Crypto is certainly here to stay, and this is still just the beginning. According to a report by Insider Intelligence, 34 million US adults own cryptocurrency. This figure is expected to rise as more people are not only intrigued by crypto, but are also looking to fight the uncertainty of the economy.
Bitcoin has come a long way since early crypto adopter Lazlo Hayecz used 10,000 bitcoins to order two pizzas from Papa John’s. Spending is fun, but building up passive income is even better, and lending out your Bitcoin is a great way to build more passive income.
Before you can grab your piece of the Bitcoin lending pie, there’s quite a few moving pieces to be aware of from the start.
- You can choose how much BTC to lend at any time.
- Trust is everything in Bitcoin lending; the platform you choose should have a great reputation.
- Lending your bitcoin has its own risks to be aware of; there are still no guarantees in crypto!
What is Bitcoin lending?
Bitcoin lending is the process of lending out part or all of your Bitcoin holdings so that borrowers get access to the funds they need. In turn, you earn interest on the Bitcoin you lend out. This is a great way to earn passive income on your Bitcoin holdings; you get to watch your balance grow over time with lower risk compared to active trading.
While borrowers do have to put up collateral in order to access crypto loans, this is not a full guarantee. There are still risks to lending out Bitcoin; we’ll go over them in the sections below.
How does Bitcoin lending work?
Like with other crypto lending, there are two paths to Bitcoin lending. The first is CeFi Bitcoin lending, which is through a centralized exchange. The other is DeFi Bitcoin lending, which is lending on a decentralized exchange, which takes a bit more crypto know-how to navigate.
Most lending is done through CeFi, where much of the heavy lifting is already done for you. However, crypto users who want to potentially earn higher interest or have more control over the lending process may turn to DeFi Bitcoin lending. Each path has its own set of pros and cons.
CeFi Bitcoin lending
Since many people begin their crypto journey on centralized exchanges, where the learning curve is less steep, it only makes sense that CeFi Bitcoin lending is the most popular choice for users. After all, the crypto is already located on the platform — and it’s held in your account after you purchase.
Plus, centralized exchanges have made it easier than ever to lend out crypto. The platforms make money on lending out crypto, and they pay some of the interest to the user to reward them for making that crypto available.
It is very common for there to be a promo rate for CeFi Bitcoin lending, and interest rates vary by platform as well as over time.
Pros and cons of CeFi Bitcoin lending
- Easy to use
- Easier reporting
- Quick deposits/withdrawals
- No smart contracts needed
- Exchange has custody of crypto
- Higher fees
- More verification required
- Lower APY
Pros of CeFi Bitcoin lending
Here are a few more points about those pros:
- Simple: If you’re already accustomed to a centralized exchange, the lending process on CeFi platforms is built in.
- Easier reporting: Easier reporting means that it’s much simpler to track transactions for tax reporting later on.
- Quick deposits/withdrawals: Many centralized exchanges even allow for transfers to or from debit cards versus traditional bank accounts.
- No smart contracts needed: Since the exchange is doing the work, there is no need for smart contracts.
Cons of CeFi Bitcoin lending
Just as there are pros, there are certainly cons to CeFi Bitcoin lending:
- Custody required: When you hold your coins or tokens on a CeFi exchange, the exchange retains custody of your crypto, full stop. What if they go belly up? It would be uncommon, but is also a big risk — especially right now, while the market is experiencing a crypto winter.
- Higher verification required: Know Your Customer, or KYC, requirements are a real thing with centralized exchanges, which means they will want to verify your identity. This can end up being a long process and may involve you offering more information to the exchange than you’re comfortable with.
- Risk of collapse: Exchanges want to do what’s right for crypto users, but they will prioritize their operations. If that means that they have to shut down, they will. That puts your assets at risk.
- Higher fees: The more a platform does for you, the more fees you can expect. With CeFi exchanges, you’re typically paying for the convenience factor in the form of higher fees.
DeFi Bitcoin lending
In many ways, DeFi is the other side of the coin to CeFi — especially when it comes to Bitcoin lending. Where the centralized exchanges are about control, the DeFi side of the coin is about making things as free as possible. Of course, that freedom does come with some downsides, including the need to navigate between blockchains, understanding how wrapping Bitcoin works, and completing a process that includes a lot more complexity.
Yet the power is also in your hands. With DeFi, your crypto assets remain yours, and you can move them at any time.
If you want to lend Bitcoin on a DeFi platform, you have to either buy wBTC or "wrap" your existing BTC into wBTC, which represents Bitcoin, but on the Ethereum blockchain. One wBTC equals one BTC, and they can be swapped back and forth at a 1:1 ratio.
Pros and cons of DeFi Bitcoin lending
- Control of your crypto
- Less verification
- More flexibility with crypto assets
- No intermediary needed
- More complexity
- More dependence on smart contracts
- More transfers needed between crypto types
- Less support potentially compared to centralized exchanges
Pros of DeFi Bitcoin lending
- Control over your crypto: The crypto always belongs to you, full stop. You retain control over your tokens and coins.
- No KYC requirements: There’s no identity verification with DeFi lending; the verification requirements are much less arduous.
- More flexibility: You don’t have to lend out your entire crypto holdings; you select how much at all times.
- No intermediary needed: With DeFi lending, you get to actually drop the middleman, working directly with the other party borrowing your crypto.
Cons of DeFi Bitcoin lending
- More complexity: There’s a lot more complexity involved in lending Bitcoin, so you typically have to be good at managing crypto between wallets.
- Smart contract issues: Smart contracts are powerful, but power comes with its own set of issues. Smart contracts have been the target of hacking attempts in the past and will likely be at risk in the future, too.
- More transfers required: Not every crypto is on every blockchain, so you will have to prepare to be able to move from one crypto to another. This can increase the cost of the overall transaction.
Bitcoin lending taxes
Does anybody actually want to pay taxes? (If you do, you can take over our share; we won’t mind at all.) Yet taxes and money-making vehicles go hand in hand — and that includes Bitcoin lending.
It’s important to understand that the interest gained from Bitcoin lending is subject to be treated as taxable income for all intents and purposes. How you should handle this is based on your specific tax jurisdiction; it is outside of the scope of this article to give anything that can be construed as legal or tax advice.
Working with a tax professional that is crypto-aware is ideal to ensure that everything is not only well-reported, but that all taxes are accounted for as well.
Final thoughts on lending Bitcoin
Lending Bitcoin is a great way to put your crypto to good use for passive income purposes. Why let it just sit there when you can take a lower-risk way to grow your assets? While nothing is guaranteed with crypto, Bitcoin’s explosive popularity means that there are still people looking to borrow this crypto coin, which will let you earn interest in exchange.
It also works the other way with ease: if you need to borrow against your own holdings, you can do that as well. Instead of withdrawing your Bitcoin and facing capital gains taxes, it is possible to go the loan route and reduce total expenses. As always, there’s more than one way to go about things in the crypto world.
Frequently asked questions
Is Bitcoin lending safe?
Should I lend my Bitcoin?
Where is the best place to lend Bitcoin?
What are the risks of lending Bitcoin?
How much can I earn from lending Bitcoin?
Will I owe taxes on Bitcoin lending?