Getting loans with cryptocurrency can often be easier than getting traditional bank loans. In this article we talk about crypto lending and how to get one.
Crypto enthusiasts are often encouraged to “HODL” their cryptocurrencies — storing them in a wallet until the price surges. But just like you’d feel uneasy about leaving your money in a bank with a low interest rates, an important question is this: how can you get your cryptocurrency to grow?
This is where crypto lending comes in. Not only can it allow savers to receive interest on their stash of Bitcoin, but it allows borrowers to unlock the value of their digital assets by using it as collateral for a loan.
Crypto Lending Explained
When investing, one of the most important challenges is cashflow — and having to raid the capital you’ve got tied up in assets for short-term costs and lack liquidity can be a big problem.
Let’s imagine that you have 2 BTC. You don’t want to sell any of it because you are sure that prices are going to appreciate substantially. You are also worried that, if you don’t end up offloading your crypto, there’ll be a risk that you end up with less Bitcoin when you buy it back at a later date.
Crypto lending platforms can come to the rescue here. Usually, you will be given the opportunity to use your Bitcoin as collateral — and receive a loan in stablecoins. Owing to the volatility of digital assets, you’ll normally have to “overcollateralize,” meaning you’ll have to lock up more BTC than the overall value of the funds you are receiving.
Once you are repaid back the loan, plus interest, your crypto will be returned in full — and you’ll make a handsome profit if BTC ended up appreciating as you predicted. Your crypto would only be at risk if you failed to keep up with the loan’s terms, or if the value of the Bitcoin held as collateral fell below the value of the loan you received.
Right around the time that economies came to a screeching halt in 2020 due to the pandemic crypto loans started to take off. This saw the interest rates get slashed, and lending for big-ticket items take a nosedive. Many people were looking for other methods to make their assets work for them. Crypto loans became a quick and easy way to gain access to fiat money almost instantly, all without selling it. All of a sudden, the days of Bitcoin and Litecoin gathering dust in an exchange or cold storage were numbered.
Unlike traditional loans, collateralized loans are much more secure for the lender, which allows the borrower to take advantage of cheap interest rates.
Cryptocurrencies can be really volatile, which is why these loans are almost always overcollateralized. This provides insurance for the lender should the price of crypto plummet. However, this can negatively impact the borrower — particularly if the platform they use requires them to always maintain their loan-to-value (LTV) ratio.
One of the major bonuses many see in a crypto loan is that, unlike traditional banking loans, you won’t be subject to your credit score being assessed. This means that lending is more for people who don’t have a financial history, underbanked consumers who don’t have a bank account and self-employed workers who struggle to access credit because their fluctuating earnings don’t meet a bank’s strict lending criteria. Repayments can also be more flexible.
And whereas it usually takes several days for loans to clear in the old-fashioned financial way, BTC loans can be instant. You can also make your assets liquid without triggering a taxable event — and you can adjust the loan to suit your needs. Users can also switch between crypto assets, so you could deposit Ethereum and borrow Tether, all on the same platform.
How to Get a Bitcoin Loan
If you like the sound of a Bitcoin loan but you don’t know where to begin, you have two main options — centralized and decentralized lending platforms.
Centralized ecosystems like BlockFi, Nexo and Binance need to follow certain rules and procedures to be compliant. You’ll have to create an account by signing up for your platform and go through Know Your Customer (KYC) procedures that are in place to prevent fraud and money laundering.
These platforms normally have some protocols in place to ensure that your collateral is safe. Some protect crypto assets via insurance or keep the majority of the digital assets in their custody in cold storage, so they’re away from an internet connection.
Centralized crypto lending platforms record all deposits and withdrawals using blockchain technology, viewable to everyone, and provide an excellent way to earn interest on Bitcoin, alongside many other cryptocurrencies and stablecoins such as USDC and DAI. To put it in perspective, the best USD savings account rates around barely scrape past the 1% APY mark, yet many platforms offer up to 8% on cryptocurrency interest rates.
There’s more paperwork involved in getting a loan through a CeFi platform, but the fact that there’s a regulated environment — and a customer service representative who’s just a click or a phone call away — could make these platforms more attractive to traditional investors.
The second option for crypto lending is to go via a decentralized platform, known as DeFi for short.
What Is DeFi Lending?
DeFi lending platforms are decentralized, and transactions are set by code rather than by people. On services like Aave, Compound and dYdX, smart contracts use algorithms and protocols to automate loan payouts.
Anyone can access the protocols on a DeFi platform, which makes them completely transparent, as nothing can be hidden on the blockchain. Unlike CeFi platforms, there’s no middleman or financial regulator, so you don’t have to go through a verification process like KYC. However, DeFi interest rates for crypto lending often pale in comparison to what centralized rivals can offer.
Getting crypto loans on a DeFi platform — is very quick as you won’t need to pass any kind of due diligence. Thanks to smart contracts, all a user will have to do is apply for the loan and then send the crypto they want to use as collateral to a specific wallet associated with the lending platform.
The users of decentralized lending platforms can apply for a loan of any size without having to confirm their identity to a third party. Loans can be supported in stablecoins like USDC, fiat money, or cryptocurrencies such as Ethereum or Bitcoin.
On many centralized and decentralized lending platforms, you can open up a savings account using your crypto, as well as trade tokens or take out loans.
With both types of lending platforms still in their early stages, it’s obvious that this is an exciting space to grow and the potential to access borrowing without the usual formalities could be a game changer for both the people and the financial services industry.