CryptoStudio Crypto Lending Glossary: Key Crypto Lending Terms Explained
In this article, you will learn…
- the relevant terms of the Crypto Lending industry,
- the concepts and definitions you need to know to understand the articles in our Lending ABC.
The base rate is the interest rate that investors get paid on a crypto savings account without meeting any conditions other than investing a cryptocurrency. This base rate is usually paid out "in-kind," meaning in the cryptocurrency in which the saving account is denominated. It does not include interest payments paid in Lending Tokens, bonus interest, or dividend distributions. In the case of crypto loans, the base rate is the interest rate a borrower has to pay on loans secured by the respective cryptocurrency without meeting any conditions other than pledging the cryptocurrency as loan collateral.
A blockchain is a database technology that stores data in encrypted form. Contrary to most conventional database technologies, there is not just a single copy of the database but multiple copies stored on a decentralized and globally distributed computer network. Every time a user changes the database, all copies of the database will be updated. As a result, the stored data is tamper-proof because data entries must always be matched against all copies of the database. The blockchain thus solves a central problem of digitization: It makes digital data immutable.
CeFi stands for "Centralized Finance." Centralized Crypto Lending platforms are owned and operated by a centralized entity such as a private company. CeFi platforms usually offer customer service, hold licenses, and are regulated by the law in their respective jurisdiction.
In crypto lending, borrowers must provide loan collateral in cryptocurrencies to receive a loan either in fiat currency or in another cryptocurrency. The amount of loan collateral required compared to the loan amount varies from provider to provider and is specified by the Loan-to-Value ratio. Usually, the more loan collateral deposited, the lower the interest rate.
Conditional Interest Rate
Crypto savers can get a higher interest rate than the base rate if they meet certain conditions specified by the crypto lending platform, for example, by agreeing to receive their interest payments in the platform's native lending token or by committing to lock-up periods. Borrowers can reduce their loan interest rate by, for example, investing in a Lending Token or paying their interest in a Lending Token instead of a fiat currency.
Compound interest means that not only the invested amount earns interest, but the interest earned in the past is included in the amount that earns interest during the next interest period. With compound interest, savers not only receive interest on their initial capital but also on the interest credited in previous interest periods.
Crypto-backed loans ("crypto loans") are loans paid in either fiat or cryptocurrencies and collateralized by cryptocurrencies. The lending platforms specify the ratio between the loan amount and the required loan collateral through the Loan-to-Value ratio.
A cryptocurrency is a blockchain-based token that can be used as a means of payment. It is also referred to as a "payment token." When making a payment with cryptocurrencies, the money is not sent via the banking system, as is the case with fiat currencies, but via a blockchain network. For example, if someone sends the cryptocurrency Bitcoin, the global Bitcoin blockchain is updated by deleting the amount from the sender's wallet and adding it to the recipient's wallet. Unlike in traditional banking, this operation is automated using smart contracts. Since all transactions are stored in an immutable blockchain database, banks or other financial service providers are no longer needed to monitor the payments.
Crypto Lending refers to the lending of cryptocurrencies. Lending transactions are usually collateralized with other cryptocurrencies, similar to traditional securities lending. Savers who provide cryptocurrencies for lending receive interest in return.
Crypto Lending Platform
Users can find mainly two offerings on crypto lending platforms: Cryptocurrency-backed loans and crypto savings accounts. Crypto lending platforms are classified as either CeFi ("Centralized Finance") or DeFi ("Decentralized Finance") platforms.
Crypto Savings Account
Savers can invest cryptocurrencies in crypto savings accounts and get paid interest. The savings accounts providers usually generate the capital to pay interest to the savers by lending the deposited cryptocurrencies to third parties.
DeFi stands for "Decentralized Finance." Decentralized crypto lending platforms are not owned and operated by a centralized entity such as a private company but are governed by a blockchain-based protocol that automates all operations using smart contracts. Such platforms usually do not offer customer service and are typically not regulated by law.
A fiat currency is a currency issued by a central bank, for example, the US dollar, the euro, or the British pound. A fiat currency's intrinsic value is based on its function as a widely recognized government-backed means of payment and store of value.
Lending tokens are cryptocurrencies issued by crypto lending providers, who use these tokens to fund or operate their crypto lending platforms. Crypto lending users who invest in these tokens typically get better interest rates on the respective crypto lending platform.
A liquidation of loan collateral can happen if a borrower fails to post additional collateral after receiving a margin call or if the Loan-to-Value ratio (LTV) rises above a certain threshold (usually, this threshold is between 90 and 100 percent). The crypto lending provider then has the right to sell ("liquidate") the borrower's loan collateral and use it to repay the loan balance until the pre-agreed LTV is restored. Some providers even maintain the right to sell 100 percent of the loan collateral and repay the loan in full, but that's not industry-standard.Loan-to-Value Ratio (LTV)
The Loan-to-Value Ratio (LTV) describes the ratio between the loan amount and the value of the cryptocurrencies deposited as loan collateral. The LTV decreases when the value of the loan collateral increases or a portion of the loan amount is repaid. The LTV increases when the value of the loan collateral decreases or a higher loan amount is drawn. Most crypto lending providers require an LTV of 50% for a loan. If borrowers choose a lower LTV, they must deposit more loan collateral and typically receive a lower loan interest rate in return. If the LTV exceeds a critical value, for example, because the market value of the loan collateral drops, the lender usually triggers a margin call.
If the Loan-to-Value ratio (LTV) exceeds a critical threshold – meaning the value of the crypto loan collateral approaches the loan's value - the crypto lending platform will trigger a margin call. The critical threshold at which this margin call is triggered varies from platform to platform and is usually between 60 and 80 percent LTV. When a margin call happens, the borrower is notified by the crypto lending platform, usually via email, text message, or phone, and required to restore the agreed LTV. The borrower then either partly repays the loan or posts further loan collateral. In most cases, the borrower is given a time limit within which the agreed LTV must be restored. If the borrower does not comply with this request or if the LTV continues to rise, the loan collateral may be (partially) liquidated.
A smart contract performs certain operations automatically, based on an if-then function. When a specific criterion is met, the smart contract automatically triggers an action. In crypto lending, operations like loan payouts or interest payments can be automated with smart contracts. For example, using the following if-then function: "If the borrower deposits 10 Bitcoin as loan collateral, he will receive 50 percent of the current market value as a loan paid out in USD Tether." Such smart contracts are used in particular by DeFi platforms.
A stablecoin is a cryptocurrency whose value is pegged to an asset with stable value, such as a fiat currency, a precious metal, or a real estate basket. The goal is to reduce the volatility of the cryptocurrency so that it may be used as a reliable means of payment or store of value.
"Token" is an umbrella term for digital assets securitized on a blockchain. There are three main types of tokens:
· Security tokens securitize a security.
· Utility tokens securitize a right to use a blockchain platform.
· Payment tokens act as a means of payment.
The term "cryptocurrency" is often used as a synonym for payment tokens.
Tokenomics describes the business model of a blockchain-based token. In Crypto Lending, the tokenomics of a Crypto Lending token describes the business model of the crypto lending platform issuing the lending token and the yield development of the lending token. Anyone who wants to invest in a crypto lending token should understand the tokenomics of the respective provider.