Lending and borrowing: How to use DeFi to earn passive income

“If you don’t find a way to make money while you sleep, you will work until you die.” -Warren Buffett

In the crypto world, you can actually make profit while sleeping. In most cases, people hold their digital assets until price appreciation applies, and this can take a rather long time. During this time, instead of keeping the cryptos lying in the digital wallets, one can put them to good use. The ecosystem is conducive to multiple passive income opportunities, where you can use your crypto holdings to make more cryptos. The most popular ways to do so is through lending and borrowing — this has become a key aspect of crypto-based financing in recent years.

You can either use your cryptocurrency as collateral (this works similarly as a mortgage but requires no physical assets or complex paperwork) for a loan; or you can lend your digital assets through the decentralized lending platforms and earn interest, known as crypto dividends — which can vary between 3% and 7% and even go up to 17% in case of stablecoins — on the same.

The concepts are very similar to the ones done through traditional banks, only here you use cryptocurrencies (in some cases, even stablecoins) instead of fiat currencies, and instead of banks you have decentralized crypto exchanges or lending/borrowing platforms. These decentralized platforms can be of two kinds. While automated platforms gives you dividends soon after you deposit assets in the crypto wallet, in a manual platform, one needs to manually stake a certain amount of cryptos to generate dividends. Most such platforms would require you to stake 25% to 50% of the loan in crypto which can be used by the investors to recover the amount in case of non-repayment of the loan.

Borrowing:

This works in a similar fashion as mortgages; here instead of your house or a physical asset, digital asset is uses as the collateral. Unlike a regular mortgage, this is a much faster process and requires no credit checks. Also, the interest rates are much lower than traditional borrowing involving a bank.

There are platforms that require you to use particular kinds of crypto that might be different from what you own; you can use the crypto you own as a collateral and get the crypto that you can use in that particular platform. You need to check with the platform beforehand if they have the required crypto listed on their platform as not every borrowing platform would have all varieties of cryptos.

Lending:

Crypto lending is an integral part of decentralized finance and allows people to earn interest, known as crypto dividends, on their cryptocurrencies and stablecoins by lending them to borrowers. This is a lucrative way of earning steady passive income from your digital assets.

This works like a traditional savings account. Here you deposit your digital assets in the wallet of a crypto lending platforms that make it available to institutional/individual borrowers to lend, and earn interest the rate of which is much higher than that of traditional savings accounts. Also, here you need not lock in your assets for a fixed amount of time. This process generates yield for the lender and liquidity for the borrower and is thus mutually beneficial.

The process:

The process requires a borrower, an DeFi platform and a lender. In this, the borrower asks for a loan from a crypto lending platform offering his/her crypto-assets as collateral. The platform attaches the same for the lender to give the loan. The borrower gets back the collateralized digital asset once s/he repays the entire borrowed amount. You can also borrow fiat currencies against your cryptocurrency without having to sell them.

In case the borrower is unable to repay the loaned amount the lender can liquidate the borrower-staked cryptocurrency kept by the lending platform as security.

The main drawback of this however is that as the borrower, you cannot use or liquidate the cryptocurrency you have collateralized unless you pay back the entire loaned amount. In case there is a market crash, you can’t sell off the digital asset to minimize loss.