Cryptocurrency has seen increasing popularity and widespread adoption in the United States and around the world. However, many digital currencies are very volatile in the short term. Bitcoin, for example, more than doubled in value between January and April, then lost almost all of that value in mid-July.
But cryptocurrency users who aren’t concerned about short-term volatility because they’re there for the long term are now using their digital assets as collateral for loans. Here’s what to know about crypto lending and some of the pros and cons to consider.
The most popular types of cryptocurrency
There are thousands of different cryptocurrencies available. According to crypto media CoinDesk, here are the top five in terms of market capitalization:
- Bitcoin: The first cryptocurrency, Bitcoin was created in 2008 by Satoshi Nakamoto, a pseudonym used by the person or group of people who invented it. Bitcoin is by far the most popular and valuable cryptocurrency. It trades in BTC on the exchanges.
- Ethereum: Ethereum is a decentralized, open source blockchain that uses Ether (ETH) as its native cryptocurrency. Although it is second behind Bitcoin in terms of market capitalization, it is the most actively used blockchain.
- XRP: XRP is Ripple’s native digital currency, a settlement system and payment network. Currency was created to reduce transfer fees and wait times for financial institutions.
- Cardano: Trading under the ADA name, Cardano is the currency that runs on the Cardano blockchain. The platform allows token holders to vote on updates, improvements and funding decisions.
- Stellar: The Stellar blockchain, created by the Stellar Development Foundation, connects financial institutions to facilitate low-cost transactions in developing markets. Stellar’s native token is Lumen, which trades as XLM.
How the crypto loan works
A cryptocurrency-backed loan uses digital currency as collateral, similar to a securities-based loan. The rule of thumb works like a mortgage or a car loan – you pledge your crypto assets to get the loan and pay it back over time. You can get this type of loan through a crypto exchange or crypto lending platform.
While you retain ownership of the crypto that you have used as collateral, you lose certain rights, such as the ability to exchange it or use it to transact. Additionally, if the value of your digital assets drops significantly, you may end up having to repay a lot more than what you borrow if you default on your payments.
People may consider crypto loans because of the benefits they offer and because they have no plans to trade or use their crypto assets in the near future. The acronym HODL, which stands for Hold For Life, is a common refrain in crypto-focused online forums.
Benefits of cryptocurrency lending
Compared to traditional secured loans, crypto loans have some unique characteristics that can make them attractive to some crypto enthusiasts:
- Low interest rates: While they are generally not as cheap as mortgages or auto loans, crypto loans are an inexpensive alternative to personal loans and credit cards. You can often get a crypto loan with an interest rate of less than 10%.
- The loan amount is based on the value of the asset: In many cases, you can borrow up to 50% of the value of your portfolio, but some exchanges are up to 90%.
- Choice of loan currency: Depending on the platform and what you need, you can usually get the loan funds in the form of US dollars or certain cryptocurrencies.
- No credit check: Lending platforms and crypto exchanges typically don’t perform a credit check when you apply, making it an incredibly attractive funding option for people with low credit or no credit history.
- Quick financing: Once you are approved, you can get your loan funds in just a few hours.
- Possibility of lending cryptos: Many crypto exchanges offer “interest” accounts that allow you to lend your own digital assets and in return receive a high APY – sometimes over 10%.
Things to consider before committing to a cryptocurrency loan
There are obvious advantages to using your digital currency to secure a loan. But due to the nature of secured loans and cryptocurrency, there are also downsides:
- Margin calls: A margin call occurs when the value of your collateral drops below a certain threshold and the lender forces you to increase your holdings to maintain the loan. In some cases, the lender may even sell some of your assets to lower your loan-to-value ratio. Since cryptocurrencies are extremely volatile in the short term, the chances of this happening can be high.
- No access to your assets: As long as your loan has an outstanding balance, you cannot access your assets to trade or transact. This can be a big problem if the price of the currency drops drastically or if you need money quickly.
- The repayment terms may vary: These loans generally work like traditional installment loans, and depending on the crypto loan program, you may have less than a year to pay off what you borrow. In other cases, you can create your own repayment schedule. With shorter payback times, it’s critical that you know up front if you can afford the payments.
- Not all digital assets are eligible: Depending on the crypto lending platform you are using, you may need to exchange your currency for a qualifying asset. This may not be preferable if you want to keep your specific asset and it cannot be considered a guarantee on any platform.
- The funds in the interest account are not insured: If you lend your own digital assets, funds in a crypto interest account are not insured like money in your bank account. So if the exchange fails, you could lose everything.
- Withdrawals from interest accounts can be slow: You can usually request a withdrawal from your crypto interest account whenever you want. But depending on the platform, it may take several days for these funds to be released so that you can use them. It can be very damaging if the value of your assets is dropping rapidly and you cannot trade them.
The bottom line
If you are in need of cash and have significant crypto holdings but don’t want to sell them, crypto lending may be an alternative to consider. Crypto loans can be inexpensive and quick, and they often don’t require a credit check. Additionally, if you have digital assets that you plan to hold on to for a long time, lending them through a crypto interest account could be a great way to maximize their value.
Before committing to either crypto loan, however, it’s important to understand the risks, especially what could happen if the value of your cryptocurrency drops quickly and significantly. If you are considering a crypto loan in either form, be sure to consider both the pros and cons, as well as all of your other options, before making a decision.