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Cryptocurrency loans let you unlock the value in your crypto assets in a couple of different ways.
If you need to borrow funds, you can use your crypto as collateral when you apply for a loan. Alternatively, if you want to earn yield on your crypto, you can lend it to borrowers through a crypto lending platform and receive yield payments in return.
But how does cryptocurrency lending work, how much can you borrow or earn and what are the risks involved? Keep reading to find out.
Disclaimer: This should not be taken as an endorsement of any of these platforms. You should do additional research to make sure you choose a reliable platform that suits your needs. Note that the availability of these platforms may vary by location. Some platforms may not be licensed or regulated in your jurisdiction.
A cryptocurrency loan is a type of secured loan. But unlike a secured personal loan where you use an asset such as your car or home equity as collateral, with a crypto loan you use cryptocurrency as collateral.
In return, you can borrow stablecoins such as USDT or USDC, other cryptocurrencies like BTC or ETH or fiat currency such as US or Australian dollars. You then have to repay the amount you borrow plus interest, but if you can't afford the repayments you'll lose your collateral.
A cryptocurrency loan works in the same way as any other type of loan. You borrow funds for an agreed period and at an agreed interest rate, then pay back the principal and interest within the loan period.
Different platforms work in different ways, but the general principle is that of peer-to-peer lending. Borrowers use their cryptocurrency as collateral to get loans while lenders deposit cryptocurrency, which is used to fund the loans.
Let's break down some of the key features of crypto loans.
Loan interest rates vary depending on your circumstances, but it's possible to access lower interest rates from cryptocurrency lending services than on a traditional personal loan.
Cryptocurrency lending services differ from traditional lenders in how they assess your ability to repay a loan. Traditional lenders examine a borrower's credit score, credit history, income and outstanding debts before approving a loan.
On the other hand, crypto lenders vary their rates depending on how much collateral you put up and the loan term you select. The more collateral you have and the shorter the loan period, the lower your rate will generally be.
Some crypto lending platforms also offer rate discounts if you stake or use the platform's native token.
Many crypto lending services only specify a minimum loan amount. This is as small as $50 or $100 with some lenders, but can be $10,000 or more with other providers.
However, the amount you can borrow is limited by the lender's maximum loan-to-value (LTV) ratio. The LTV is the value of the amount you're borrowing compared to the value of the collateral you provide to secure the loan. You can calculate the LTV ratio by dividing the loan amount by the value of your crypto asset, then multiplying the result by 100.
For example, let's say you want to borrow $1,000 and you put up $2,500 worth of Bitcoin as collateral. So the LTV is 1,000/2,500 then multiplied by 100, which gives you an LTV of 40%.
Most cryptocurrency lending platforms offer a maximum LTV of 50%, but there are exceptions. If you want to borrow $5,000, you'll typically need to put up at least $10,000 of collateral.
Finally, if you're willing to offer more collateral to get a lower LTV, you can often access a better interest rate.
The next factor you need to consider when comparing cryptocurrency lending services is the type of crypto you can use as collateral. Some lenders accept Bitcoin only while others accept major cryptocurrencies such as Ethereum and Litecoin.
Some larger platforms accept dozens of crypto as collateral. For example, Celsius supports over 45 coins and tokens.
However, take note that you'll usually only be able to pay back your loan with 1 type of crypto asset.
The application process for a crypto loan is a little different to applying with a traditional lender. Rather than assessing your credit score and income, the main concern of crypto lenders is ensuring that you can provide enough collateral to meet their maximum LTV.
Depending on the lending platform you choose, you may also need to provide photo ID and proof of address when you apply for a loan.
Another factor you'll need to consider is whether you access a centralised or decentralised loan.
Centralised lending platforms screen borrowers and issue the loans themselves, then simply share the profits with the lenders. This creates an experience similar to the way banks offer loans and pay interest to savings account holders.
Decentralised finance (DeFi) lending platforms act as marketplaces where borrowers and lenders can come together and browse one another's offers. They rely on DeFi protocols and smart contracts to govern the borrowing and repayment process.
You can use the funds you borrow for any personal expense. For example, you might use a crypto loan to:
There are also some crypto lending services that specialise in loans for businesses.
Cryptocurrencies are highly volatile, with prices rising or falling dramatically in a short time. Take Bitcoin, for example, which was trading above $90,000 in November 2021. By January 2022 it had dropped below $50,000.
It's this volatility that makes crypto loans a risky prospect for borrowers. If the value of your crypto collateral falls below the LTV on your loan, this could trigger a margin call.
When this occurs, you'll need to either offer more crypto as collateral or pay down your loan. You'll typically only have a deadline of hours or days to do so. If you don't, the lender will liquidate your collateral.
LTV and margin call requirements vary depending on the lending platform you choose. But as a general guide, a margin call is usually triggered when the LTV increases to 65–70%, with liquidation occurring when the LTV reaches 80% or 85%. Check the fine print that applies to your crypto loan to find out all LTV terms and conditions.
If the value of your collateral increases and your LTV drops below a certain point, some lenders such as Celsius offer what's known as a reverse margin call. This results in a portion of your collateral being returned to you.
Why consider a crypto-backed loan? Cryptocurrency lending offers the following benefits:
Before applying for a crypto loan, make sure you understand the risks involved:
Here's what you need to do to apply for a cryptocurrency loan:
Many cryptocurrency lending platforms allow you to assume the role of lender. Here's how it works.
You stake your cryptocurrency on the platform for other users to borrow and you earn yield in return. It's a simple way to generate income from your crypto investments while still holding onto your coins and tokens long-term.
However, be aware that there are risks involved. While you can withdraw from your crypto lending account whenever you want in most cases, some platforms don't allow you to access your funds until the borrower has repaid the loan. There's also the risk of losing money if the borrower defaults on the loan or if the value of your crypto drops.
Finally, remember that there are also tax implications to cryptocurrency lending. The yield you earn will need to be included as part of your assessable income on your tax return. Find out more in our cryptocurrency tax guide.
Before deciding whether a crypto loan is right for you, consider other more traditional lending options. These include:
Of course, if you're not holding your crypto for the long term, you could also consider selling some of your assets to access the Australian dollars you need. Just remember that disposing of cryptocurrency is a CGT event. You need to consider the more affordable option: paying CGT when you cash out some of your crypto or making interest repayments on a cryptocurrency loan.
Cryptocurrency lending is an effective way to put your crypto assets to use in the real world. However, there are risks and drawbacks attached. The main downside for borrowers is the volatility of crypto assets, which means it's worth considering a range of other options before deciding whether a crypto loan is right for you.
Disclosure: At the time of writing, the author holds ADA, ICX, MIOTA, POWR and XLM.
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