- Cryptocurrency backed loans are secured loans that use digital assets like bitcoin as collateral.
- You won’t have to undergo a credit check to qualify for a cryptocurrency-backed loan.
- Cryptocurrency backed loans can also distribute funds almost instantly, unlike traditional lenders.
- Learn more about Personal Finance Insider loan coverage here.
Cryptocurrency has grown in popularity over the past decade, and a new type of financial offering, crypto-backed loans, has emerged with it.
There are different types of cryptocurrency, like bitcoin or ethereum, which are digital forms of money. Cryptocurrency is essentially a virtual asset that you can use to purchase goods and services, as opposed to physical money. The blockchain, or digital ledger, keeps track of every bitcoin transaction.
How does cryptocurrency lending work?
Cryptocurrency backed loans are secured loans. Borrowers use digital assets as collateral for loans, much like a house or car is used as collateral for a mortgage or car loan. You may not have the intention of using or trading your cryptocurrency for the foreseeable future, so this allows you to get cash for the expenses you need to cover now without having to make transaction with your digital assets.
You can find cryptocurrency backed loans in markets like BlockFi, Binance, and Celsius, although this list is not exhaustive.
To take out a cryptocurrency-backed loan, you must first register on the platform of your choice and choose the desired loan amount. Then this platform will calculate how much cryptocurrency is needed as collateral, you will deposit that amount and apply for the loan. Once your loan is approved, you will receive your money.
You’ll pay off the loan balance plus interest over a fixed term, although most platforms don’t charge any penalties for prepaying your loan. And some platforms, like Abra, even offer interest rates as low as 0%.
What are the benefits of cryptocurrency lending?
You won’t have to undergo a credit check to qualify for a crypto-backed loan, which can make it a great option for borrowers who don’t have the best credit history. You can often benefit from a lower rate with a cryptocurrency-backed loan than with a traditional personal loan.
You won’t have to sell your cryptocurrency to take out a crypto-backed loan, so if you think your asset will increase in value over the long term, it may appreciate by the time you receive your collateral. In other words, cryptocurrency backed loans give you the ability to borrow against your balance without completely cutting yourself off from attractive market returns.
Cryptocurrency backed loans can also distribute funds almost instantly, unlike traditional lenders who may take days to get your money. Your loan amount will be based on the value of your assets, and many exchanges will allow you to borrow up to 50% of that value.
What are the disadvantages of cryptocurrency lending?
Since the value of cryptocurrency is more volatile than that of other assets, you might find yourself in a situation where the value of your digital currency drops and your lender forces you to increase your collateral to hold the loan, also known as under the name of margin call. In some cases, your lender may even sell some of your assets to lower your loan-to-value ratio.
For example, if you took out a loan of $ 1,000 and pledged $ 2,000 in cryptocurrency assets, your loan-to-value ratio would be 50%. If the value of your cryptocurrency has decreased by $ 1,000, your lender may ask you to pledge an additional $ 1,000 in digital assets or to pay off your loan immediately.
Depending on the platform you are using, some digital assets may not be eligible for loans, so you may need to convert your cryptocurrency to another type of asset. You also won’t have access to your assets until you pay off the loan balance, which means you won’t be able to sell or trade your cryptocurrency quickly.
Cryptocurrency-backed loans are not federally insured, so you are not guaranteed compensation for any security breach.
You may want to consider alternatives to cryptocurrency backed loans, like a home equity loan or 0% upfront interest credit card. However, if you want to hold onto your cryptocurrency and need cash quickly, these loans might be a good option for you.