Historically, traditional financial services like lending and borrowing were only available through established banks and financial institutions. However, the introduction of blockchain technology has shaken things up. In particular, the expansion of cryptocurrency to include stablecoins like DAI and USDT has led to an entirely new facet of lending outside of traditional banks and credit unions.
Unlike traditional lending, however, stablecoin lending is not facilitated by brick-and-mortar lending institutions. As with other types of crypto tokens, stablecoin lending is done on crypto exchanges, and is facilitated by crypto users who want to earn passive income on their tokens. With this type of lending, crypto users who hold stablecoins earn returns on their assets by lending their tokens to other users, who can then use the tokens for any number of purposes. In return, the lenders are paid interest on the tokens they loan out.
This type of lending can be done on a number of different platforms, including both decentralized (DeFi) exchanges and centralized (CeFi) exchanges. There are pros and cons to both DeFi and CeFi stablecoin lending, and there are also some potential benefits and downsides to stablecoin lending itself. Before you jump into this type of lending, it’s important to know what you’re getting into. Here’s what you need to know about stablecoin lending, from the risks to the benefits and more.
- Stablecoin lending is just one of the lending options that crypto users have when it comes to earning passive income on their assets.
- While there are numerous platforms to choose from, CeFi lending comprises 80% of crypto loans — including loans made with stablecoins.
- While DeFi lending isn’t as popular, there are perks to lending stablecoins with a decentralized exchange, including greater control over your assets.
What is stablecoin lending?
Stablecoin lending refers to loans made with stablecoins, like USDC, DAI, BUSD, or USDT (Tether). Stablecoins are cryptocurrencies that have their value tied to a fiat currency such as the US dollar or Euro. In turn, the stablecoin values don’t fluctuate wildly like the values of other crypto tokens do, which means that there isn’t much room for traders to capitalize on the volatility of these coins.
To make money on stablecoins, many crypto users opt to lend out their tokens on exchanges instead. This lets them earn interest on the stablecoins they lend while providing the necessary tokens to borrowers. It’s a smart way to earn on coins that don’t perform the way that other types of crypto do, but the interest rates earned by borrowers can vary significantly based on the exchange, the demand for certain types of stablecoins, and other factors.
How does stablecoin lending work?
Stablecoin lending works much like any other type of loan would from a standard financial institution. Borrowers put up collateral on an exchange or platform and then access the funds they desire. In return for borrowing, they pay interest to the lender. The big difference is that In this case, most users are providing crypto as collateral — and it’s other crypto holders who are doing the lending.
Many of the other details are similar to traditional loans. The loan is issued against the collateral to ensure that it’s repaid to the lender, and the loan is repaid with interest — typically within a specific amount of time.
While crypto loans are a much newer method of borrowing compared to traditional loans, these types of loans are quickly becoming more popular due to a number of enticing features, like generally low interest rates, no credit checks, low or no transaction fees, and instant funding.
CeFi stablecoin lending
Most users opt to lend their tokens on CeFi platforms, as these platforms are typically the most user-friendly option. One big difference between centralized and decentralized platforms is that centralized exchanges require users to complete a Know Your Customer verification process.
That process is required by law, but it can be somewhat intrusive and laborious on the side of the user. It also typically requires you to verify your identity with numerous steps and documents, removing the anonymity that cryptocurrency otherwise provides. However, the trade-off is that crypto transactions are streamlined in a user-friendly way, and that’s especially true for lending.
When you lend stablecoins or other types of tokens on a CeFi platform, you’re typically able to just log on, offer your tokens to the exchange for lending purposes, and then sit back and rake in the interest payments. You may have to agree to lock your tokens up for lending for certain periods of time — typically between a few days and a few months or more — but not all exchanges require a time commitment for lending.
There are multiple CeFi lending platforms to choose from, including BlockFi, Gemini, and Nexo. These platforms give the lender access to simple crypto collateral lending with stablecoins. Rates of return vary from platform to platform, but can be as high as 7% to 10%, depending on the token and the exchange.
Pros and cons of CeFi stablecoin lending
- Easy to use, no matter your experience level
- Stablecoin interest rates tend to be pretty high
- Customer support is available
- Limited lending options
- Exchange temporarily takes custody of your crypto
Pros of CeFi stablecoin lending
Easy to use for any experience level
The main benefit of lending stablecoins on a CeFi platform is that these types of exchanges are typically user-friendly. All you have to do is find a CeFi platform that offers lending and then complete the initial KYC process. From there, it’s typically smooth sailing.
Stablecoin lending rates are typically high
Stablecoin lending is in high demand — and the demand often exceeds the supply. This works out great for lenders, who are able to capitalize on the demand in the form of higher interest rates on the coins they lend to borrowers on these platforms. Rates typically exceed double-digits, which means big returns for lenders. Plus, there’s little in the way of volatility with stablecoins, so you don’t have to worry about the token losing value while borrowers are using it for other purposes.
Customer support is available
Unlike decentralized exchanges, CeFi exchanges offer access to customer support, which can come in handy if you’re in need of some assistance with your lending or other transactional needs on the platform.
Cons of CeFi stablecoin lending
The exchange takes temporary custody of your tokens
When you lend on a CeFi platform, you’re giving the exchange temporary custody of your tokens. This may not be an issue with most platforms, but on the off chance that the exchange were to fold, you would lose your tokens in the process. That risk is typically minor, but it can be a big deterrent for some users.
