DOT Lending: What to Know About Rates, Exchanges, Risks and Benefits

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Best lending rates available from top lending platforms for October 7, 2022

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Crypto lending has become a hot commodity among crypto enthusiasts, who can reap the benefits of putting their unused tokens up for borrowing purposes. Much like traditional lending, borrowers put up collateral in order to take advantage of crypto loans. What differs is that it’s not banks or credit unions offering the loans — it’s other holders, who offer their tokens and rake in the interest payments in return.

And, one of the tokens that crypto holders are putting to work is DOT, the native token of the Polkadot platform. DOT is a governance token, allowing holders to have control over the Polkadot protocol through voting, and it’s also used to validate transactions that occur on the Polkadot network. If you’re holding DOT in your wallet and don’t need access to your tokens in the immediate future, lending out your DOT just might be the right move for you.

Before you get started, though, it’s important to understand how DOT lending works, as knowing how to navigate the lending landscape is an important step in the journey. By understanding the functions and benefits of DeFI (decentralized) lending and CeFi (centralized) DOT lending, it will be a lot easier to determine which path is right for you.

Key takeaways

  • Crypto borrowing is in high demand, and borrowers can use the tokens from their loans for a number of different purposes
  • Individual crypto holders can rake in the interest payments by loaning out their DOT tokens on a number of exchanges
  • Lending can be facilitated on DeFi and CeFi platforms — and there are pros and cons to both options

What is DOT lending?

DOT lending is quite similar to traditional lending. Borrowers take out loans for the DOT tokens they need — whether for trading or other purposes — and then pay back the crypto loan with interest over time. They’re typically required to put up collateral in the form of another type of crypto to borrow what they need, which helps to ensure that the loans are paid back.

The main difference is that the banks and credit unions that facilitate mortgage lending or personal lending aren’t the ones initiating the DOT loans. Individual crypto holders are — and are the ones being paid the interest in return. Another difference is that there aren’t the long waits for funding, the copious amounts of paperwork, or other traditional loan requirements. It’s a simple process, one that can be navigated quickly and easily.

How does lending Polkadot work?

If you’re interested in lending out your DOT, you can do so through CeFi and DeFi platforms. When you lend out DOT on a decentralized exchange, you’re offering it in a peer-to-peer manner. When you’re using a centralized exchange, the exchange acts as the middleman, facilitating the lending process and taking a fee, typically a portion of the interest payments, in return. There are possible benefits and downsides to both options, but either way, you’ll earn interest on the DOT coins that are sitting unused in your wallet.

Lending on either type of platform is similar to traditional lending. There are borrowers who apply to take out a loan and then put up collateral to guarantee that the loan will be repaid. After the collateral is received, the borrowed crypto is sent to the borrower’s wallet. Depending on the loan terms, the borrowed crypto is paid back, with interest, to the lender — which can be either the exchange or the individual lender or lenders.

If the loan is completed on a decentralized exchange, the interest payment will go directly to the lender (in a peer-to-peer decentralized situation) or get divided among the lenders who pooled their tokens for borrowers to use. If the loan was facilitated on a CeFi exchange, the exchange will facilitate repayment and disburse the interest to lenders after taking a portion of the interest payment.

CeFi DOT lending

When it comes to DOT lending, there’s a lot of appeal to using a CeFi platform. For starters, CeFi platforms are built to cater to newer crypto users — and the slick interface and user-friendly functionality tend to be a big draw. Exchanges like Nexo, Binance, and BlockFi are all centralized platforms that are well established in the market. However, the rates of interest paid on DOT and other crypto loans will vary from exchange to exchange.

CeFi exchanges aren’t just easier to navigate. They’re also easier when it comes to lending because the exchange acts as a middleman between the borrower and the lender. This removes any hurdles to finding a borrower and navigating the loan process. It also ensures that the verification process has been completed on the borrower, which can make lending safer.

Pros and cons of CeFi DOT lending

Pros

  • The lending process is simple and easy to navigate
  • Transaction tracking makes tax reporting a lot easier
  • Deposits and withdrawals are streamlined
  • No smart contract knowledge necessary

Cons

  • The fees tend to be higher
  • The exchange takes temporary custody of tokens
  • Long verification process

Pros of CeFi DOT lending

A simple lending process that’s easy to navigate

Because the exchange acts as a middleman for the lending process, the loan process on a CeFi exchange is basically plug-and-play. Users are verified by the exchange, loan collateral is collected by the exchange, and loans are repaid with interest and then dispersed by the exchange. That makes it extremely simple to get started with DOT lending, even for novice crypto users. All users really have to do is connect to the exchange and offer up tokens for lending. The exchange takes care of the rest.

Transactions are tracked, which makes taxes easier

CeFi exchanges track the transactions that occur on the platform, and you’re able to access a log detailing what occurred with your account. That makes it a lot easier than it otherwise would be to keep track of the transactions that could affect your taxes. In fact, the complicated tax reporting that goes hand in hand with crypto is a big deterrent for many people, so having a detailed report of the profits you made from lending is a major perk.

Deposits and withdrawals are streamlined

A CeFi exchange can act as an onramp for withdrawing and depositing fiat currency — which can come in handy when you’re earning interest payments. In fact, some centralized exchanges will let you transfer to or from a debit card rather than requiring you to use a bank account — which can further streamline the process. That makes it simple to get direct access to your money when you need or want to.

No smart contract knowledge necessary

A major benefit of using a CeFi exchange is that you don’t need to have prior knowledge of smart contracts — or how to use them. Centralized exchanges don't use smart contracts to carry out actions for users, instead, transactions and trades are processed by the company's internal tools and protocols.

