Mahi Sall, Advisor, Fintech-Bank Partnerships, Payments and Financial Inclusivity
January 25th, 2023
Mahi Sall is the CEO & Founder of FinXpair, a Berlin-based strategic advisory boutique firm focu[...]
What to Know About Borrowing Against Crypto
Guest Post | Mar 25, 2022
The world of crypto is at this point advancing toward being mainstream very quickly. Cryptocurrency is something more and more people are using for transactions and as a payment method. Crypto is also an investment opportunity.
Beyond those applications, crypto borrowing and lending are growing in popularity as well.
Crypto lending is a type of Decentralized Finance or DeFi. With DeFi, investors can lend their crypto to borrowers. The benefit for a lender is that you can get interest payments in exchange, which are known as crypto dividends. There are a number of platforms specializing in lending crypto.
While the benefits of acting as a lender may be apparent—you can earn on your holdings passively, what about the perspective of a borrower?
Below, we delve into some of the things to know about borrowing against crypto and the pros and cons of doing so.
An Overview of Crypto Lending
Crypto lending, as mentioned, lets people who hold crypto have the potential to earn interest on it.
If you’re someone with ten bitcoins as an example, and you want to earn a steady stream of passive income, you can deposit them into a crypto lending platform wallet. Then, every week or month, you receive interest.
Interest rates vary. On the low side, interest rates may be around 3%, and on the high side, as much as 17%.
Borrowers can stake their cryptocurrency as a guarantee that they’ll repay the loan or as security. Then, investors can sell their crypto assets in the event the borrower doesn’t pay off the loan, providing a route to cover losses.
Most platforms will ask a borrower to stake anywhere from 20% to 50% of the loan in crypto.
A third party is required to connect a borrower to a lender. A borrower can be an individual as well as a business requiring funding.
There are a few steps that occur in general in the process.
The borrower finds a platform they want to use. Once they identify the platform, they request a crypto loan.
A borrower stakes their crypto collateral when the loan request is accepted by the platform. Until the borrower can pay back the loan in its entirety, they won’t be able to get back the stakes.
The lender automatically funds the loan through the platform. The lender then receives regular interest payments. Once a borrower pays off the complete loan, they get back their collateral crypto.
Common Features of Crypto Loans
If you get a crypto-backed loan, it’s one requiring collateral, which is the stake. In many ways, a crypto loan has similarities to a car loan or a home loan because you have an asset securing your funds.
Cryptocurrency loan platforms tend to offer interest rates that may be comparatively low—often in the single digits. That’s going to nearly always be less than the interest rates on a credit card or an unsecured personal loan.
Crypto loans aren’t usually as cheap as a car or home loan, however, so you shouldn’t use this option to make a big purchase.
You will almost always face limits on how much you can borrow. A lot of platforms will let you borrow up to 50% of the value of your crypto, but some will go all the way up to 90%. You receive your loan funds as USD or a digital currency.
See: Rise of Regulatory Compliant DeFi Protocols
There’s almost never a credit check when you apply for a loan backed by crypto. If you don’t have perfect credit or you have a limited credit history, this can be one of the biggest pros that you might think about with this personal finance option.
The funding will usually be fast—often with funding coming through the same business day. For someone who needs fast cash, that holds a lot of appeal.
For lenders, the upsides of crypto loans include the fact that you’re probably going to get higher returns than using something like a savings account, and you don’t have to lock in your assets.
What To Keep In Mind Before You Borrow Cryptocurrency
If you’re considering borrowing crypto, you need to choose the right platform, making sure that it’s legitimate and secure. After you find a reliable platform, taking out a crypto loan tends to be a simpler, easier process than getting a traditional loan.
The loan amount is going to depend on how much collateral you can use. The loan-to-value ratio in this context is the amount of the loan compared to the value of the collateral.
Because of the inherent volatility of crypto markets, these loans usually have extremely low LTV ratios.
Other considerations include:
- You could be subject to what’s called a margin call. If you borrow against a big portion of your holdings and the price goes down, which often happens because of crypto’s volatility, you might need to deposit more collateral in the form of more crypto. Another option in this situation would be that the lending platform would sell some of your holdings, reducing the LTV ratio. You have to be very careful about how much leverage you can use as a result.
- If you use crypto to secure a loan, it’s locked in until you pay it off in full. If you faced an emergency where you needed to liquidate your holdings, you wouldn’t be able to. Also, if there’s a big drop in crypto prices, you can’t sell to limit the losses.
- The repayment terms can vary widely between one another, so be aware that many of these loans are very short-term.
Finally, you can’t use any coin to get a loan. Some platforms will only accept a limited number of options, while other platforms might accept dozens.
Getting a crypto-backed loan is a growing possibility for consumers, but also one with risks and considerations to keep in mind before jumping in. As with anything in personal finance, weigh the pros and cons before doing anything. Along with researching the loans in general, make sure you choose the best platform for your needs.
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