The primary use cases for crypto borrowing, according to research by Genesis Capital, can be bucketed into three categories: Speculation/hedging, trading/arbitrage, and working capital.
As cryptocurrencies are extremely volatile, lenders usually demand more than the borrowed value to be deposited as collateral (usually a minimum of 150%). The onerous collateral requirement for crypto loans precludes normal small-scale retail users from borrowing in cryptocurrencies to fund their short-term expenses (why would I have to deposit $150k in collateral to fund my $100k college fee expense?). With the current loan offerings largely unattractive to regular users, we can assume that most people who borrow crypto loans are doing so to gain leveraged exposure to the underlying collateral. We have covered the topic of how to gain leveraged exposure through borrowing in crypto in one of our previous editions.
With speculation and trading being the biggest use cases for crypto borrowing, the right comparison for crypto borrowing rates would be the interest rates charged for margin accounts in the traditional finance world. A quick look at the interest rates charged by leading brokerage firms such as Fidelity and TD Ameritrade indicates that the market rate charged for margin accounts with up to $50k in borrowed capital ranges from 8.5% to 9.5%, which is much higher than the 3-4% interest rates for housing and vehicle loans. This perhaps explains the high borrowing rates for crypto loans in the current scenario. It is also a reflection of the market acknowledging the fact that the underlying collateral in both crypto as well as margin borrowing, while liquid, is very much a volatile financial security/asset class, unlike an inert car or a house, which might not be as liquid, but is also relatively less volatile.
The market is still in its nascent stages, which explains the huge differences in rates between various DeFi lending platforms. In the figure above, for instance, Nuo offers 20% APR for lenders as opposed to 5% on dYdX. These figures also fluctuate frequently. Also, unlike in other spot and derivative markets, it is not an easy task to ‘arbitrage’ exchange rates across markets currently.