What are Crypto Loans and How They Work

The world of cryptocurrencies has come a long way from 2008 when it was envisioned by the mysterious creator, Satoshi Nakamoto in the paper for Bitcoin. The journey has been nothing short of astronomical, with cryptocurrencies giving financial freedom to people all across the globe. Cryptocurrencies have gained much more adoption in the past 5 years than the years before that, with thousands of altcoins, projects, technologies, etc. coming into the market. It is innovating the financial space with each passing year. Crypto loans are one such innovation where the users can get access to loans against their crypto assets […]

What are Crypto Loans and How They Work

The world of cryptocurrencies has come a long way from 2008 when it was envisioned by the mysterious creator, Satoshi Nakamoto in the paper for Bitcoin. The journey has been nothing short of astronomical, with cryptocurrencies giving financial freedom to people all across the globe. Cryptocurrencies have gained much more adoption in the past 5 years than the years before that, with thousands of altcoins, projects, technologies, etc. coming into the market. It is innovating the financial space with each passing year. Crypto loans are one such innovation where the users can get access to loans against their crypto assets known as Crypto Backed Loans, and Crypto Loans without Collateral(Flash Loans), etc.  

Here, we bring you all there is to know about cryptocurrency-backed loans and how you can get loans against crypto, and the advantages and risks associated with them. 

What is Crypto Loans

In order to understand what a crypto loan is, it is important to understand what a conventional loan is and how it works. A conventional loan can be of two kinds: Secured or Unsecured. Secured loans require security or collateral against them as a hedge in face of the loanee being unable to pay the loan back. Unsecured loans do not require security or collateral, rather they are given out on the basis of the loanee’s CIBIL or credit scores. 

Thus a crypto loan is also similar to the conventional loan in a way that the underlying security or collateral needed to secure the loan is not a physical asset, rather it is a cryptocurrency asset. There is also another kind of crypto loan, known as a Flash Loan that is not secured by any asset and is operated on smart contracts. But when we speak of a crypto loan, it refers to crypto secured loan. 

BlockFi crypto loans
        Image Credit: BlockFi 

There are many platforms that act as a conduit for securing crypto loans, such as BlockFi, Celsius, Aave, Compound, and even centralized exchanges such as Binance

Crypto Loan Advantages

The next big question that comes to mind is whether getting a crypto loan is a good idea or not. When it comes to cryptocurrency loans, there are multiple options available to any user. They can choose to be either the borrower or the lender. Each of these roles has its advantages and disadvantages, such as:

Earn Interest

As a lender, there is a huge opportunity for people to earn interest on the loans they give. It is an easy way to earn a steady passive income by loaning out your crypto assets, stable coins such as USDT, or cash. 

Low-Interest Rate

For borrowers, crypto collateral loans serve as a very lucrative prospect as the interest rates are very low. For e.g. BlockFi offers a 4.5 percent APR(Annual Percentage Rate) on the loan. Many other platforms also have a very low-interest rate on their cryptocurrency loans when the loans are secured for the long term. 

No Need for Banks

Cryptocurrency loans empower people in a way where it takes the power of approval or denial of loans away from the banks and other financial institutions. Although the amount in the majority of crypto-asset-backed loans is usually above $10000, it still is very lucrative and gives access to people to funds that would take them a long-time to secure through conventional methods. 

Fast and Secure

The main issue with conventional loans is that they are very time-consuming and not everyone can be assured of securing a loan. With cryptocurrency loans, the time taken to get a loan is minimal and almost everyone can get one.

Ownership of Crypto assets

If someone holds a large number of crypto assets and is in need of cash, then they do not need to sell their crypto assets. Rather they can secure cash loans by keeping their crypto assets as collateral and get them back after repaying the loan. 

Crypto Loan Disadvantages

While cryptocurrency loans might seem very lucrative and the sensible thing to do when it comes to getting loans for people that dabble in the world of crypto. There are some inherent disadvantages associated with them. Some of these disadvantages are: 

High minimum loan amount

When it comes to cryptocurrency loans, the loan amount is usually high. It makes it that much riskier for people to think about getting one. Moreover, in order to secure a cryptocurrency loan worth $10000, platforms such as BlockFi, require a minimum crypto-asset holding worth $20000 in order to get approval for the loan. 

Short Repayment Period

Most cryptocurrency loans have a short repayment period ranging anywhere between 12 months to 3 years. When compared to conventional loans, this time period is shorter and puts much more pressure on the borrower. 

Volatile Nature of Crypto Prices

The crypto asset against which a loan is secured can go through massive volatility in their prices over the course of a loan period. If the price of the crypto asset drops below the threshold level set by the lender, there is a risk of a Margin Call. If a margin call occurs, the borrower might need to deposit more amount of that asset in order to fulfill the loan requirements. If the borrower fails to do so, the platform can choose to sell your assets to recuperate its losses. 

Crypto Assets are locked

Once a loan is secured against a crypto asset, they are locked in for the entire duration of the loan. During which, the borrower can no longer access their assets and use them for trading and other purposes. In case the price of your asset goes to the moon, you won’t be able to sell them. Likewise, if the price drops substantially, you won’t be able to sell them to cut short your losses. 

Conclusion

While cryptocurrency loans are very easy to secure and have a lot of inherent advantages while giving financial liberation to people across the globe. The mechanism and the platforms offering them are still at a very nascent stage. Moreover, the volatile nature of crypto assets that form the backbone of cryptocurrency loans makes them a very risky endeavor. Even if you are a lender that wants to earn interest by lending their crypto assets, it is a much better idea to hold your assets on CoinStats Wallet and earn interest on your holdings. And on top of that, manage all your crypto assets across different platforms using the CoinStats Wallet and App

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