Why are crypto lenders central to the digital asset market?

The decision by Celsius to temporarily prevent its clients from withdrawing funds has shone a light on a group of crypto lending platforms that have been an important engine powering the growth of cutting edge industry projects.

These lenders have served as a bridge between do-it-yourself retail investors and the vast universe of decentralized finance or DeFi projects seeking financing to help them grow.

The core business model of lending platforms, which include BlockFi and Nexo, is similar to a consumer bank. The platforms take deposits from customers, and then lend that money out for an agreed period to mainly institutional borrowers, such as market makers. The lending platforms then take a cut of the interest on those loans, and pay the rest of the interest back to the depositors.

Consumers have flocked to these platforms because they offer typically interest rates of about 10-15 per cent on their investments, much more than conventional banks and even many traditional investments. Celsius last year said more than 1mn customers had used the scheme.

To meet their promises to pay those outsized returns, crypto lenders have branched out into sometimes riskier activities beyond simple lending. Some firms have themselves traded in crypto markets, such as futures.

But a portion of the money has gone to support new developments in the crypto industry. In particular assets have poured into DeFi projects, which mostly aim to offer replicate parts of the existing financial system, like a stock market, but shorn of the centralized authority that usually underpins the system.

Many need to be backed by pools of assets in order to run their blockchains, and will pay investors who are willing to put their money on the line for a longer period of time. In return, the consumer receives an attractive yield, which can vary depending on which crypto asset the customer has staked and is happy to receive as payment.

The total assets locked up in DeFi projects rose from $ 601mn at the start of 2020 to a peak of $ 253bn at the end of last year, before falling in recent months, according to data from CryptoCompare.

However, crypto lending platforms are generally not subject to the same regulations as banks, meaning clients’ funds aren’t backed by a government guarantee. And some lending platforms activities involve taking on more risk.

DeFi projects are often prone to hacks, design faults or disputes about how they should be run. Critics of lending platforms say that some companies take on excessive risk in their DeFi portfolios, and are not transparent enough on what they are doing with client’s money to generate their appealing interest rates.

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