Securing loans with collateral has recently become a common way to borrow money, especially widespread among individuals with less-than-stellar credit. When providing cars, houses, and other physical assets of value to lenders has been around for some time, using digital assets to secure loans is just beginning to gain popularity. What is a crypto loan, and which risks and benefits does it bring? Let’s get straight!
A crypto loan is a secured loan pledged by a borrower’s crypto asset. Investors provide individuals with funds in exchange for interest payments, also known as “crypto dividends.” Many platforms offer crypto loans in the form of stablecoins, other cryptocurrencies, or fiat currency. After getting a crypto loan, a borrower repays it in monthly installments for up to 60 months. As long as they make their payments to a lender and pay the loan amount in full, they can get the collateral back at the end of the loan term. While Bitcoin and Ethereum are the most popular collateral for crypto loans, some lenders accept more than 40 cryptocurrencies to secure the loan.
Taking out crypto loans is available through third parties (lending platforms). These platforms set interest rates both for the lender and the borrower. Investors deposit their assets into a lending account to provide them to their clients. In their run, borrowers create accounts with their lenders where they pledge collateral. The amount of your crypto loan depends on the value of the cryptocurrency you pledge as collateral. It is calculated through the so-called loan-to-value ratio. After securing the loan, you don’t lose the ownership of your assets. However, you lose some rights to them, such as the ability to trade these cryptocurrencies and make transactions. It may also happen that the value of your currency falls significantly. Therefore, you should understand the risk of owning more than you borrowed when applying for a crypto loan.
There are two main types of crypto loans you should be familiar with:
Most crypto loans are centralized, which means a lender has total control over your assets during the loan term. Your collateral is stored in a specific account on the lending platform without the ability to access it.
DeFi loans rely on smart contracts - automated digital agreements to ensure the two sides meet the loan requirements. Although this type of crypto loan comes with higher interest rates than CeFi loans, it does not deprive the borrower of control over the assets. You can watch where the money goes and lock it without intermediary intervention.
Crypto-based loans are an innovation that is constantly gaining popularity. The reasons why more and more individuals choose this borrowing option include the following:
Despite the many benefits, the potential risk of crypto loans can force borrowers to consider other financing options.
It will be true to say that cryptocurrency lending is a double-edged sword. It is especially risky if you are a borrower. Although you can get fast money with no credit check, your rights are not protected. This means that if the lending platform fails, you can lose your funds. Some lenders may also charge sky-high interest rates, which makes your borrowing terms unfavorable. Being a crypto lender also involves certain risks, including locking their money in the lending platform due to insufficient funds, suspicious activity, security breaches, technical issues, and so on. Therefore, it is essential to approach crypto lending responsibly.
Crypto lending has become incredibly popular in a relatively short time. Many existing and emerging platforms offer numerous opportunities for crypto enthusiasts, including borrowing and lending funds, trading, money exchanges, etc. Before making any transactions with cryptocurrencies, make sure you understand all the risks involved. Remember that crypto-based loans mean not only the lack of credit checks and low rates but also no insurance and access to your funds, margin calls, and the potential need to exchange your current crypto for eligible assets.