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Cryptocurrency: Interest Rates Explained

BitForex Editor
Dec 29, 2020

The idea of borrowing and lending digital currencies is currently making waves in the crypto finance sector. This sub-sector currently shapes how crypto assets are perceived and their value in the market. Even when lending and borrowing cryptocurrency is still in its infancy, there's been a consistent growth in crypto-lending platforms. As you may ask, what are the interest rates of each platform? Do they vary? Are they accessible to everyone? How volatile are these rates? We'd look into all of these shortly.

Interest Rates In Cryptocurrency

Like we've known with the traditional financial markets, the interest rates from financial institutions are determined by the current state of the economy. Factors like the current asset valuation models and the economy's health help banks set interest rates. However, interest rates in cryptocurrency are often determined by the constant increase in the demand for the assets. When incentivizing cryptocurrency users think to borrow an asset, they overlook the interest rates.

In traditional financial loans, collateral is mainly tied with the condition of the economy or currency valuation. Borrowers stand to lose a lot when the loans aren't paid back and the collateral has to be taken. The banks look at the future and present market value of your collateral before issuing a loan to lenders. Meanwhile, crypto lenders loan their cryptocurrencies because of the certainty they would earn higher returns from giving them out. It makes more sense because the interest rates are more beneficial than the profit from the assets seating in their wallets.

The rate for lending digital currencies is propelled by the continuous demand for borrowing which makes a lender realizes the interest on capital in a short period. Since the crypto market is always active, trading, and investment into the currencies increase daily. With this large stream of demand in a market, a lender could sacrifice a few coins for the greater good. In time, the borrower realizes just enough to return the borrowed cryptocurrency with interest.

Even when this sub-sector is still at its early stage, its viability attracts multiple crypto lenders by the day. Investors and lenders stand to benefit from the constant market activity and growth of the crypto market. In 2019, a little below 0.01 percent of the crypto-capitalization market was actualized from collateralizing loans. Every year, a fraction of the increase in the crypto market is actualized from cryptocurrency loans which means the interest rates have been favorable.

The Variance In Cryptocurrency Interest Rates

Unlike traditional financial loans, the interest rates on digital currency deposits could vary up to 4%. Of course, this is completely dependent on the individual crypto lender or the lending platform. Now, everyone keeps wondering why there's so much variance in cryptocurrency interest rates. The simple answer to that lies in the differences in business policies, structures, and models of the lenders. Crypto lenders have different clients and operate using various lending and borrowing structures.

Some service providers operate by borrowing cryptocurrencies solely from retail customers while they lend them in fiat. Nexo is one of the very few that operates with this style of leading but still within the 4% interest rate margin. Others process the loans of large institutional businesses in either fiat currency or crypto. On the other hand, we have DeFi lenders like MakerDAO that operates on a crypto-for-crypto lending and borrowing program.

The varying operational structures of these lenders are the reason they have variable interest rates. The cost of processing funds varies for each lender which affects their interest rates in the crypto market. Also, the service levels and fees attracted to each loan vary because their clients have different expectations. There's a prophecy, however, that crypto lenders with highly unstable interest rates would be handicapped in this business, and those with low rates wouldn't a great many borrowers.

There haven't been many facts backing those theories for years now, but certainly, the wide interest rates margin isn't favorable to a financial market. But the argument has always been that the crypto market isn't like any other financial market. Unlike other markets, this is a free market that eliminates the disadvantage of restricted business models and structures. The crypto market promotes the standards of operation through viable and active competition.

The Interest Rates Volatility

Perhaps the major reason people avoid crypto loans is the high volatility and fluctuations in the interest rates. The fluctuations and unsustainable volatility make potential borrowers find it difficult to keep track of the interest rates. The interest rates of cryptocurrencies have been known to witness a sudden and sharp declination between percentages over the years. Just recently, the Ether (EtH) dropped to a ridiculous 0.01% from 1.3% in interest rates over a short period on DeFi lending platforms.

Interestingly, major CeFi lending platforms also witnessed a massive decline mainly from 4.5% to 2.75% in the same period. Crypto analysts concluded this massive volatility in the interest rates to have resulted from the low demand by ETH borrowers. They also added that the stunted performance of the asset that year propelled the sudden decline in those rates. In the space of 6months in 2019, the ETH's market price struggled between a strong $334.5 high to a $127.8 low.

With the high risk in the crypto sector, it's no surprise we have this much volatility recorded in the borrowing and lending sub-sector of cryptocurrency. Yes, Bitcoin, the digital currency with the largest trade volume incurs annual volatility of 17% higher than US indices. The interest rates and price volatility for Bitcoin are not news since the currency has experienced increased demand over time. Here's the summary of how interest rates and digital currencies are being calculated. As long as the crypto loans increases, the volatility on the interest rates would decline.

Conclusion

Borrowing and lending, earning, or buying cryptocurrency are the various methods to acquire the currency. Meanwhile, the idea of lending and borrowing is still new but has gotten the attention of lenders and investors. The interest rates vary across the different types of lending platforms in the crypto market. However, the interest rates are highly volatile and unpredictably unstable resulting from the increase in demand for the currencies.

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BitForex is programmed in a way that it can quickly adapt to the changes of the Crypto market while introducing new features like margin trading, enhanced trading charts,  derivatives, and a host of others. The headquarter of BitForex is located in Hong Kong, while there are branch offices in countries like the United States, South Korea, and Singapore.

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