Become informed about important facts regarding cryptocurrency lending including the types of crypto-loans and the risks involved.
Cryptocurrency Lending Facts You Should Be Aware Of
The cryptocurrency lending industry has really taken off in the last couple of years. For lenders crypto-loans offer a good return on their digital assets and they benefit borrowers by providing them with funds without having to sell their cryptocurrency holdings. There are numerous sites online where both borrowers and lenders can find services with instant Bitcoin loans as well as for other cryptocurrencies.
Some people consider getting a crypto-loan to be pretty much the same as acquiring a loan from a bank. However, while there are some similarities, there are some differences between crypto-lending and traditional lending. For those not familiar with cryptocurrency lending we have provided some facts about the service.
There Are Two Main Categories of Cryptocurrency Loans
There are two main categories that cryptocurrency loans will fall into; centralized loans, also known as custodial or CeFi loans and decentralized or DeFi loans.
With centralized loans the lending platform sets the loan terms and interest rates. Borrowers and lenders must go through a KYC verification process. The lending platform will also have access to the user’s private keys. Loans from centralized platforms can be in cryptocurrency, stable coins or fiat currency. Interest rates tend to be lower on centralized loans and the lending platform is more user friendly.
Decentralized loans are managed by smart contracts. The lender sets the interest rates and it is up to the borrower whether or not they accept. Interest rates on DeFi loans will generally be higher. Both borrower and lender maintain control of their cryptocurrency assets but if a loan payment is missed, the lender can take action against the borrower’s account. Loans from DeFi platforms can be in cryptocurrency or stable coins but not fiat currency.
Cryptocurrency Loans Don’t Require a Credit Check
Anyone who has ever applied for a loan from a bank knows that there is a huge amount of paperwork involved which includes an extensive credit check. This is not the case with cryptocurrency loans. Users of centralized crypto lending platforms will have to complete a KYC verification process but there is no credit check. DeFi platforms don’t even require users to complete the KYC process.
The only requirement to qualify for a crypto-loan is to provide the necessary collateral. Once the borrower provides the collateral, loan approval is complete anywhere from a few minutes to a few hours depending on the particular platform.
Be Familiar with the Loan to Value (LTV) Ratio
The Loan to Value or LTV ratio determines how much collateral a borrower must provide and along with the type of cryptocurrency used as collateral and the length of the loan term influences interest rates.
LTV is the amount of the loan divided by the amount of the borrower’s collateral. For example, if a loan of $1000 requires collateral worth $2000 the LTV is 50%.
- $1,000 (loan amount) / $2,000 (collateral) = 50% (LTV)
To determine the amount of collateral required for a loan multiply the amount of the loan times the LTV.
- $1,000 (loan amount) x 50% (LTV) = $2,000
Cryptocurrency loans are generally always over-collateralized meaning that the amount of collateral will be higher than the amount of the loan. Depending on the lending platform, the LTV will range from 20% to 90%. The lower the LTV the lower the amount of interest that will be charged.
Not All Cryptocurrencies Are Eligible as Collateral
There are around 20,000 different cryptocurrencies with over 10,000 of those being active. However, most lending platforms will only accept a small number of these as collateral for a cryptocurrency loan. Most platforms will accept the popular cryptocurrencies like Bitcoin, Ethereum, Litecoin and a number of others. A number of stable coins such as Tether, USD Coin and Binance USD are also widely accepted. Some lending platforms accept as many as 50+ different cryptocurrencies and stable coins as collateral while others only accept 4 or 5. If you are holding a somewhat unknown cryptocurrency, you may have a difficult time finding a platform that accepts it or may even have to trade it for a different digital coin.
There Are Some Risks Involved with Cryptocurrency Lending
Those considering becoming involved with crypto-lending should be aware that there are some risks involved. Cryptocurrencies are volatile and borrowers may be subject to margin calls if they experience a drop in the value of their collateral and the LTV dips below that agreed on.
There is also little or no regulation of the crypto-lending industry. The level of regulation depends on your location. For example, crypto-lending in the US may be somewhat different than that in other countries. Without the strict insurance requirements imposed on traditional banks by regulation, lending platforms can be subject to problems like those recently experienced by Celsius who was forced to pause all account withdrawals.
Cryptocurrency lending can be a great tool in your investment strategy but make sure to do your research first.
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