Traditional banks have been around since the 15th century, but crypto banks have existed for less than a decade. With the rising popularity of digital currencies, crypto banks are poised for worldwide adoption. But what is a crypto bank, and how does it differ from a crypto exchange or crypto wealth management platform?
This new category of finance brings together two sectors: traditional banking and blockchain technology.
In this blog post, we’ll explore how crypto banking works and how it differs from wealth management platforms.
Crypto Banking Explained
Crypto banking platforms are similar to traditional banks in that they allow customers to save, earn, and borrow money.
The key difference is that crypto banks revolve around cryptocurrencies (also known as digital currencies) like Bitcoin for transactions rather than fiat currencies like U.S. Dollars or Euros.
Crypto banks are also different than standalone digital wallets (also known as cryptocurrency wallets) and cryptocurrency wealth management platforms. Unlike the other two applications, crypto banks typically include federally insured bank accounts and debit/credit card services.
How Do Crypto Banks Work?
Much like traditional banks, crypto banks generally require users to complete a know your customer (KYC) check before they can deposit funds. After a user passes a KYC check, they can start using the platform.
Next, users can acquire cryptocurrency. Users first need to use a crypto exchange to convert cash to crypto. Some platforms have a built-in exchange that enables customers to purchase crypto with fiat. Funding an account with crypto requires the creation of a digital wallet (also known as a crypto wallet).
Not all crypto banks allow users to access digital wallets. For example, some crypto banks don’t give users the option to withdraw crypto to external wallets. On the opposite end of the spectrum, many crypto banks offer additional services besides digital wallets.
Earning Higher Yields
Several crypto banks have quickly gained traction because they offer much better rates for lenders and borrowers. For the most part, traditional banks offer less than 1% APY for savings accounts, which don’t come close to outpacing annual inflation levels. In contrast, several crypto banks offer 10% APY or higher for stablecoins like USD Coin (USDC) and Tether (USDT).
Arbitrage is a key reason why crypto banks can offer high interest rates to savers. In the case of crypto banks, arbitrage is defined as the difference between the interest rate the platform pays to crypto interest accounts and the interest that borrowers pay to the platform. The arbitrage margin (profit) is much higher for crypto banks compared to traditional banks.
When a customer lends funds to a crypto bank, the borrower (i.e. a hedge fund or an institutional trader) can use that capital to generate high returns on certain trades. This means that borrowers are generally willing to pay higher interest rates on loans.
Using Crypto as Collateral for Loans
Some crypto banks offer interest rates at 1% APR or less on crypto loans. A major benefit of crypto loans is that users don’t have to sell speculative assets, which have the potential to increase in value over time.
Crypto loans are more convenient than traditional loans in that they don’t require lengthy background checks or application reviews. Some crypto platforms can issue loans instantly. Depending on the loan provider, users may receive a fixed-term loan and/or flexible-term loans.
With crypto lending platforms, users lock their cryptocurrency holdings like Bitcoin and Ethereum as collateral. Then, they receive a loan in the form of a stablecoin. Each platform requires the user to maintain a specific loan-to-value (LTV) ratio. So if the price of the collateral asset decreases, the user might need to add more crypto as collateral to keep the loan open or avoid liquidation.
Risks and Benefits
As we explore in our fiat bank vs. crypto platform blog post, the biggest risk of crypto is the fact that it’s part of an unpredictable, emerging market. The biggest benefit of crypto is the potential for explosive market growth.
Risk — Market Volatility
Regardless of which crypto bank a user chooses, it takes time to get used to market volatility.
Cryptocurrency prices tend to fluctuate at a much greater scale than other asset classes like stocks or precious metals. Of course, this can be an amazing result if crypto prices increase. However, when prices decrease, newer market participants often lose faith and end up panic selling at a loss.
Many new investors get FOMO (fear of missing out) and only buy when the market hits all-time highs. Unless you’re a day trader, investing wisely requires patience and the ability to maintain a long-term outlook that is agnostic of short-term market trends.
Risk — Security
Security is another important factor that can’t be underestimated. Even with custodial crypto platforms which manage funds, customers must be cautious of security threats.
The responsibility of keeping one’s account secure is at least partially reliant on the customer. Phishing attacks or just sending funds to the wrong public address are common problems.
Unlike traditional banks that can reverse banking transactions in special cases (i.e. credit/debit card theft), crypto platforms can’t reverse blockchain transactions. That’s why it’s essential to always use the best crypto security practices.
Benefit — Financial Inclusion
The main advantage of crypto banking is worldwide availability. In many countries, traditional banks have failed their customers. Issues like lack of banking infrastructure or deposit insurance, hyperinflation, high remittance fees, and bank closures have prevented economic progress.
Crypto is starting to tackle these issues and provide a new system that can foster financial inclusion. Customers of crypto platforms have equal access to financial services, regardless of where they live or their income levels.
Benefit — 24/7/365 Access
Another benefit of using crypto banks is that there is usually no distinction between business hours and off-hours.
If a user wants to take out a loan on a Friday night, there’s no need to wait until a Monday morning. If a user wants to send funds from a digital wallet to a lending platform to start earning interest, the process is practically instantaneous. Plus, interest starts accruing immediately.
As the adage goes, “Crypto never sleeps.” While that can sometimes be problematic if you’re staring at price charts all the time, it’s definitely a benefit when it comes to being able to access financial services.
Earn High Yield with Abra
Abra is a crypto wealth management platform on a mission to create a simple and honest platform to enable millions of crypto holders to maximize the potential of their crypto assets.
Download the Abra app and start earning yield on your crypto holdings today!
Abra Earn offers competitive interest rates for both cryptocurrencies like Bitcoin and Ethereum as well as stablecoins. You can now earn additional interest paid in Crypto Perx ($CPRX) tokens through Abra Perx — our loyalty program exclusively for Abra users. You can also earn CPRX by borrowing and trading crypto on the Abra app or referring your friends.
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