While cryptocurrency is new, crypto lending is quite similar to traditional lending. With a cryptocurrency loan, a borrower typically offers up their cryptocurrency as collateral to the lender, who gives them cash or a stablecoin cryptocurrency that’s tied to a traditional currency, and charges the borrower interest on the loan.
For most cryptocurrency loans, the lender isn’t a bank, but another individual investor. That means an individual can either be a cryptocurrency borrower or lender. There are a number of popular lending platforms where people can lend money to cryptocurrency investors, hold their cryptocurrency digital assets as collateral, and create an income stream from the interest payments of the borrowers.
Reasons to Get a Cryptocurrency Loan
The major advantages of crypto-backed loans are the speed and flexibility they offer. A borrower might be able to secure a loan in hours, and pay-back terms have a wide range—whether a borrower is looking to pay back the loan in a few days, for example, or 12 months.
But investors may want to secure a cryptocurrency loan for any number of reasons. They may need cash liquidity, without missing out on the potential for growth that is a draw to individuals investing in cryptocurrency.
Long-term crypto investors may be reluctant to liquidate their cryptocurrency digital assets. But at the same time, they may need money for short-term needs, like a business or medical emergency, or what they consider to be an irresistible investment opportunity—maybe even investing in bitcoin. That’s where a cryptocurrency loan can make a lot of sense for some investors.
Is Crypto Lending Safe?
The history of cryptocurrency is dotted with disastrous hacks. For that reason and more, security should be foremost in the mind of anyone handing over their cryptocurrency assets as collateral.
Whether borrowing or lending, it’s important to research the security of the lending platform’s custodian and its reputation in the financial markets. Also, it may be worth investigating if there’s an insurance policy against the possibility of the platform being hacked.
Risks to Borrowers
The volatility of cryptocurrencies means that the amount of the digital currency borrowers have to put up as collateral may be many times the amount of actual cash they receive in the loan. That, in effect, multiplies the amount they stand to lose if they should default on the loan.
Defaults can be costly: Many major crypto lending platforms allow lenders to keep roughly 80% of collateral if the borrower defaults.
Other risks borrowers should know about include the wild fluctuations in the value of the cryptocurrency used as collateral. If the value of the collateral goes down, some lenders can make a “margin call”, in which they ask for more collateral to get the total value back up to the original ratio of the loan. While a borrower will get that cryptocurrency back when they repay the loan, it can be a highly disruptive financial event, and can come with financial penalties if the borrower doesn’t have the cryptocurrency to meet it.
Where to Get a Cryptocurrency Loan
Getting a Bitcoin loan or any other cryptocurrency loan is a process that’s rapidly evolving. There are many online platforms that allow borrowers to take out loans against the cryptocurrency they own, with new competitors joining their ranks all the time. There are a few centralized platforms that offer the loans directly to cryptocurrency investors. But most crypto loan platforms are decentralized financial (DeFi) platforms—they work by connecting cryptocurrency-investing borrowers with cash lenders.
As investors start researching crypto loan platforms, they may come across a variety of platforms including Nexo , SALT Lending , and Blockfi. The interest rates that crypto lending platforms charge can vary widely depending on a variety of factors, including the particular cryptocurrency being used as collateral. Rates might be much higher than the average mortgage rate, and can sometimes come close to the double-digit interest rates charged by credit cards. Borrowers typically also have to pay the peer-to-peer platform a commission, along with other fees.
While a borrower may seek out the lowest available rate, there are other reasons to choose a platform. For one thing, it’s important that the platform is reliable, with strong financial backing, so that it will still be viable when it comes time to get your collateral back.
How to Get a Cryptocurrency Loan
Getting a cryptocurrency loan is fairly straightforward, once a borrower has identified a platform.
1. Create an account. A borrower will need to verify both the cryptocurrency collateral for the loan, as well as their own identity and reliability as a borrower. The platform will then assign a “trust score”, based on the degree to which the platform can verify both identity and financial history.
2. Select a loan type. Borrowers will likely have options depending on the collateral they want to put up and the interest rate they’re willing to pay. Often, if one agrees to a higher interest rate, they won’t have to put up as much cryptocurrency as collateral.
3. Start receiving loan offers. This stage happens quickly. Borrowers typically start to receive loan offers within a few hours after submitting their application form. Once a borrower accepts the terms of the loan, they get the money instantly.
Is Crypto a Good Investment?
An investor who seeks a crypto loan likely believes that their crypto assets will grow in the future. But investing in cryptocurrency comes with risk, just like any other investment.
Plus, there are a unique set of things to know before investing in cryptocurrency. The incredible returns of some currencies have attracted both investors and criminals.
Buying cryptocurrency means sifting through a host of fraudulent schemes that promise dazzling returns. As an entirely digital asset, it’s prone to hacks, and some investors have had their digital currencies stolen.
Many investors don’t want to keep their assets on crypto exchanges, to protect against cyberattacks and theft. Those individuals turn to “cold storage” options to securely store their cryptocurrencies, like hardware or paper wallets, which bring the risk of losing those physical keys, and those cryptocurrency assets, forever.
Also, many cryptocurrencies flat-out fail. Being cutting-edge technologies, cryptocurrencies carry the risk that they won’t work in real-life scenarios. Competition among thousands of blockchain projects is intense, and regulators around the world have periodically cracked down on the crypto industry.
Cryptocurrency is a new and complex area of the capital markets, with seemingly incredible opportunities. Crypto loans offer an opportunity for quick liquidity, providing one way to stay invested in these markets while freeing up capital for short-term needs.
That said, both cryptocurrency loans and cryptocurrency investing come with their own set of possible pitfalls for investors. Cryptocurrency is a high-risk/high-reward investment, and should be treated as such. Newer cryptocurrencies may offer higher risks and rewards than more established ones. But blockchain as a whole is growing in use, with institutional-level custody services and futures markets joining in the action.
This article originally appeared on SoFi and has been republished with permission.
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