Cons of CeFi DOT lending

The exchange takes temporary token custody

When you lend your tokens on a CeFi exchange, you’re giving up temporary custody of your tokens to the exchange. That can put you at the mercy of the exchange — and if something happens to the exchange itself, like bankruptcy or collapse, you could lose your tokens for good.

Long and invasive verification process

CeFi exchanges are required to have U.S. customers follow a strict verification process before they can use their accounts. As part of that process, you’ll have to provide a number of identifying documents and offer certain information, which could include your Social Security number, your ID, and may also include a phone call with a representative of the exchange. That may not seem like a big deal, but the anonymity of the crypto market is a big draw for many users, so these requirements can be a big turn-off. The process can also take a while, which can mean long waits before you can lend.

The fees tend to be higher

Higher fees are the price you pay for the convenience of using a CeFi exchange. If you’re using the exchange sparingly it may not be a big hit to your pocket, but if you’re doing high volume trades, or if you’re trying to maximize your interest payments from lending, it can cut into your profits quickly.

DeFi DOT lending

Opting for a DeFi platform removes the middleman — which cuts down on fees. With a decentralized exchange, you’re conducting peer-to-peer lending instead. This can occur either directly with a borrower or by pooling your tokens with other lenders and then offering them to borrowers.

There are perks to doing this, including lower fees and higher interest rates. You also don’t have to complete the long verification process that you otherwise would with a CeFi exchange. However, you’re taking on a bit more risk — and may be in for a longer wait if you have to hold off on lending until a borrower comes along.

DeFi platforms can also be a little tricky for new users, as they’re not nearly as slick or easy to navigate. You’ll need a bit of experience with the crypto market — and may also want some experience with lending before trying to navigate one.

Pros and cons of DeFi DOT lending

Pros

  • Lower fees mean bigger profits
  • Lenders retain custody of their tokens
  • KYC verification requirements aren’t involved

Cons

  • Not ideal for new users
  • Tax reporting can be tricky

Pros of DeFi DOT lending

Lower fees mean bigger profits

By removing the middleman, you’re lowering the fees you’re paying as a lender — which means bigger profits in some cases. However, you’re dealing with a lot of the lending details yourself since the exchange won’t be the one to facilitate it. Still, not having to worry about the extra costs eating into your lending profits can be a big draw.

Lenders retain custody of their tokens

When you use a decentralized exchange, you aren’t handing over the custody of your tokens to a company to lend out on your behalf. When lending Polkadot on DeFi protocols, the middleman is cut out and users have much more control over their tokens through their wallets and interacting with smart contracts.

KYC verification requirements aren’t an issue

Lenders or borrowers who use DeFi platforms aren’t required to go through the Know Your Customer verification process — which can keep the anonymity of the market intact and also streamline the process of lending. Without the long verification process, you can simply log on with your wallet and offer your tokens to borrowers in a matter of minutes.

Cons of DeFi DOT lending

Not ideal for new users

If you’re a new user, a DeFi platform may not be the right option for lending your DOT to borrowers. DeFi exchanges aren’t really built to cater to novice users. They’re better for experienced users, as you'll need to understand how to set up a DOT-compatible wallet, send funds to that wallet (or purchase DOT within the wallet), then connect the wallet with the dApp of your choice to begin lending. Furthermore, you need to be comfortable with practicing security habits like disconnecting your wallet when you're done trading and securing wallet recovery phrases.

Tax reporting can be tricky

Unlike CeFi exchanges, DeFi exchanges don’t track the transactions that occur in your account. In fact, you don’t have an account on a DeFi exchange; you simply log on and complete transactions. That can make it very tricky during tax time — and could lead to a slippery slope if you aren’t careful.

Polkadot lending vs. staking

Lending isn’t the only option you have for earning returns on your crypto. Staking is another popular choice — and you’ll earn rewards for doing so. When you stake your DOT tokens, you’re helping to secure the network and validate transactions. In return, you’re paid rewards — typically in the form of the crypto you’re staking.

There are numerous ways to stake DOT, but the minimum you will need to begin staking is 120 DOT. If you don’t have that many tokens, you may have the option of joining a staking pool on a platform. The minimums for staking pools will vary depending on which platform you choose. The big difference between staking and lending is that you’re not lending out your tokens to borrowers when you stake; you’re helping the network complete important tasks instead.

DOT lending taxes

If you are earning profits when lending your DOT, there is a good chance you are going to owe taxes on that income. According to Notice 2014-21, the IRS sees the profits you earn on DOT, or any other crypto, just like any other type of income.

That said, you aren’t going to owe taxes for simply lending your DOT to borrowers. You will owe taxes on the profits you receive from lending out your DOT, which is what you will be taxed on. Crypto taxes can be tricky, so if you have specific questions about your situation, your best bet may be to consult an experienced tax professional with knowledge of the crypto industry.

Final thoughts on lending DOT

There are big benefits to lending your DOT tokens to borrowers, but as with any other crypto transaction you make, it’s important to know what you’re getting into. It’s also important to do your homework on what platforms and exchanges may be your best bet. If you want to earn on your DOT without lending, you may have other options, like staking, which has an annual average yield of 10% — a huge draw for crypto enthusiasts. Ultimately, the goal is to put your crypto tokens to work, and how you do that is up to you.

Frequently asked questions

  • Is DOT lending safe?

  • Should I lend my DOT?

  • Where is the best place to lend DOT?

  • What are the risks of lending DOT?

  • How much can I earn from lending DOT?

  • Will I owe taxes on my DOT lending profits?