Strategy
Adam stakes 10 ETH on a liquid staking platform (say Rocketpool) and receives 10 rETH in return. He deposits his rETH as collateral on the crypto lending platform Aave to borrow ETH. Adam then stakes the borrowed ETH and receives new rETH against it. This strategy is also known as leveraged Ethereum staking.
Adam can choose to repeat the process depending on his risk appetite.
Remember that these strategies are risky and can result in devastating losses if the price of ETH and LSTs fall. The cost of gas fees is also a critical risk, as Adam will have to conduct numerous transactions to undo the cycle of borrowing and staking.
NFT Lending and Borrowing
Just when you thought that the “monkey jpegs” do not have any use other than Twitter profile pictures, NFT lending steps in. NFT enthusiasts work day and night to bring more utility to the space, and lending and borrowing using NFTs seems like a natural place to start.
Peer-to-peer NFT lending platforms like NFTfi allow users to list their NFTs as collateral against which DAI, USDC, and wETH can be borrowed. The borrower will only get their NFT back once they have repaid the loan. On the other hand, lenders can view listed NFTs and accept desired loan terms.
In May 2023, Blur – a leading NFT marketplace – launched an NFT lending protocol called Blend. By the end of the month, Blend attributed 82% of borrowing volume across all NFT lending protocols. Experts pointed to Blend’s support for popular blue-chip NFTs like Azuki, Bored Ape Yacht Club, CryptoPunks, and DeGods as key to its success.
The major UX problem in the NFT lending sector is the lack of support for lesser-known NFT collections. The floor price of the NFT collection is the critical metric that can determine if your NFT can be used as collateral to borrow or not. In a peer-to-peer protocol, the market decides whether your NFT is worth lending against or not.
NFT lending is a nascent sector. We will see the full potential of the space once “hard assets” like real estate and high-value art are tokenized into NFTs.
Stablecoin Lending and Borrowing
Stablecoin finance represents the most mature crypto lending and borrowing side. The Maker Protocol and its crypto-backed stablecoin DAI are synonymous with stablecoin lending. Users can borrow DAI against their ETH and LSTs using Maker’s affiliate platform, Summer.fi.
In 2023, rival platforms Curve and Aave followed suit and designed their stablecoins. Curve allows users to mint crvUSD stablecoin by locking up ETH, wBTC, and LSTs (sfrxETH and wstETH) in smart contracts.
Meanwhile, Aave is pushing to launch its GHO stablecoin in the second half of 2023. Users will be able to borrow GHO against their crypto assets.
Flash Loans
Flash loans are a type of crypto loan popularized by Aave. Flash loans allow users to borrow assets without depositing any collateral. The catch is that the borrower has to repay the loan within one block transaction (the average Ethereum block time was about 12 sec at the time of writing).
According to Aave, flash loans are designed for developers due to the technical knowledge required to execute them. A flash loan is coded to a smart contract that executes and pays back the principal, interest, and fees within the transaction.
Flash loans are mainly used for collateral swaps, market arbitrage, and loan liquidation incentives. They have a sketchy reputation in the industry because of their use in liquidating third-party loans and for their help in DeFi protocols attacks.
Centralized Finance (CeFi) Lending
Crypto lending and borrowing options provided by centralized companies like Nexo and Crypto.com will always stay in the narrative due to their ease of use and attractive yields. These offer user-friendly interfaces that provide services to buy crypto using fiat and lending/borrowing options under one roof.
The collapse of CeFi firms like Celsius and BlockFi in 2022 has made users aware of the risk of locking up cryptos with these private companies. Thousands of users could not withdraw their funds when Celsius and BlockFi filed for bankruptcy.
The Bottom Line
The crypto lending and borrowing sector’s main challenge is cultural. At the moment, the majority of loans are used for crypto trading and market activity.
If crypto lenders can funnel their capital to fund promising crypto startups and innovative companies, the entire crypto industry will prosper.
