What are crypto loans?

What are crypto loans?

Crypto lending is the process of depositing cryptocurrencies that are loaned to borrowers in exchange for regular interest payments. Payments are made in the form of the cryptocurrency being deposited and are typically compounded daily, weekly or monthly.

There are two main types of cryptocurrency lending platforms: decentralized cryptocurrency lenders and centralized cryptocurrency lenders. Both offer access to high interest rates, sometimes as high as 20% annual percentage yield (APY), and both typically require borrowers to post collateral to access a crypto loan.

key takeaways

  • Cryptocurrency loans pay high interest rates on deposits.
  • Crypto loans offer access to cash or crypto through collateralized loans.
  • Crypto lending is inherently risky as margin calls can occur if asset prices fall.
  • Crypto lending platforms act as intermediaries for lenders and borrowers, and there are centralized and decentralized markets available.

Understanding Crypto Loans

Cryptocurrency lending platforms offer opportunities for investors to borrow against deposited crypto assets and the ability to lend cryptocurrencies to earn interest in the form of crypto rewards. Lending platforms became popular in 2020 and have since grown to billions in total value locked across various platforms.

Crypto loans have two components: deposits that earn interest and crypto loans. Deposit accounts work similarly to a bank account. Users deposit cryptocurrencies and the lending platform pays interest, up to 8% APY (depending on platform and cryptocurrency). The platform may use the deposited funds to lend to borrowers or for other investment purposes.

Crypto loans are typically offered as collateralized loan products, requiring users to deposit a minimum of 100% (and up to 150%, depending on the lender) in crypto collateral to borrow cash or cryptocurrency.

Like traditional loans, interest rates vary by platform and require monthly payments. Unlike traditional loans, cryptocurrency loan terms can be as short as 7 days and can go up to 180 days and charge an hourly interest rate, like Binance. Then there are other lenders that offer an indefinite line of credit instead, like Nexo, which offers 0% APR.

Types of crypto loans

There are several types of cryptocurrency loans available:

secured loans

Secured loans are the most popular and require deposited cryptocurrencies that are used as collateral for the loan. Most platforms require overcollateralization, which means that borrowers can access only a certain percentage of the collateral posted (typically below 90% loan-to-value). The lower the loan-to-value (LTV) ratio, the lower the interest rate, as well as the lower the risk of margin being called.

crypto line of credit

Instead of offering a traditional loan with a predetermined term, some platforms offer a crypto line of credit. This is a type of secured loan that allows users to borrow up to a certain percentage of the collateral deposited, but there are no set payment terms and users only pay interest on withdrawn funds.

unsecured loans

Unsecured loans are not as popular, but they work in a similar way to personal loans. Borrowers must complete a loan application, pass identity verification, and complete a credit check to be approved. These loans carry a higher risk of loss for lenders, as there is no collateral to liquidate in the event of a loan default.

quick loans

Flash loans are usually available on cryptocurrency exchanges and are instant loans that are borrowed and paid for in the same transaction. These are very high-risk loans that are typically used to take advantage of market arbitrage opportunities, such as buying crypto for a lower price in one market and instantly selling it for a higher price in another, all within the same transaction.

Risks of Crypto Loans

Cryptocurrency lending is inherently risky for both borrowers and lenders, as loans and deposited funds are beholden to the ever-volatile cryptocurrency market. As the recent Celsius debacle unfolded, billions of dollars in deposits were frozen overnight, leaving crypto enthusiasts less than thrilled.

Here are some of the risks of crypto lending:

margin calls

When users pledge collateral and borrow against it, a drop in the value of the collateral posted could trigger a margin call. This happens when the LTV of a crypto loan falls below the agreed rate. When this happens, borrowers must post more collateral to recover the LTV or risk being liquidated.

illiquidity

When crypto assets are deposited on crypto lending platforms, they typically become illiquid and cannot be accessed quickly. While some crypto lending platforms allow lenders to withdraw deposited funds fairly quickly, others may require a long waiting period to access funds.

not regulated

Cryptocurrency lending platforms are not regulated and do not offer the same protections that banks do. For example, US bank deposits are FDIC insured up to $250,000 per depositor, and in the event the bank becomes insolvent, user funds are protected up to that limit. For crypto lending platforms experiencing solvency issues, there are no protections for users and funds may be lost.

high interest rates

While some crypto loans offer low rates, most crypto loans charge over 5% APR, with some charging as high as 13% APR (or more).

How to get a crypto loan

To apply for a crypto loan, users will need to register with a centralized lending platform (such as BlockFi) or connect a digital wallet to a decentralized lending platform (such as AAVE). Next, users will select the collateral to be deposited, as well as the type of loan and the amount to be requested. The amount available will vary depending on the collateral and the amount deposited.

To complete the transaction, users will need to deposit collateral into the platform’s digital wallet, and the borrowed funds will be instantly transferred to the user’s account or digital wallet.

Most loans offer instant approval and loan terms are set through a smart contract.

How to lend cryptocurrencies

To become a crypto lender, users will need to register with a lending platform, select a supported cryptocurrency to deposit, and send funds to the platform. On a centralized crypto lending platform, interest can be paid in kind or with the native platform token. On a decentralized exchange, interest is paid in kind, but there can also be bonus payments.

Are crypto loans safe?

Cryptocurrency loans are a double-edged sword. For one thing, most loans are secured, and even in the event of a default, lenders can recoup their losses through liquidation. They also offer much higher interest rates on deposits than traditional bank accounts. On the other hand, lending platforms have the sovereignty to simply block user funds, as is the case with Celsius, and there are no legal protections for investors. There are also risks for borrowers, as the collateral may lose value and be liquidated, selling your investment at a much lower price. Lending platforms are being targeted by regulators around the world, with regulations forming around deposit accounts, even leading to the Securities and Exchange Commissions (SEC) fining BlockFi $100. million for violating securities laws. In general, crypto loans can be safe for scrupulous users, but they present significant risks for both borrowers and investors.

How do you make money lending cryptocurrencies?

By depositing cryptocurrencies on a lending platform, users can earn a generous amount of interest on those deposits, often more than traditional banks. The deposited funds are lent to borrowers who pay a portion of that interest, and the funds can also be alternatively invested for additional returns.

What are decentralized finance (DeFi) loans?

Decentralized finance (DeFi) lending is a platform that is not centrally governed, but rather offers loan and loan services that are managed using smart contracts. DeFi loans are instant and decentralized applications (Dapps) allow users to connect a digital wallet, deposit collateral and instantly access funds. DeFi loans allow users to deposit crypto through a digital wallet and start earning interest immediately, usually compounded minute by minute. Most DeFi lending platforms require excessive collateral on loans, depositing 110% (or more) of the loan amount. The difference between DeFi and centralized platforms is that the deposited collateral also earns interest, even when attached to a loan.

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