Crypto loans and lending platforms have emerged during 2020. Simply put, crypto loan platforms allow users to put their crypto down as collateral and borrow fiat.
The Interest rates for cryptocurrencies are set to incentivize users to loan out their crypto assets. Why? Because users can earn a higher return on lending assets than they can by storing them. Crypto loans can also let an investor add liquidity to their bank account without triggering a taxable event.
The current pandemic has also drawn huge attention in this sector, when banks are reporting negative interest crypto lenders are making their assets and money work for them.
Within this article, we will look deeper at crypto loans for borrowers and the advantages and possible pitfalls.
Why should I consider a crypto loan?
The majority of crypto holders have a long-term view of their investments. Most have no intention to sell but although they plan to hold their crypto assets, sometimes circumstances will force investors to sell their crypto for fiat currency.
But given the underlying investment strategy, rather than selling, crypto loans allow investors to use their cryptocurrencies as collateral towards a cryptocurrency backed loan. This allows them to maintain ownership of their funds while gaining access to the FIAT currency they need.
In other words, they are using the asset they have (that they do not wish to sell) to release money that can be utilized for everyday things and more significant life purchases.
How do they work?
Firstly, it is easiest to think of a lending platform such as Maker or Compound as a bank. Users lend their crypto to the platform and then the platform lends that money to borrowers at a certain interest rate.
Part of that interest rate is given back to lenders as yields and the remainder is kept by the platform as profit. The entire process is operated by smart contracts therefore reducing the need for intermediary charges.
Additionally to lending money to those holding cryptocurrency, the platform will also distribute loans to traders and institutions that need liquidity for margin trading operations.
Collateralized loans
This type of loan is referred to as a collateralized loan. It represents a style of borrowing where a client stakes an asset against the funds they are receiving. Most platforms offer a service whereby clients can exchange crypto to USD or the platform’s native stablecoin.
Once the loan is paid off, the crypto is returned, along with any increases in value that occurred throughout the lifetime of the loan. The amount of collateral a borrower needs to stake can be determined by the loan’s loan-to-value ratio.
The advantages
Collateralization limits the risk of vulnerability on the lender’s side. For example, crypto markets are relatively volatile. If the value of your collateral decreases past a certain amount, the lender can liquidate a portion of the collateral to bring the loan back into good standing.
The lender gets the reassurance of holding the collateral, the borrower gets to leverage the value of their long-term cryptocurrency investment and get it back once the loan is paid off effectively creating a winning situation for both parties.
In-summary
Borrowing against crypto assets enables you to access the value of your Bitcoin (BTC), Ether (ETH), or other held crypto without having to sell. However, the crypto loan sector of DeFi is still in the infant stage and users need to exercise caution and do the appropriate research before committing to loans.
This video from CoinTelegraph provides an excellent overview of crypto loans and lending from the first official loan on NEXO to Brock Pierce through to today’s buoyant market.
Blockchain technology has already changed how we do business and led the world into a financial revolution in terms of decentralized digital currencies and the potential they offer. In 2020 it has become the norm for cryptocurrencies to be used as a new form of collateral, and in turn, decentralize the entire lending industry.
