“Crypto Lending Risks to Be Aware Of”

 

There are several benefits to crypto lending, which is why it is so appealing in the eyes of financial actors. In bank lending, you will get enabled in bureaucracies and extensive verification processes. These include credit score, which is a procedure that takes time to develop. In crypto lending, things can move at a quick pace because there is no requirement of a credit score in order to gain access to the loan. On top of that, crypto loans are more accessible than traditional bank loans that establish the interest rates and amount, as well as the loan period.

 

While crypto lending is frequently compared to conventional savings or interest accounts, and it is advantageous in various ways, it is not without risks. These are newer platforms and are therefore riskier than highly regulated traditional banks. It is important to keep these risks in mind so that you are prepared and to understand why some are still apprehensive of this new form of lending.

 

1 – Liquidity & Value

 

Borrowers typically take on the inherent risk of supplying liquidity should their collateral value drop below the required value. They need to do this to ensure that lenders are always whole. What this means is that borrowers need to meticulously monitor their collateral ratio to make sure that it remains within a safe range.

 

So far, liquidation systems have proven themselves to be quite robust and lenders have yet to lose their investment. However, this continuing success is not set in stone and should be watched carefully.

 

Moreover, in the case of decentralized options, there is sometimes an issue of low liquidity. These can drastically shift rates if a large amount of capital moves in or out of the system. Generally speaking, the creation of interest rate functions is out of a need to incentivize a moderately stable equilibrium, but volatility does occur.

 

2 – Technology

 

In the decentralized space, there exists a technological risk when it comes to smart contracts. Computer code in the form of smart contracts controls capital flow inside the system, so in theory, a hacker could attack the platform via a glitch or exploit.

 

3 – Taxation & Regulation

 

A major use case of borrowing is directly related to evading a taxable event. For the most part, many jurisdictions have cloudy guidance on the nature of most of these assets, including stablecoins. Consequently, it becomes difficult for an individual to properly understand the tax implications of their crypto lending activities. A popular recommendation for users would be to speak with a tax consultant. Furthermore, a majority of the decentralized platforms operate without a license and no KYC disclosures. This means that their regulatory future is uncertain.