How Do Crypto Loans Work: All You Need to Know
7 Min Read
There are multiple kinds of secured loans. While some of them accept collateral in the form of physical assets, such as houses or cars, others may provide you with cash against stocks or your savings account balance. But as the world evolves, new types of loans, such as crypto loans, appear. Nowadays, people who have crypto holdings can also use them as a repayment guarantee.
Although crypto lending is a relatively new form of financing, loans that use digital currencies as collateral are gaining more and more popularity. But how do crypto loans work? And what risks and pitfalls do they carry? Let’s get it straight.
What Is a Crypto Loan?
A crypto loan is a secured loan option that provides the ability to borrow money (fiat dollars or stablecoins pegged to the US dollar) against your crypto assets. These loans allow lenders to earn interest on their crypto holdings by giving them to other individuals for a set period of time.
From a borrower’s point of view, crypto lending gives the opportunity to unlock their digital assets value by using it as collateral for a loan. Thus, they are a bit similar to regular secured loans. A borrower gets cryptocurrency or fiat dollars in the form of a lump sum deposit. Then, they repay the funds plus interest to a lender in equal monthly installments. Once the loan is paid off, a borrower gets their crypto assets back.
The repayment term is usually up to 60 months. Crypto loan interest rates are usually lower than those for regular personal loans. In most cases, an annual percentage rate doesn’t exceed 10%. The amount you can get depends on the value of your collateral.
How Do Crypto Loans Work?
Unlike regular secured loans that you can get from a bank or online lender, crypto loans are available through specific lending platforms. These platforms set interest rates on crypto loans for both the borrower and the lender. Lenders deposit their assets into lending accounts and can give money to borrowers in exchange for interest payments. In their turn, borrowers create accounts with their chosen lenders and pledge crypto collateral into them.
The collateral you need to provide is determined by the loan amount you want to get. Crypto lending platforms typically use a loan-to-value ratio (LTV) to calculate the maximum amount you can borrow. This means that you can only get a portion of the value of the cryptocurrency you provide as a security deposit. The exact LTV depends on the platform and the cryptocurrency you’re going to pledge.
Types of Crypto Loans
It’s considered to be two main types of crypto loans:
- Decentralized finance loans (DeFi). DeFi loans give you more control over your crypto assets. This means that a user can control where their money goes and can easily lock their asset without any middlemen intervention. DeFi loans come with automated smart contracts that allow both a borrower and a lender to ensure compliance with the terms of the loan agreement. A crypto lender can only take actions against your account if you violate your loan terms.
- Centralized finance loans (CeFi). CeFi loans make up the majority of all loan options offered on a crypto market. These loans provide full control over your crypto assets to a lender. Your assets will be stored in the account on a centralized platform with no ability to access them, and if there’s a hack, your crypto funds will be at risk.
Pros and Cons of Crypto Loans
If you want to get a crypto-backed loan, consider the following advantages and drawbacks to make sure you understand what you’re going into.
- Fast loan process. You can apply for a loan quickly and get money within 24 hours;
- No traditional checks. Crypto lenders don’t perform hard credit checks via major credit bureaus. This also means that you can get a crypto loan even with bad credit;
- Low interest rates. Most crypto loans are cheaper than traditional loans, with an APR not reaching 10%;
- Flexible loan terms. You can choose the repayment period that will be comfortable for your budget;
- No restrictions for the loan purpose. You can use the funds as you wish, as lenders don’t track the way you spend the money.
- Risks associated with losing your cryptocurrency. If you don’t pay on time, a lender can repossess your assets;
- You need to already have crypto holdings to get such a loan;
- You may be asked to provide more crypto if its value drops, increasing an LTV ratio;
- In most cases, you won’t be able to access your crypto while it’s pledged;
- Crypto loans are not insured by the Federal Deposit Insurance Corporation. This means that if something goes wrong with your crypto platform, you’re most likely not to get your crypto back.
Are Crypto Loans Safe?
Crypto loans are considered riskier than traditional loan options. This is because there’s no legal protection you can get if a platform you use fails. If you’re a borrower, there are risks associated with your asset’s value drop. This way, you may end up selling your investments at a lower price.
From the lender’s point of view, crypto loans are relatively safe. This is because they are collateralized loans, meaning that a lender can get their money back by repossessing the collateral provided. However, many platforms can simply lock user’s accounts and funds for various reasons, such as insufficient funds, suspicious activity, security breach, technical issues, and others. This way, users may be left with nothing. Therefore, crypto lending is a double-edged sword. Whether you’re a borrower or a lender, you should approach it cautiously.
How Can I Borrow Against Crypto?
The crypto lending process is pretty fast and quite easy to complete. Here are the steps you need to take:
- Choose a crypto lending platform. Make sure it accepts the currency you’re going to deposit as collateral.
- Review available lenders and their terms to pick the most reasonable offer. Also, pay attention to eligibility requirements set as they vary by lender.
- Open an account with the lender.
- Select a loan with an appropriate LTV and repayment term. Most lending platforms have online calculators, helping you understand what amount you can borrow by providing the collateral that you’re comfortable with.
- Submit a loan request.
- If approved, make a collateral deposit and get the funds within 24 hours.
Where Can I Get a Crypto Loan?
The crypto lending market is represented by multiple platforms and crypto exchanges. These platforms have different interest rates, vary by loan terms, and may accept different cryptocurrencies. Some platforms work with the most popular digital currencies, such as Bitcoin or Etherum, while others may accept a broad range of currencies. The most popular centralized platforms include Binance, Gemini, BlockFi, Celsius, and others.
Crypto Loan Alternatives
If a crypto loan is not your option, here are a few more ways to get the desired loan amount.
Traditional loans can help you access the funds without providing collateral. Most financial institutions offer up to $100,000 financing within a borrower’s solvency. Repayment terms are typically up to 5 years. However, you need to have a satisfactory credit score to qualify.
Home Equity Loans
If you own a house, consider using the portion of its equity as a pledge and borrow money against it. You can typically get up to 85% of your home’s value. Just keep in mind that you can lose your house if you stop paying a loan.
Many credit card issuers offer 0% APR products. This means that you can save money on interest under certain conditions. Such credit cards come with interest-free promotional periods. Thus, the condition is as follows: you pay off your balance within the set term, and the interest rate won’t be applied.
Small Personal Loans
A small personal loan can help you get up to $2,000 for several months, often with no credit check performed. Additionally, such a loan is usually bad credit friendly, so you can qualify even with negative records in your credit report. But be ready for higher interest rates for this type of loan.
A crypto loan is a secured loan that uses your crypto assets as collateral. Although it comes with multiple benefits, such as low costs, accessibility, and flexibility, there are some risks associated with it. Before getting a crypto loan, make sure to understand how it works and what pitfalls may await you on your way.
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