What is crypto loans and how does it work?

Similar to traditional assets such as stocks, real estate, and vehicles, your cryptocurrency can be used as collateral to secure a loan. Similar to other secured loans, cryptocurrency-backed loans require repayment with interest over a specified period.

Crypto loans offer several advantages, including short-term access to cash, low interest rates, rapid funding, and the absence of credit checks. However, there are potential drawbacks. If the cash value of the pledged cryptocurrency drops, you might be required to provide additional crypto as collateral. Additionally, missing a payment can result in penalties.

Despite the inherent risks, opting for a crypto loan provides a means to access funds without liquidating your cryptocurrency holdings.

What is a crypto loan?

A crypto loan is a secured lending arrangement where individuals use their cryptocurrency holdings as collateral to secure a loan from a lender. This loan, repaid in installments, is typically a percentage of the cryptocurrency's value, known as the loan-to-value ratio. Various cryptocurrencies, with Bitcoin and Ethereum being popular choices, can be used as collateral, and some lenders accept up to 40 different cryptocurrencies.

In the world of decentralized finance (DeFi), crypto lending mirrors traditional lending, allowing users to lend out their cryptocurrency and earn interest, known as "crypto dividends". While reminiscent of traditional finance, DeFi operates with less stringent regulation.

For borrowers in crypto lending, digital assets serve as collateral, similar to a house securing a mortgage. Borrowers can access funds without selling their cryptocurrency by collateralizing it, paying off the loan over time, and reclaiming their assets. Flash loans without collateral are possible but require a deep understanding of crypto and lending platforms.

Loan amounts are determined by the loan-to-value (LTV) ratio, where staking a certain amount of crypto as collateral allows borrowers to receive a loan. However, borrowers temporarily lose some rights over their collateral until the loan is repaid.

On the investor side, participants contribute their crypto assets to a pool managed by a lending platform, earning a share of the interest generated by the lending process. Investors can receive varying interest rates, typically ranging from 3% to 7% and sometimes reaching as high as 17% with stablecoins. In cases where borrowers default on their loans, investors may sell the collateral to cover losses.

Types of crypto loans

There are two primary categories of crypto loans: Centralized Finance (CeFi) and Decentralized Finance (DeFi).

Centralized finance (CeFi) loans operate on a custodial basis, wherein the lender gains control over your cryptocurrency for the duration of the repayment period. The majority of crypto loans fall under the CeFi category.

Decentralized finance (DeFi) loans, on the other hand, leverage smart contracts, automated digital agreements, to enforce adherence to loan requirements. With DeFi loans, you maintain control of your crypto assets, but the lender has the ability to take automatic actions against your account if you default or miss a payment. It's important to note that DeFi crypto loans may come with higher interest rates compared to CeFi loans.

Moreover, within the DeFi space, there is a growing trend of leveraging decentralized autonomous organizations (DAOs) for governance and decision-making, providing users with a more democratic and community-driven approach to managing loans and protocols. This aspect adds an additional layer of decentralization to the DeFi lending ecosystem.

How do Crypto Loans Work

A cryptocurrency loan operates similarly to a secured loan, utilizing investments as collateral to secure funds. However, distinct from traditional bank loans, cryptocurrency loans streamline the borrowing process by eliminating the need for extensive credit checks and paperwork.

In the crypto lending landscape, possessing digital assets serves as a key factor. Essentially, your cryptocurrency investments function as a form of collateral, akin to a robust credit score. This not only qualifies you for a loan but also influences the interest rate, potentially leading to more favorable terms based on the value of your crypto holdings.

Crypto lending platforms often impose a minimum loan amount for borrowers. For instance, on Nexo, borrowers can secure a minimum of $50 in stablecoin loans and a minimum of $500 in fiat loans.

Conversely, platforms establish maximum loan amounts and loan-to-value (LTV) ratios. While a common maximum LTV is set at 50% of your crypto collateral, platforms like YouHodler and Nexo are known for their generous offers, allowing users to borrow up to 90% LTV against their collateral value. However, it's crucial to recognize that such enticing deals may come with higher interest rates, as crypto loan platforms acknowledge the inherent risks in their business.

In the event of a delayed repayment, the loan company wields significant leverage. Given the cryptocurrency market's volatility, borrowers often need to put up collateral valued significantly higher than the loan amount. This ensures that, even in the event of a market downturn, the deal remains favorable for the loan platforms.

Additionally, a high loan-to-value ratio may limit your flexibility in choosing a longer repayment term. Shortening the repayment period allows loan platforms to mitigate potential impacts of market volatility and associated risks.

Before deciding on a loan-to-value ratio or opting to borrow with cryptocurrency, seeking sound investment advice is essential. Understanding these nuances is crucial to making informed decisions in the dynamic landscape of crypto lending.

Are Crypto Loans Safe?

Making the decision to borrow cryptocurrencies is a financial move that demands meticulous consideration and planning. While this asset class offers certain advantages, it's essential to acknowledge the substantial risks inherent in cryptocurrencies.

Crypto loan platforms typically offer two primary services: extending crypto loans to borrowers and providing interest accounts to lenders. Some platforms even facilitate digital currency exchanges on their websites. However, all these services necessitate users to entrust their assets with the platform, raising concerns about the safety of their funds.

