Over the last few months, there has been a ton of crypto news to digest. After all, the market has been more volatile than it was just one year ago, and talk of exchange collapses and a crypto winter dominate the news cycles. But perhaps one of the most surprising crypto phenomena occurred in May 2022 when the value of a well-known and respected stablecoin, TerraUSD (USTC), crashed from its peg at $1.00 to a little over $0.30 cents.
That may not seem like a significant dip when compared to other crypto tokens and coins, such as Bitcoin, which has been known to rise and fall by thousands of dollars in a day. However, TerraUSD is a stablecoin— which means that the value of the coin is meant to stay aligned with the value of the U.S. dollar. In the crypto world, stablecoins are the closest equivalent we have to dollar bills, so to have a trusted coin fall like Terra did is cause for concern.
That said, there are still tons of other stablecoins that have less likelihood of volatility, including USDT or Tether tokens. Like Terra, USDT is a stablecoin, but unlike Terra, the recent USDT volatility, which occurred when it dropped to $0.95 from $1.00, was brief and unexpected — and it occurred as a direct result of the drop in Terra’s value. If you’re holding USDT, you may have questions about what you should do with your assets, especially if you want to earn passive income on the tokens you’re holding. Well, the good news is that USDT lending can be a lucrative and relatively safe path to earn on your tokens. Here’s what you need to know.
- Stablecoins have different lending risks than traditional crypto, but in general, USDT lending is a safe and potentially lucrative avenue to take.
- Lending USDT typically results in a very solid return, especially considering that demand for stablecoin lending stays high.
- There are some risks associated with stablecoin lending, though, like loan defaults and market crashes, which we saw with TerraUSD recently.
What is USDT lending?
Like other stablecoins, USDT differs from most other cryptocurrencies on the market. While we typically think of fiat currency as being directly linked to a governmental body and crypto as unregulated, the waters get muddied when talking about stablecoins. Because USDT is a stablecoin, it’s directly linked to the value of the U.S. dollar, so it functions more like a third-party crypto-dollar bill than a token like Bitcoin or Shiba.
That said, USDT is still a cryptocurrency, which means there are a limited number of tokens available, and it does not function like the U.S. dollar does — at least not when it comes to exchanging currency. One of the ways you can use your USDT coins is through a process known as lending.
In the crypto world, lending means that you’re allowing borrowers to use your tokens for any number of purposes in return for interest payments on your assets. During this process, you are essentially locking down tokens for a period of time so that others can use them, which means you cannot interact with them. That’s the tradeoff for earning interest on what you loan to other crypto users.
How does USDT lending work?
One of the ways we can choose to lend our crypto is by way of a centralized exchange (CEX). These exchanges are more user-friendly and are simpler to navigate than their counterpart, a decentralized exchange (DEX), in both how and why they work.
Lending to a CEX allows you to earn interest because you’re essentially acting as a lender on the platform. The CEX acts as the middleman, accepting tokens from investors and offering them to borrowers who are seeking loans of certain tokens or coins. The borrower is typically required to put up collateral and pays interest on the loan. The interest payment is then split between the lender and the exchange, which takes some off the top for facilitating the loan.
The process of lending on a DEX, on the other hand, is a lot less streamlined. Unlike a CEX, a DEX does not act as the middleman in a loan deal. The loans (and other transactions) on these platforms occur in a direct peer-to-peer fashion, meaning that lenders are directly interacting with another user who wants to borrow their tokens.
This process of transacting on a DEX is regulated by smart contracts and automated money makers (AMMs). These terms are not required to understand how lending on a DEX works, but are interesting concepts nonetheless. These smart contracts act as automatic middlemen and are part of the coins being traded – which is possible because USDT is an Ethereum-based coin.
These AMMs are able to make these trades happen because of liquidity pools, which are basically pools of tokens from numerous users that are meant for one purpose — which in this case is to act as the liquidity for the loans given to borrowers on the platform. Where the AMM comes in is that it takes from and adds to the pools as necessary, which makes lending smooth and seamless on these platforms.
In other words, if you lend USDT or other currency on a DEX, you’re actually lending to a liquidity pool — and the token stockpile that comprises it. As a result, all lenders who contribute to a liquidity pool on a DEX will get a portion of the trading fees paid by the borrowers. The amount you’re paid for lending on a DEX is directly proportional to the assets you contribute to the pool.
