Crypto investors are pledging their digital assets to buy homes, cars and more crypto by securing loans through crypto exchanges or crypto lending platforms that are quickly becoming the new craze in the cryptoverse.
Cryptocurrencies such as Bitcoin and Ether are being used as loan security by investors who pledge a portion of their crypto assets as collateral for the money they borrow.
Lenders take deposits in form of cryptocurrencies, which earn higher-than-average interest rates. The crypto deposits are used to fund loans to borrowers who pay it off over time.
Cryptocurrency lenders take a similar approach as traditional banks, but unlike banks, which are regulated by the government and are required to have reserves of deposits to protect them from bad debts, crypto lenders are not regulated to the same standards.
Crypto-backed borrowers keep ownership of the assets they pledge to the lender while paying off the loan. However, they risk losing a significant amount of their collateral if they default on their payments, just like one would with a secured loan such as a car or mortgage loan.
These new loans come in many forms. Borrowers can get dollars or other traditional currencies, or stable coins – any cryptocurrency designed to have a relatively stable price – depending on the lender.
Some people opt for crypto loans because they do not want to use their crypto assets soon aka hodl.
“The idea is to shift some of your digital assets into real-world profits so you can’t lose them,” said Antoni Trenchev, co-founder and managing partner at the crypto lender Nexo Capital Inc.
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Other people consider taking out crypto loans because of the benefits they provide such as low interest rates, fast funding, choice of loan currency and no credit check. Crypto lending platforms rarely check borrowers’ credit history when applying for a loan, making it attractive for people with a poor credit history.
Some lenders will require their borrowers to get a loan with a non-custodial crypto. These are assets held in a digital wallet that is not linked to an exchange. However, most of the lenders require the borrowers to keep their digital assets with the platform to be eligible.
Crypto loans are largely affected by margin calls, which happen when the value of the collateral falls below a certain threshold. When that happens, the lender requires the loanee to increase their crypto holdings to maintain the loan.
Sometimes the lender may sell some of the crypto assets to cut the borrower’s loan-to-value ratio – the ratio of the loan amount to the lender-assessed value of the collateral. The chance of this happening is high because of the short-term volatility of cryptocurrencies.