How Loan Platforms Store Cryptocurrencies:

The collateral provided by borrowers and the assets deposited by those with savings accounts are securely stored by the lender. Given the substantial value of these assets, crypto lenders often collaborate with third-party custodians to ensure the safety of these assets through cold storage.

For instance, Nexo, a UK-based crypto lender, safeguards its users' crypto assets with trusted custodians like BitGo, Ledger Vault, and Bakkt. Similarly, YouHodler relies on Ledger Vault's self-custody management solution to oversee users' assets.

Insurance Coverage:

In contrast to traditional banking, where the FDIC safeguards depositors, crypto service providers lack similar protections in case of bankruptcy. To mitigate risks, crypto loan platforms often secure insurance services from third-party custodians. BitGo, a leading custodian firm, is an example that provides insurance and custodial services for crypto assets. Nexo and YouHodler both highlight substantial insurance coverage – Nexo insures up to $375 million, while YouHodler boasts a $150 million pooled insurance fund with Ledger Vault.

However, it's important to note that these insurance policies typically cover risks like theft or phishing attacks on the platform, leaving gaps in coverage in bankruptcy scenarios. Users might be treated as creditors in such instances.

Moreover, if hackers gain access to your loan or savings account, insurance coverage might not apply. Therefore, it's crucial to follow all security instructions to protect your account when using a crypto loan platform.

How Lenders Secure Your Account:

Account security is paramount when using a crypto loan platform, and while most platforms prioritize embedding robust IT security, users play a crucial role in safeguarding their data.

Crypto lenders often implement "Know Your Customer" (KYC) procedures, requiring users to submit a picture of a passport or a valid government-issued ID during the application process. KYC not only aligns with government policies but also ensures that loan platforms are familiar with their user base.

Additionally, crypto lenders incorporate various security measures, such as:

2-factor authentication
Mobile app PIN
Transaction PIN or password

Users should take personal responsibility to ensure exclusive access to their accounts by using unique, memorable passwords. Platforms like YouHodler provide additional resources, such as personal security and scam protection guides, to enhance user awareness and security practices.

How to Select a Crypto Lending Platform

Securing a reliable crypto lending platform is essential for a successful crypto lending experience, and there are critical factors to consider when making your selection.

Interest Rates:

One of the key determinants when choosing a lending platform is the interest rate. Opt for a platform with competitive rates tailored to your specific crypto assets. Some platforms offer crypto loans with interest rates below 10% and, in some cases, as low as 0%.

Platform Risks:

Evaluating a platform's track record concerning security risks is crucial. Given the rise of cyber attacks targeting cryptocurrencies, it's vital to choose platforms that transparently outline their security measures on their website. Research indicates that fraud and theft in the DeFi sector exceeded $10 billion in 2021.

Costs:

Compare fees across various platforms for different crypto assets. Keep in mind that you don't have to use the same platform for all your cryptocurrencies.

Loan Duration:

Examine the parameters of loan duration offered by different crypto lending platforms. Verify whether the loan duration is fixed or flexible.

Minimum Deposit Limit:

Check if the platform imposes a minimum deposit requirement, ensuring it aligns with your financial preferences.

Collateral:

For borrowers, understanding the collateral requirements for a specific loan amount is crucial. Compare collateral requirements across platforms to make an informed decision.

Geo-Restrictions:

Some crypto lending platforms have geo-restrictions that might affect your eligibility to use them based on your location.

When venturing into crypto lending, you'll need to choose between automated and manual lending platforms. Many prefer automated platforms for their simplicity in ensuring continuous asset profitability.

Pros and Cons of Borrowing Using Your Cryptocurrency

Before applying for a cryptocurrency-backed loan, it's crucial to weigh both the benefits and drawbacks:

Pros:

Low Interest Rates: Cryptocurrency lending platforms typically offer crypto-backed loans with annual percentage rates in the single digits. This is considerably lower than the rates for many credit cards and unsecured personal loans.
No Credit Check: Unlike traditional financing options, crypto-backed loans usually don't involve a credit check. This is advantageous for individuals with less-than-stellar credit, as it provides a more accessible financing alternative.
Fast Funding: Crypto loans are known for their quick funding process, often being funded on the same business day and sometimes instantly. This swift access to cash is beneficial for those in need of immediate financial support.

Cons:

Borrowing Limits: Most platforms limit the borrowing amount to around 50% of the cryptocurrency's value, though some may go as high as 90%. Loan funds can be received in U.S. dollars or select digital currencies.
Risk of Margin Call: Cryptocurrency's inherent volatility poses a risk of margin calls. If the value of your collateralized holdings drops, you might be required to deposit more crypto to maintain the collateral, or the platform may sell some of your assets to reduce the loan-to-value ratio.
Locked Collateral: When using cryptocurrency as collateral, it becomes inaccessible for payments or trades until the loan is fully repaid. Emergency liquidation or selling to limit losses is not possible during the loan period.
Short-Term Loans: Repayment terms vary across platforms, ranging from 90 days to 12 months. It's essential to assess whether the repayment period aligns with your financial capabilities and borrowing needs.
Eligibility of Coins: Not all digital currencies are accepted as collateral. Some platforms have restrictions on eligible options, requiring users to exchange their desired currency for an approved one. It's advisable to explore platforms that accept a variety of currencies.

It's worth noting that in addition to these considerations, borrowers should stay informed about the evolving regulatory landscape and any changes in the cryptocurrency market to make informed decisions when securing crypto-backed loans.

Please note that Plisio also offers you:

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