The Lay of the Land in Crypto Lending & Borrowing: What to Know for Today’s Bull Run

Lending protocols have long been the backbone of DeFi. Permissionless borrowing and lending platforms – often known as money market protocols – uphold crypto’s decentralized ethos while granting users access to financial primitives without the red-tape tradeoff. With smart contracts replacing intermediaries, these trustless protocols have been responsible for tens of billions worth of transactions.

During the heady days of DeFi Summer in 2020, crypto lending took off in a major way, particularly with Compound’s introduction of a governance token, $COMP, that it used to reward liquidity miners. By 2021, thanks to Compound, Aave and others, crypto lending/borrowing was the largest single segment in DeFi, constituting roughly half of all TVL.

Although the market froth soon dissipated, lending remains one of the best ways to earn yield from your crypto – and borrowing is just as attractive for people seeking a fiat- or crypto-based loan. With talk of the next crypto bull run turning incessant due to BTC ETF approvals, the approaching bitcoin halving, and loose Federal Reserve monetary policy, now could be a good time to explore the opportunities in crypto borrowing/lending.

Crypto Borrowing/Lending 101

Crypto lending is easy enough to understand. In a nutshell, lenders deposit cryptocurrency, which the platform then lends out to borrowers in return for interest payments. Borrowers, of course, must put up collateral to secure their loan.

It should be noted that although typically associated with DeFi, there are a number of centralized lending platforms too, and interest rates vary across the board. Some platforms also charge fees for their services or entice users with attractive perks for locking assets up for a longer duration.

While centralized lending protocols like Nexo and Crypto.com manually manage the process for customers, their DeFi counterparts rely on smart contracts to automatically pair compatible lenders and borrowers – who can access capital without needing to complete a credit check.

Needless to say, as with borrowing/lending in the world of traditional finance, there is a degree of risk to this activity. In the past, CeFi lenders like Celsius and BlockFi have imploded, leaving users out of pocket. DeFi applications have also fallen victim to flash loan attacks which can cause financial losses for both the protocol and users.

Liquidation is another clear and present danger borrowers must contend with. This is what happens when the collateral used to secure a loan is abruptly sold to cover the debt. It happens when the value of your collateral falls below the threshold imposed to guarantee the loan. In the case of DeFi, there’s no reasoning with the protocol and promising to draft in funds from elsewhere (as with a margin call): your position is forcibly closed and your collateral is gone for good!

This is crypto, so the prospect of your collateral value falling isn’t exactly unrealistic: the market is volatile by nature. Thus, the potential for high interest rates/easy access to capital has to be balanced with the risk of catastrophe whenever you interact with these protocols. In early 2021, $115 million in DeFi lending positions were wiped out in one day after a drop in the price of ETH.

Of course, interacting with them during a bull run is theoretically safer: with prices on the rise, the value of borrowers’ collateral should be going up rather than down.

Bull Market Strategies

Inevitably, hype about a crypto bull market will compel crypto investors and traders to explore whatever opportunity they can to turn a profit. Borrowing and lending protocols are of course among the most popular options. Today, the total value locked in DeFi lending protocols exceeds $27 billion – around half what it was during its 2022 peak.

Naturally, many different strategies can be employed in this area. During bull market fever, stablecoins prove popular as traders look to hedge their positions. Thus, lending stablecoins can be a good way to earn steady yield.

Another popular bull market strategy, albeit one fraught with risk, is known as looping. The process is more or less as follows: the user buys ETH, deposits it into a lending protocol like Aave to borrow USDC… in order to buy more ETH. The process is then repeated several times; with the price of ETH going up, more USDC can be secured and more money reinvested in ETH.

Some looping techniques depend less on the yield differential supplied by a DeFi protocol, and more on the interest generated by yield-bearing tokens. Of course, if borrowing/lending rates suddenly change, fortunes can quickly swing in the other direction.

Tools for Safe Crypto Borrowing/Lending

To some degree, the risks of participating in DeFi, including lending/borrowing, are unavoidable. But over the last few years, some projects have emerged that promise to mitigate at least some of the risk.

Nolus is a great example. Influenced by the tradfi leasing model, the protocol dispenses with the typical borrowing terms we see in DeFi, which require users to over-collateralize their loans. Instead, it offers up to 150% on the investor’s capital and lets them gain ownership of the borrowed asset after full repayment.

Unlike DeFi lending protocols, Nolus doesn’t reactively liquidate users’ assets when prices fall either. Instead, it liquidates a small percentage (“partial liquidations”) to restore leases to healthy levels. Users only start to suffer losses after the asset’s value has plummeted by over 50%, assuming they have yet to repay their outstanding debt.

Altitude is another lending service taking a novel approach. As with Nolus, one of the goals is to address the capital inefficiency caused by over-collateralized loans. What Altitude does is actively manage users’ loan debt and collateral in real-time in order to maximize their capital efficiency.

In cases where one’s loan doesn’t require all of their available collateral, the platform reallocates it to generate auto-compounded yield (which also reduces the loan size). It can also rebalance the loan if the collateral is needed to maintain the loan-to-value.

One of the simplest tools for managing risk in DeFi lending and borrowing is a portfolio tracker like Zerion, which provides an at-a-glance view of all your tokens, DeFi positions, NFT collections, and transactions. Zerion saves you the trouble of bouncing between browser tabs, chains and apps, and it has the added convenience of letting you access the dApp you need right from the portfolio. Thus, the risk of suffering a liquidation is minimized.

You Have to Be Careful in the Land of the Free

DeFi has opened up a world of possibility for investors, traders, borrowers, lenders – even artists who now have the ability to tokenize their paintings and illustrations and sell them on a peer-to-peer marketplace like OpenSea.

With that said, the risk of losing money must be judiciously weighed. Blundering ahead without a clear strategy in mind is a fool’s errand. Thankfully, there are protocols and tools (not to mention educational resources) designed to minimize risk and help users avoid the most common pitfalls.

Bull market or no bull market, you should make the most of them.