- Crypto-backed loans are secured loans that use digital assets like bitcoin as collateral.
- You won’t have to undergo a credit check to qualify for a crypto-backed loan.
- Crypto-backed loans may also distribute funds almost instantly, unlike traditional lenders.
- Read more of Personal Finance Insider’s loan coverage here.
Cryptocurrency has become increasingly popular over the past decade, and a new type of financial offering, crypto-backed loans, has emerged along with it.
There are different types of cryptocurrency, like bitcoin or ethereum, which are digital forms of money. Cryptocurrency is basically a virtual asset which you can use to buy good and services, as opposed to physical money. The blockchain, or digital ledger, keeps track of every bitcoin transaction.
How does cryptocurrency lending work?
Crypto-backed loans are secured loans. Borrowers use digital assets as collateral for loans, similar to how a house or a car is used as collateral for a mortgage or auto loan. You may not intend to use or trade your cryptocurrency in the foreseeable future, so this allows you to get money for expenses you need to cover now without needing to make a transaction with your digital assets.
You can find crypto-backed loans on marketplaces like BlockFi, Binance, and Celsius, though this list isn’t exhaustive.
To take out a crypto-backed loan, you’ll first sign up on the platform of your choice and choose a desired loan amount. Then, that platform will calculate how much cryptocurrency is needed as collateral, you’ll deposit said amount, and apply for the loan. Once your loan is approved, you’ll receive your money.
You’ll pay off the loan’s balance plus interest over a designated term length, though most platforms don’t have any penalties for paying off your loan early. And some platforms, like Abra, even offer interest rates as low as 0%.
What are the pros of cryptocurrency lending?
You won’t have to undergo a credit check to qualify for a crypto-backed loan, which may make it a great option for borrowers who don’t have the best credit histories. You can often qualify for a lower rate with a crypto-backed loan than with a traditional personal loan.
You won’t have to sell your cryptocurrency to take out a crypto-backed loan, so if you believe your asset will increase in value in the long term, it may appreciate by the time you receive your collateral back. In other words, crypto-backed loans give you the chance to borrow against your balance without completely shutting yourself off to attractive market returns.
Crypto-backed loans may also distribute funds almost instantly, unlike with traditional lenders who may need multiple days to get you your money. Your loan amount will be based on your asset value, and many exchanges will allow you to borrow up to 50% of that value.
What are the drawbacks of cryptocurrency lending?
Since the value of cryptocurrency is more volatile than other assets, you might find yourself in a situation where the value of your digital currency dips and your lender requires you to increase your collateral to keep the loan, also known as a margin call. In certain cases, your lender may even sell some of your assets to reduce your loan-to-value ratio.
For example, if you took out a $1,000 loan and pledged $2,000 in cryptocurrency assets, your loan-to-value ratio would be 50%. If the value of your cryptocurrency decreased by $1,000, your lender may require you to pledge another $1,000 in digital assets or to pay off your loan immediately.
Depending on that platform you’re using, certain digital assets might not be eligible for loans, so you might have to convert your cryptocurrency into another asset type. You also won’t have access to your assets until you pay off the loan’s balance, which means you won’t be able to sell or trade your cryptocurrency quickly.
Crypto-backed loans aren’t federally insured, so you aren’t guaranteed compensation in the event of something like a security breach.
You may want to consider alternatives to crypto-backed lending like a home equity loan or a 0% introductory interest credit card. However, if you want to hold on to your cryptocurrency and need money fast, these loans could be a good option for you.