Over the course of the epidemic, the overall market capitalization for cryptocurrencies has increased from around $150 billion to over US$2.5 trillion.1 Looking ahead, between 2021 and 2026, the market is anticipated to grow at a compounded annual growth rate of 60.8 percent. 2 Whether you believe in cryptocurrency’s widespread adoption as money or not, the large expansion of the crypto market indicates that crypto will be a form of financial asset that people will be interested in for years to come.
Despite the crypto markets’ strong performance, crypto-asset holders’ purchasing power is still somewhat restricted. This limitation exists in part because: there are few ways to spend cryptocurrencies on real world items and services, and crypto-asset investors would rather keep their coins because they expect them to appreciate in value. As a result of this approach, the value of cryptocurrency isn’t as leveraged as other financial assets and stays trapped in the wallets of the Bitcoin owners.
What is Crypto lending?
A lender loans fiat cash to a crypto-owning borrower and secures the loan by taking a security interest over the borrower’s cryptocurrency assets. The lender frequently retains control over the cryptocurrency assets in this connection, keeping them as collateral until the loan is paid off or liquidated. Typically, repayment of a traditional financial institution’s loan to a borrower in a centralized crypto lending relationship is made via cash payments spread out across the length of time specified in the terms of agreement. If a borrower fails to repay the loan, the lender may sell the crypto assets under its control in order to recoup the money they advanced. The Ce-Fi model, which is a centralized crypto lending relationship, differs from decentralized or peer-to-peer lending solutions that fall within the scope of decentralized finance (De-Fi). Money is often amassed by participant lenders in an application governed by code (i.e., smart contracts), which is utilized to create crypto loans, automate payouts, and create lender yields for certain participants in De-Fi lending arrangements.
In either scenario, the borrower may cash out and capitalize on their cryptocurrency assets, providing them liquidity without forcing them to sell off their underlying cryptocurrencies. In addition, the lender may profit by creating more secured loans with higher rates of return using a loan structure that protects it against default should the borrower fail to repay.
Legal considerations for crypto lenders
The Lenders’ Guide to Cryptocurrencies and Blockchain, which was published in January 2018 by The Futures Project, says that before providing a crypto loan, the potential lender must first grasp the contractual processes and remedies needed to secure a specific cryptocurrency asset and enforce their security interest in the case of default.
For example, a lender should consider the following legal factors:
Regulatory compliance: Maintain regulatory compliance with any relevant regulations that dictate whether and how it can provide crypto loans.
Taking security: Determine how to take a first-ranking security interest over the crypto asset.
Consider how to protect the position from significant price swings in the underlying crypto assets and, if required, devise a mechanism and procedure for demanding further collateral from the borrower.
Understand the rights that the borrower will have with respect to crypto assets serving as collateral throughout the term of the crypto loan. In some cases, a lender may make money not only from charging interest and collecting fee revenue on borrowings, but also from administering crypto deposits to generate yield earnings.
Collateral security: Create strategies to protect the crypto asset’s security throughout the loan term, including methods for ensuring proper key management and responding to changes in a blockchain that impact the collateral while it is in custody. Token exchanges, rollbacks, and splits are all examples of blockchain-related modifications.
There are a variety of exchange rates used throughout the world that don’t always reflect local regulations, taxes, and other factors. For example, in some countries (e.g., China), Bitcoin’s official price is higher than its market price due to government-imposed restrictions on foreign currency flows into the country; this difference may be significant and affect how loan proceeds are transferred from the lender to the borrower and when principal and interest payments are made back to the lender. The tax status of the underlying crypto asset will determine whether transfer limitations exist. A lender must first determine the type of crypto asset, such as a protocol token, application token, non-fungible token, or any other kind of cryptocurrency. As a result, the lender must evaluate the form of the crypto asset (e.g., a protocol coin), decide whether it is real property (i.e., tangible property or intangible property), and how that will impact loan terms. Currency, solidity
Repayment: What type of repayment will be used? Will it be paid back by cash installments or cryptocurrency?
Is there a contract in place that allows it to enforce security in a timely manner?
You should consult legal experts who specialize in secured lending and cryptocurrency to ensure you are properly managing your risk if you’re interested in joining the crypto lending market.