Cryptocurrency is changing the financial landscape of the world. From the way people move money to how people invest, Bitcoin and other digital assets are fundamentally altering our perception of finance. This is also true where lending is concerned. Crypto lending is becoming more popular. Some even believe that this type of lending could ultimately replace traditional financing.
Whether individuals need a small loan to pay off credit card debt or financing for a car, crypto-backed loans offer a wide range of possibilities. They also have the potential to provide passive income sources for lenders.
What are Crypto-Backed Loans?
Numerous online cryptocurrency lending platforms have appeared in the past year. The basic premise is that these services allow cryptocurrency investors to use the crypto they hold as collateral for a fiat loan. The loan is secured by a deposit of cryptocurrency that an individual makes on the platform.
Let’s look at an example. Let’s say that you currently control $5,000 worth of Bitcoin. You are suddenly faced with an expense and don’t have enough cash reserves to cover the cost. Rather than sell your Bitcoin for cash you could put that crypto up as collateral for a cash loan. You would then repay the loan in installments as you would a bank note. If you defaulted on the loan the Bitcoin you provided as security could be taken to satisfy the outstanding balance.
One of the primary lenders offering such a service is BlockFi. The service provides USD loans that are collateralized by cryptocurrency assets. Those who need a loan can deposit Bitcoin, Ethereum, Litecoin, and a number of other cryptocurrencies as security for a loan. The individual fills out an application and if the application is approved the USD amount requested is deposited to the individual’s bank account in as little as 90 minutes.
This type of loan allows individuals to bypass traditional lenders like credit unions and banks. The interest rates offered by a crypto-backed loan may be better than those offered by banks. The rate depends upon credit history, location, and other factors. In many ways getting a crypto-backed loan is just like getting a loan from a financial institution.
Why Would Someone Consider Crypto Lending?
There are many reasons why someone would choose crypto-backed loans over the traditional variety. The first one is obviously related to one’s credit history. Many people do not have the credit score needed to obtain a loan from a bank or finance company. While crypto lenders do review credit scores of borrowers to determine interest rates and loan amounts, the probability of getting a loan with poor credit is higher when crypto is used to secure the loan.
Another reason that some individuals might want to borrow in this fashion is to tap liquidity where their crypto portfolio is concerned. Many cryptocurrency investors have amassed large sums of digital currency. It works for them as an investment vehicle, often being traded on exchanges. However, being able to tap the investment as a source of fiat capital opens up a large number of investment possibilities.
Here’s an example. John is a crypto investor that has a portfolio valued at around $25,000 USD. John decides that he would like to invest $10,000 in a stock options trading account, but he doesn’t have that kind of capital. He cannot qualify for a loan of that amount with his bank, so John’s only option is to pursue a crypto-backed loan. He applies to a crypto lender, deposits his holdings as collateral, and is approved to receive his $10,000 trading capital.
The reasons that someone would take out a cryptocurrency loan are many. All those reasons boil down to the same basic concept – leveraging crypto assets for cash.
How to Use a Crypto-Backed Loan
There are other examples of how some individuals might chose to use a cryptocurrency backed loan. Almost all of them relate to situations where traditional financing is not an option. You should know up front that crypto lenders are providing a unique service that isn’t available anywhere else.
Traditional banks will not touch cryptocurrency with a ten-foot pole. Can you imagine having $10,000 in Bitcoin and wanting to use that as collateral for a $1,000 loan at your bank? They would laugh you out of the building. Even if they did agree to let you use Bitcoin as collateral the interest rate would be insane. Banks don’t trust crypto. Period. They see these assets as too volatile, and they really hate that they can’t hold them in physical form.
Therefore, you might decide to use a crypto lender to get a loan for the home you have been wanting. You could secure the home with your crypto and then use the loan funds to purchase the home outright without a mortgage. Later you might decide to mortgage the home and use the traditional loan you receive to pay off the crypto loan. Choices are vast.
One of the best ways to use a crypto-backed loan is to pay off other expensive debt. The interest rate on your crypto loan is likely to be less than the interest you are paying on your credit cards. Take a loan, pay off the credit card, and save money.
Can you see a trend in these ideas for using crypto-backed loans? Almost all of these scenarios eliminates the need for third-party involvement from banks and traditional lenders. What do we mean by this? Let’s look at the house purchase as an example.
You decide to buy a $100,000 home and get a home loan from your bank. This money will go to the seller of the home, but wait. When you receive the title to your home the bank’s name will be right there on the deed as holder of the lien. In essence, you don’t own the home. The bank does until you pay off the loan.
When you use cryptocurrency to secure a loan for the home, the home is yours. There is no lien. Yes, you can lose your crypto if you fail to repay the crypto-backed loan, but there is no third-party involvement where your home is concerned.
As you might imagine, such a scenario is very troubling to banks. They are beginning to see a world where their services might no longer be relevant. It may seem like science fiction to consider a world where fiat currency becomes a thing of the past, but this is happening right before our very eyes. In another 20 years paper currency could be a thing of the past.
Some Popular Crypto Lenders
We mentioned BlockFi as a crypto lender. There are also others such as Nexo and AssetStream. All of them have some subtle differences in how they approach the lending of cryptocurrency.
For example, AssetStream has its own local cryptocurrency. The thing that really sets this platform apart is that it supports peer-to-peer lending. AssetStream uses Smart Contracts to establish agreements between lenders and borrowers.
Nexo limits its platform to the deposit of stablecoins as collateral. These coins are far less subject to the volatile movements of the cryptocurrency markets. There are also no minimum deposits at Nexo, whereas BlockFi requires a minimum deposit of $5,000 in crypto assets.
In the coming months and years you can expect to see more of these lending platforms begin to appear. You can also expect the world to keep finding innovative ways to use digital assets.