Bitcoin has been revolutionizing the traditional financial system actively, right from investment behaviors to payment transactions, especially when decentralized finance (or De-Fi) platforms started offering 10x more interest rates than traditional banks. As a result, there has been a spurt of institutional interest in the crypto-backed loans ecosystem.
Cryptocurrency loans have gained a lot of attention in the past few years, now becoming a mainstream conversation for institutional investors and banking experts.
What are crypto-backed loans?
Before diving into whether crypto-backed loans are legal and safe, we need to understand what the terms mean. These are loans where you can keep your cryptocurrency as collateral. You do not require extensive documentation, credit checks, and verification – all without any hassles.
Thanks to different decentralized platforms, you will be able to borrow crypto loans with ease; here, smart contracts are created after the lender and the borrower come to a mutual agreement. The overall process is very transparent and straightforward and does not involve any hidden fees. Once you (the borrower) repay the loans, your crypto-assets will be returned to you.
Because the value of cryptocurrency keeps fluctuating, the lenders are protected by margin calls. This means that if the value drops sharply, you will have to increase the collateral.
What are the details of crypto-backed loans?
Here is how Bitcoin loans or Ethereum loans work:
When you plan on getting a loan, you will have to secure it with crypto-assets. This means that you will have to deposit cryptocurrencies that are worth more than the value of the loan.
- Value of the loan
In most cases, the loan value needs to be anywhere between 50% and 70%. For instance, if you want to borrow a sum of $10,000, you will need to deposit $20,000 worth of cryptocurrency, if the loan-to-value ratio is at 50%.
As we already know, the value of digital assets like cryptocurrencies is volatile. Hence, P2P crypto platforms sell the collateral once it reaches a threshold (like 90% LVT). Hence, your investment remains protected.
When it comes to returns, most crypto lending platforms yield anywhere between 8% and 10% annually. These platforms also offer an interest-based investment account, which will allow you to instantly access your investment.
Are crypto-backed loans safe?
If you were lucky and started investing in cryptocurrency when it was new, you may have a nice stash sitting in your hardware wallet. It is very important that you keep your cryptocurrency secure and safe from hackers. In this case, crypto lending will allow you to put up your cryptocurrency as collateral for a fiat loan. Additionally, the interest rates are much lower than banks. Also, these institutions do not care much about your purchasing history or bad credit history; all you need to have is your crypto collateral.
While the benefits of crypto-backed loans seem too good to be true, it is something that you should never consider blindly. There are always many risks involved, especially when it comes to security and default risks. When it comes to default risks, you need to remember that most people that are attracted to such loans usually have been deemed a high risk of default and have a bad credit history.
As a safety measure for lenders, it has been stated that the lender can keep about 80% of the crypto collateral in case the borrower defaults. However, this condition may vary from one lender to another; ensure that you read the terms and conditions properly before agreeing to the loan.
Even borrowers are not entirely safe from the risks. You will have to transfer your crypto-assets to the lender; this means that you need to be completely confident in the lender’s custodian. You need to look for a respectable lender. Additionally, look up insurance policies in case you get hacked and how much compensation will be paid out.
Yes, there is a rise in the number of people opting for crypto-backed loans. These loans offer a lot of benefits, especially to people with bad credits. However, there are quite some risks involved in these types of loans, mostly because the concept is still new to the masses. However, improvement is being done in leaps and bounds and soon, we may find crypto-backed loans become more popular than its traditional counterparts.