Cryptocurrency has become popular in the last few years, and together with its boom comes cryptocurrency-backed loans.
Bitcoin and Ethereum are some of the different kinds of cryptocurrency, which is a virtual form of money. Cryptocurrency is a digital means where an individual can buy goods and services. The blockchain or a public digital ledger monitors each transaction made using these cryptocurrencies.
Mechanism of Cryptocurrency Lending
Cryptocurrency-backed loans are a kind of secured loan where virtual assets are utilised as collateral by borrowers. Users may not plan to use or trade crypto in the future, but this permits loan applicants to obtain funds for current expenses without transacting with their own digital assets.
Different platforms allow cryptocurrency-backed loans. Some of these are Celsius, Binance, and BlockFi.
In order to be granted a cryptocurrency-backed loan, crypto holders sign up on their desired platform and decide on the loan amount. That crypto platform will calculate the required value of crypto needed as collateral. The user will deposit the amount and apply for the loan. The borrower will be granted cash once the loan is approved.
Borrowers then can pay for the balance of the loan plus interest over a predetermined term of the loan. There are some crypto platforms that do not charge penalties if a loan is paid earlier. Abra and some other platforms even charge a 0% interest rate for such cases. Users could learn more about the cryptocurrency market through credible platforms such as Bitcoin Era
Advantages of Cryptocurrency Lending
Borrowers do not need to undergo a background check in the application for a cryptocurrency-backed loan. This is preferable for clients who do not have the best credit scores. A lower interest rate can be granted to qualified borrowers with a cryptocurrency-backed loan compared with that of a traditional personal loan.
Borrowers do not need to sell their cryptocurrency in order to be granted a cryptocurrency-backed loan. Crypto holders still can benefit from virtual assets in the long term as these might appreciate by the time the collateral is back. Borrowers can still benefit from the revenues their cryptocurrency could gain as cryptocurrency-backed loans allow them to be granted a loan against their crypto balance.
Borrowers could also obtain cash from cryptocurrency-backed loans instantly. This is in contrast with traditional lenders who grant funds within multiple days. The amount of the loan will be based on the borrower’s asset value. Most exchanges permit borrowers to apply for a loan that is equivalent to 50% of that value.
Disadvantages of Cryptocurrency Lending
With the market volatility of cryptocurrency, borrowers might find themselves in a situation where the digital currency’s value decreases and the lender require the borrower to increase his collateral, which is also called a margin call. There are instances when some of the borrower’s assets will be sold by the lender in order to decrease the borrower’s loan-to-value ratio.
For instance, if a borrower was granted a $100 loan and pledged $200 in crypto assets, 50% is the loan-to-value ratio. If the cryptocurrency value dips by $100, the lender may demand the borrower to pledge another $100 in virtual assets or be required to pay the loan immediately.
Each crypto platform has its own process of granting crypto-backed loans. There are some digital currencies that are ineligible for loans, and the owner might need to convert this specific digital asset into another kind of digital asset. The borrower also will have transitory access to his assets until he has paid the balance of the loan. The borrower cannot engage in trading his cryptocurrency as long as his balance is still not paid off.
Since the federal government does not insure cryptocurrency-backed loans, the borrower is not guaranteed compensation in case the system is hacked.
Crypto-backed loans are a good alternative for crypto investors who want to obtain cash for their immediate expenses. However, this also has its own potential drawbacks that a borrower needs to understand before applying. There are also other options for crypto-backed lending, such as credit cards. In cases where the borrower wants to hold on to his crypto and still need immediate funds, cryptocurrency-backed loans are a good alternative.