Why are crypto lenders central to the digital asset market?

Celsius' decision to temporarily block its customers from withdrawing funds has shone a light on a group of crypto lending platforms that have been a key driver of the growth of innovative industry projects.

These lenders have served as a bridge between DIY retail investors and the vast universe of decentralized finance, or DeFi, projects seeking funding to help them grow.

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

Consumers flock to these platforms because they typically offer interest rates of around 10-15 percent on their investments, much higher than traditional banks and even many traditional investments. Celsius said last year that more than 1 million customers had used the system.

To fulfill their promises to pay these outsized returns, crypto lenders have branched out into sometimes riskier activities beyond simple lending. Some companies themselves have traded on crypto markets like futures.

But some of the money was used to support new developments in the crypto industry. In particular, assets have flowed into DeFi projects that primarily aim to replicate parts of the existing financial system, such as a stock market, but without the centralized authority that typically underpins the system.

Many need to be backed by pools of assets to run their blockchains and will pay investors willing to put their money at risk for an extended period of time. In return, the consumer receives an attractive return, which can vary depending on which crypto asset the customer has stocked and would like to receive as payment.

Total assets locked in DeFi projects rose from $601 million at the start of 2020 to a peak of $253 billion at the end of last year, before declining in recent months, according to data from CryptoCompare.

However, crypto lending platforms are generally not subject to the same regulations as banks, meaning that customers' funds are not backed by a government guarantee. And some activities of lending platforms involve higher risk.

DeFi projects are often vulnerable to hacks, design flaws, or disputes over how they should operate. Critics of lending platforms say some companies take excessive risks in their DeFi portfolios and are not transparent enough about what they do with customers' money to achieve their attractive interest rates.