Mastering Crypto Peer-to-Peer Lending: A Complete Guide for Investors and Borrowers

Traditional Peer-to-Peer Lending

Outside of cryptocurrencies, conventional or traditional P2P lending can be “social lending” or “crowdlending.” In these cases, P2P loans are made between two parties transacting in fiat currency. They are usually facilitated by a platform but don’t occur within the conventional banking system.

Crypto Based Peer-to-Peer Lending

In crypto or blockchain-based P2P lending, borrowers and lenders can enter into a loan agreement without requiring a third party or intermediary. Blockchain’s smart contracts enable these “trustless” transactions. Trustless, in crypto, simply means there’s no need to trust a third party. Such loan transactions usually take place on a DeFi or P2P crypto lending platform.

Centralized vs. Decentralized Crypto Lending

Centralized crypto lending relies on a platform controlled by a single entity, which could be a cryptocurrency exchange or crypto lending platform that’s privately owned and controlled as a business.

In contrast, decentralized crypto lending platforms or DeFi protocols operate through smart contracts and automate the entire lending process without any third-party control. Loans are executed or satisfied when preset conditions are met, and interest rates are determined by an algorithm.

The Mechanics of P2P Lending

P2P lending connects borrowers and lenders more directly. Often, a centralized or traditional P2P lending platform sets rates and terms and enables the loan transaction. P2P lenders are investors looking to use their assets to earn a return. P2P borrowers may be looking for an alternative to a loan from a bank.

Although there are variations of crypto P2P lending, in simple terms, lenders lend assets in return for interest. Borrowers take out loans. Cryptocurrency assets can be used as collateral, and the loan must be paid back plus interest within an agreed-upon time frame.

In traditional lending via a local or national bank or a financial institution, an individual or business will borrow fiat currency. The process can be relatively complex, involving application forms and paperwork, credit checks, and a loan that may need to be secured with collateral.

Traditional lenders are highly regulated, and interest rates will be influenced by central banks and government policy. In contrast, cryptocurrency lending can be without geographical borders, can help people with limited access to traditional lending or a poor credit rating, and be a faster alternative. That said, cryptocurrency regulation is still evolving and can be nonexistent in some jurisdictions, so crypto lending is much riskier.

There are two main types of P2P crypto lending platforms: centralized and decentralized. However, many other types of platforms and protocols allow crypto users to earn a return from their crypto assets. Crypto staking is one such example.

Centralized Crypto Lending Platforms

Centralized P2P lending platforms, sometimes called CeFi platforms, are controlled by a central or single entity such as a company, but they also use blockchain-based smart contracts. They can be easier to use for beginners and have additional security and services such as customer support.

Decentralized Crypto Lending Platforms 

Decentralized P2P crypto lending platforms are automated. These platforms have lending pools where crypto owners add their assets, and smart contracts distribute loans to borrowers when specified criteria are met. The lenders earn interest, and rates are determined by an algorithm.

Decentralization, Accessibility, and Inclusivity

Crypto P2P lending allows individuals to transact with each other without the constraints of a major bank, financial institution, or a fiat currency’s borders and can serve the unbanked and those with poor credit histories. Almost anyone with an internet connection and a device can participate in P2P and DeFi lending platforms.

Cost and Efficiency

Removing third parties in lending and borrowing and using technology and automation with less focus on forms and background checks reduces costs and increases efficiency. P2P lending transactions are performed far more quickly than conventional loan application processes. 

Returns on Crypto Assets

Crypto P2P lending platforms provide an opportunity for crypto owners to earn interest on their assets whilst retaining ownership. Activities like yield farming and liquidity mining can generate passive returns from crypto holdings.

Security

Technological security is both a benefit and a risk of crypto P2P lending. Blockchain technology and smart contracts can be decentralized, transparent, and immutable, but they are still vulnerable to bugs and hacks.

Volatility and Loss

P2P crypto lending exposes both borrowers and lenders to the volatility of cryptocurrencies. The collateral a borrower commits can quickly decline in value, increasing the lender’s risk if the borrower defaults and risking a platform liquidating a loan depending on the loan-to-value (LTV) ratio required. Falling cryptocurrency prices can also affect the borrower’s ability to repay loans.

Credit and Counterparty Risk

Borrowers in crypto lending aren’t usually required to demonstrate their creditworthiness, and the chance of borrowers defaulting on a loan is higher than in conventional finance. Lenders are reliant on the value of collateral provided if a borrower defaults, which again can be impacted by the high price volatility of crypto assets.

Regulation

Global governments and financial bodies are still responding to the fast growth of the cryptocurrency and DeFi sectors and evaluating how to regulate them. Regulation, where it exists, is often complex.

Illicit Platforms and Scams 

A lack of regulation can expose DeFi users to risks, including scams and illicit actors, and there is zero consumer protection should funds be lost in a hack, rug pull, or if an entity liquidates.

Security

Traditional banks and financial institutions operate strict cybersecurity measures but can be at risk of data breaches and fraud. Cryptocurrency technologies can add security to transactions but have other risks, including bugs and hacks.

There are many risks associated with both cryptocurrencies and P2P lending which should be explored in detail by lenders and borrowers alike. Here at CoinHint, we’d advise investors to be aware of their risk tolerance, and deploy risk management strategies like diversifying their portfolios, while taking the maximum security measures available, including ensuring that platform smart contracts are regularly audited. 

There are numerous features to look for when choosing a cryptocurrency lending platform, and these include:

• Reputation and trustworthiness
• Security measures and controls
• Smart contract audits
• Supported cryptocurrencies
• Terms and fees
• Loan-to-value (LTV) ratios
• Annual percentage rate (APR)/interest
• User experience
• Features and services
• Regulatory standards/compliance

There are many well-reviewed crypto lending platforms, and an individual’s choice will depend on their activities, needs, and risk tolerance. AAVE, for example, is a decentralized lending and borrowing platform on the Ethereum blockchain. Users can deposit assets to AAVE’s liquidity pool and earn interest on funds loaned to the platform’s borrowers, with rates that are based on supply and demand. MakerDAO is another example where crypto owners use their assets as collateral and create DAI stable coins.

Depending on the purpose of the loan, both traditional lending from banks and financial institutions and non-crypto P2P lending may be alternatives to crypto P2P lending for borrowers requiring a loan.

Cryptocurrency owners seeking a return on their crypto holdings may explore several DeFi alternatives to lending. Staking and yield farming, for example, are popular methods investors use to put their crypto assets to work. However, these alternatives have their own risks. 

Crypto peer-to-peer lending, like its alternatives, has risks and advantages. Savvy investors and borrowers will research lending methods and platforms and weigh the benefits and potential downsides carefully against other options.

Evolving cryptocurrency regulation, continued price volatility in the cryptocurrency market, and the sector’s development over time will all influence the future of crypto P2P lending, and these are all important factors for any crypto user to consider. 

However, the crypto lending market is, also evolving with new features, platforms, products, security, and benefits likely to continue to improve its attractiveness.