CeFi USDT lending
Pros and cons of CeFi USDT lending
- Verified borrowers
- Easy interchange of fiat and crypto
- Simple to navigate for any type of user
- Temporary loss of token custody
- KYC verification requirement
Pros of CeFi USDT lending
The identity of anyone who engages with a central exchange has been verified prior to the transactions taking place. That’s because CEXs are required to follow the Know Your Customer (KYC) requirements, which means that they’re vetting every single account that is created on the platform. In turn, there’s less of a chance of dealing with shady borrowers on the platform, but even if there are some stragglers, you’re only ever dealing with the exchange itself when lending since it acts as the middleman.
Fiat on and off ramps
The interest payments you receive on the assets you loan are typically issued in crypto, not fiat currency. One big benefit of using a CEX to lend is that centralized exchanges typically make it easy to swap between fiat and non-fiat currency, which means that it’s easy to cash out and move the profits to your bank account when you want or need to.
Simple to use
Central exchanges are intuitive and user-friendly, which makes them a great option for new users, who may otherwise struggle to navigate the complicated DEX platforms. After you create an account and are verified, you log on, offer your USDT tokens for lending purposes, and then receive interest payments according to the exchange’s rate and interest payment schedule.
Cons of CeFi USDT lending
Token custody is given to the exchange
When you use a centralized exchange to lend your tokens, you’re giving up temporary custody of your coins to the exchange. This is antithetical to the idea of cryptocurrency, and opens users up to a number of risks, including losses from hacks, exchange closures, and other related issues.
Requires KYC verification
CEX users are also required to verify their identity to create an account, which typically includes offering personal information, identification documents, and other personal information. As such, you’re forfeiting anonymity and privacy, and in some cases, you may not even get approved for an account after offering up this information.
DeFi USDT lending
Pros and cons of DeFi USDT lending
- No verification required
- Active trading pools
- Retain control of tokens
- Recordkeeping can be tough
- Smart contracts can be glitchy
- High liquidity in place
Pros of DeFi USDT lending
No identity verification
There is no identity verification requirement when using a decentralized exchange, and therefore no loss of privacy or anonymity when engaging with these platforms. You simply connect your wallet and transact.
Active trading pools
Stablecoins, including USDT tokens, tend to be in high demand on DEXs, so the liquidity pools are typically very active. Lenders will typically see a high number of trades taking place related to stablecoins, and if you’re investing enough into the USDT pool, it can lead to very consistent returns.
Retain custody of tokens
Decentralized exchanges use smart contracts to make trades, which removes the middleman from the equation. As such, there is never a point in which you’ll lose custody of your tokens or be forced to temporarily give up custody to the exchange.
Cons of DeFi USDT lending
When you’re using a DEX, you’ll typically have to oversee any record keeping of the transactions you make for tax purposes or earnings calculations. A CEX has to keep their own records and allows users to access them, but a DEX has no such feature — which can be a problem when you need to calculate earnings.
Smart contract security
A lot of the popular DEXs have their own robust smart contract suites, but it’s not a guarantee of safety. Smart contracts allow DEXs to make trades, but are ultimately still just lines of code being run. That means there’s a chance for errors or bugs to appear — and because of the nature of smart contracts, these bugs will not go away.
High USDT liquidity
USDT is one of the most popular tokens to make trades with due to its value being directly tied to the U.S. dollar. While the demand remains high, lending to USDT pools could feel like you’re just adding to an overfilled pool, and the gains you make per transaction may be less desirable as a result.
USDT lending taxes
Crypto is defined as property by the IRS and gets taxed as any other income would. What that means is that if you have earnings from lending USDT, you’ll likely owe taxes on them. If you want to find out more about the tax specifics of your personal situation, it’s always a good option to speak with an accountant or tax professional who has a solid understanding of the crypto market.
Frequently asked questions about USDT lending
Is USDT lending safe?
Should I lend my USDT?
Where is the best place to lend USDT?
What are the risks of lending USDT?
How much can I earn from lending USDT?
Will I owe taxes on USDT lending?
Final thoughts on lending USDT
The trust in Tether took a hit earlier this year when the price fluctuated following the unexpected collapse of another stablecoin, Terra, which caused USDT to drop below the $1.00 mark. This has led to some skepticism related to the token — and rightfully so. Still, the USDT token remains one of the top coins used by crypto enthusiasts, which means that lending USDT can be a solid opportunity to gain some passive income and contribute to a stablecoin economy.