Limited lending options
Unlike DeFi platforms, the token options can be limited on CeFi exchanges — and that includes the lending options. Some exchanges may not offer the stablecoin lending options you want, or may offer rates that are lower than average for that type of lending. As such, you may have to search to find the right platform.
DeFi stablecoin lending
DeFi exchanges are another option that you may have for stablecoin lending. When it comes to lending any tokens, decentralized platforms have a much steeper learning curve to contend with when compared to centralized platforms.
That’s because, unlike CeFi platforms, DeFi platforms aren’t required to validate customer identities — you simply log on with your wallet and swap, borrow, or lend your tokens. That may sound like a big benefit, but the platforms you’re logging onto are typically pretty utilitarian, and they require at least some expertise or know-how in the crypto space.
You’re also lending directly to other crypto users in many cases or taking part in a liquidity pool, which is a pool that combines users’ tokens and then allows borrowers to utilize them. That can make the transactions a little more complicated — and the options may be limited to certain tokens as well.
That said, there are a few different DeFi options that you can choose from, including MakerDAO (Oasis), Aave, and Compound — all of which offer different rates or returns on lending. For example, the MakerDOA (Oasis) platform allows crypto users to lend out their tokens to generate DAI, which is a stablecoin pegged to the U.S. dollar.
The lending rates can vary on Oasis but historically range from 0% to 8.75%. Aave offers different yields and interest rates to lenders, but they typically range between 1% to 3%.
Pros and cons of DeFi stablecoin lending
- Retain custody of tokens
- Hefty potential returns for lenders
- High demand from borrowers
- Difficult for new users to navigate
- Smart contracts may have exploits
- Tax reporting is more difficult
Pros of DeFi stablecoin lending
Retain custody of your tokens
When you use a DeFi exchange to lend stablecoins, you aren’t giving up custody of your tokens to a centralized exchange exchange. The platform simply facilitates the lending transaction via smart contracts; it doesn’t act as a middleman during the transaction. As such, you retain greater control of your tokens throughout the process.
Demand is high
One of the risks you take when lending your tokens to borrowers is that there won’t be much demand for the tokens. That isn’t the case with stablecoins. The demand for stablecoins is high — and the demand often exceeds the supply. This works out great for lenders, who don’t have to wait long for a borrower to come along like they may have to with other tokens.
Returns can be hefty
Rates on stablecoin lending vary, but can be quite high when there's an uptick in demand from borrowers on DeFi platforms. This can translate to a potential for big returns for lenders. Plus, there’s little in the way of volatility with stablecoins, so you don’t have to worry about the token losing value while borrowers are using it for other purposes.
Cons of DeFi Stablecoins lending
Exploitable smart contracts
While the risks of lending stablecoins on DeFi platforms are limited, they do exist. DeFi lending protocols run on smart contracts, which are a web of complex codes that auto-execute when certain conditions are met. Since many DeFi protocols make their codes open-source, their smart contracts are at risk for malicious actors to find exploits and drain funds.
Difficult for new users to navigate
DeFi exchanges aren’t user-friendly. They’re not built for the user experience; they’re built for utility. If you aren’t somewhat familiar with the crypto market, or if you’re just starting out, it may be too labor intensive for you to navigate a DeFi exchange, at least initially.
Tax reporting is more difficult
CeFi exchanges keep records of the transactions that take place on the platform, which can streamline the tax filing process. On the other hand, DeFi exchanges do not track transactions, which can make it difficult to keep track of profits, losses, and other necessary financial information. In turn, that can make the process of filing your taxes a lot more difficult.
Stablecoins lending taxes
If you’re earning interest by lending stablecoins to other users, you will likely owe taxes on the profits. According to the IRS, stablecoins are listed as “property” under Notice 2014-21 — so the interest you earn is considered to be income, just like any other type of income you’d earn.
Your crypto loan transactions are typically categorized one of two ways by the IRS. If you are earning the same crypto that you loaned to borrowers, you will be paying income tax on the profits. If you are receiving a different kind of crypto in return for lending, this is likely categorized as a capital gain and you will be paying a capital gains tax. However, it’s always best to consult an experienced tax advisor who can work with you on the specifics of your situation.
Frequently asked questions about stablecoin lending
Is stablecoin lending safe?
Should I lend my stablecoins?
Where is the best place to lend stablecoins?
What are the risks of lending stablecoins?
How much can you earn by lending stablecoins?
Will I owe taxes on stablecoin lending?
Final thoughts on lending stablecoins
If you’re looking to earn passive income on your crypto, lending out your stablecoins can be a great option. Stablecoins aren’t subject to the typical volatility of other tokens, like Bitcoin or Ethereum, so when you lend these tokens out, you aren’t risking a market collapse or impermanent loss. There will always be a risk with lending, of course — including borrower defaults — but stablecoins tend to be less risky than other options.
They tend to be more lucrative, too. There’s a significant demand for stablecoin loans among crypto users, which means that the rates for these types of tokens are often much higher than you’d get with other types of crypto. That can be a big draw for certain types of crypto users, but it’s always important to understand what you’re getting into before you make any moves.
Choosing the right platform can make lending a lot easier and safer. Take your time to research what the different platform options have to offer you as the lender. Make sure you understand the process fully — and the pros and cons of each platform.