Yield by lending Cryptocurrencies – the Possibilities
With the advent of Smart Contracts by Ethereum, the application possibilities were not long in coming. Peer-2-peer rental platforms (also called lending) are an exciting and revolutionary application. In addition, central platforms such as crypto stock exchanges or financial intermediaries such as Bitbond, offer crypto rental. The credits in all possible cryptocurrencies promise money increase and small risk. Let us look at some possibilities of the crypto rental business.
- Unchained Capital
Decentralized Finance (DeFi) Lending: What Crypto Investors should know
Decentralized Finance (DeFi) is currently the “buzzword” in the crypto scene. The creation of a decentralized financial ecosystem is intended to revolutionize classic financial services. With attractive offers for investors, the progressive development of block chain technology and an increasingly large number of providers, Decentralized Finance seems to continue to attract attention in 2020. It can probably be assumed that many of the classic financial services will also be found in the DeFi sector in the future, opening up new attractive investment opportunities for customers.
In this article we would like to take a closer look at the probably best known and most widespread DeFi application: the lending of cryptocurrencies (DeFi Lending).
How does DeFi Lending work?
If you invest your money in the bank in the traditional way, you receive interest on your deposits. However, in view of the ongoing low interest rate policy, this is not very attractive for investors. These deposits are partly used by the bank to on-lend to borrowers. With “Defi Lending”, the bank is not involved as an intermediary in this process. This not only gives the investor more control over his investments, but also allows him to expect higher interest rates due to lower costs resulting from the absence of an intermediary bank.
The lending business is automated with the help of smart contracts, which are usually based on the ERC20 standard of the Ethereum blockchain. The interest rate is not set by the bank, but special protocols automatically set interest rates between lender and borrower. The lender deposits the cryptocurrency in a so-called “pool”, depending on which provider he chooses. There the counterparty, i.e. the borrower, can borrow cryptocurrencies again if there is sufficient collateral. The information for the lending transaction is again stored on the block chain with the help of an intelligent contract and executed automatically.
Depending upon which platform one decides in the long run, different cryptocurrencies can be lent usually in simple way with the help of an Ethereum Wallet. In principle, “Defi Lending” can be compared to a call money account with variable interest rates, where the bank does not manage the deposits, but a corresponding “DeFi Pool” takes over this role and acts autonomously. With sufficient liquidity, the investor can withdraw his deposited cryptocurrencies at any time.
Compared to the lending of cryptocurrencies, e.g. over trading platforms, which has been known for a long time, with DeFi Lending the interest rate is determined automatically without an intermediary and runs usually anonymously without KYC process (Know Your Customer).
When choosing the right provider, always be careful and check whether the provider has already established itself. Well-known providers of DeFi Lending platforms are for example Compound, Aave or Nuo Network.
How is the Interest from DeFi Lending taxed?
It is not yet clear whether the interest earned is classified as capital income or other income. In principle, however, most of the income can be allocated to other income according to §22 No.3 EStG and is to be valued at the market value at the time of inflow. For tax purposes, the market value at which the interest accrues to the wallet is therefore decisive. Accordingly, these are taxable inflows.
What are the Tax Advantages and Disadvantages of DeFi Lending?
If the cryptocurrency has a high market value at inflow, taxes on the market value at the time of inflow are incurred first. However, if the cryptocurrency loses a lot of its value before being sold, these exchange losses cannot be claimed for tax purposes when the currency is sold. The received cryptocurrencies are not considered as purchased in the fiscal sense, but only as received. In the absence of an acquisition the received cryptocurrencies can be sold tax-free also below the holding period of one year. Thus, however, no tax losses can be claimed in case of exchange rate losses.
Depending upon course fluctuations it can be advisable to sell a part of the flowed to cryptocurrency time near against euro to have so with strongly sinking courses over sufficiently liquid means for a possible tax arrears payment.
If the interest accrues in the form of Stablecoins (e.g. DAI, USDC), this problem can be skilfully avoided, since Stablecoins are usually subject to no or only minor exchange rate fluctuations.
What is the Retention Period for Cryptocurrencies that have been lent?
In principle, cryptocurrencies can be sold tax-free after a holding period of one year. Whether this also applies to the cryptocurrencies used for lending depends on whether the income from the cryptocurrency used is generated by the company itself or not. Thus the holding period can increase in individual cases from one to ten years. Generally it is to be assumed in most cases however after current iurisdiction that the incomes are not obtained from the cryptocurrency itself, but by the lending business and thus the holding period of one year continues to exist.