6 Things to Consider When Borrowing Cryptocurrency
The popularity cryptocurrency has been enjoying across mainstream inventors and consumers make it easier to invest in. Thanks to some platforms such as crypto exchanges, it is possible to secure a loan using your digital assets. Although there are incentives to doing so, you should also be aware of the risks of crypto borrowing. This article will show you six things to take into account when borrowing cryptocurrency.
What is crypto lending or borrowing?
Cryptocurrencies such as Bitcoin are digital assets with several uses, such as securing loans. Crypto lending or borrowing entails borrowing money using cryptocurrency as collateral. It is the same as traditional loans, only that you can get them from conventional financial institutions.
These loans are available on crypto exchanges and decentralized finance (DeFi) platforms. Unlike regular loans, you do not need a credit score. Instead, they check your loan-to-value ratio. This compares the number of crypto coins you own to determine the amount you can borrow. Most lending platforms demand a 50% loan-to-value ratio.
Types of cryptocurrency loans
Cryptocurrency loans fall into two broad categories. These are:
● Custodial crypto loans: In these loans, the borrower has no access to the collateral assets since the lender has control over the assets’ private keys.
● Non-custodial crypto loans: In this model of crypto loans, both the lender and borrower rely on smart contracts. Also, the trader has control over the private keys of the assets.
Benefits of borrowing crypto-based loans
● Low-interest rates: Compared to credit cards and personal loans, crypto loans provide a cheap alternative. Often, the interest rate on crypto loans is below 10%.
● Freedom to choose loan currency: Depending on your needs and the platform, you can get loans in select cryptocurrencies or the US dollar.
● Quick funding: After platform approvals, you can receive loan funds in a few hours.
● The loan is based on your asset value: Usually, you can borrow up to 50% of your portfolio, although some exchanges allow up to 90%. For instance, The Wall Street Journal reports that crypto enthusiasts are tapping their holdings to purchase homes, more crypto and cars.
● No credit check: Normally, crypto lending platforms do not run a credit check. So, it is an attractive financing option for individuals without credit history or with poor credit.
● Ownership: A cryptocurrency loan lets you get the money without selling your holdings when you need cash.
6 Things to consider when borrowing cryptocurrency
Selecting the right platform
To borrow cryptocurrency, ensure you choose the right platform. Although many platforms exist, you need to research until you find one that is trustworthy. Crypto-lending platforms fall into two categories, i.e., decentralized and centralized. Each type of cryptocurrency lending platform has its pros and cons.
If you are wondering how to choose a crypto lending platform, there are things you need to look out for. First, ensure the platform is legit and safe before you proceed to borrow. Once you find it, ensure you can borrow the crypto you wish to lend. Also, ensure you get a grasp of the yearly returns for the crypto.
Currently, centralized lending is leading thanks to its cross-chain solution. Also, most crypto borrowers prefer it because it eases fiat conversion. Nevertheless, decentralized platforms are improving each day, decreasing the distance to centralized platforms.
Besides, some platforms do not support all digital assets. So, depending on the platform you choose, you may have to exchange your currency for eligible assets. It is not ideal to hold onto your asset that does not qualify as collateral on the platform. Thus, choose a platform that accepts your current crypto assets as collateral.
Repayment terms
Crypto-based loans usually function as traditional installment loans. So, depending on the lending platform, you may have less than a year to pay the loan. Sometimes, you have the option of creating a repayment schedule that fits your needs. However, with short repayment terms, ensure you can afford the payment beforehand.
Margin calls
In crypto-lending, a margin call occurs when the collateral value falls below a set threshold, and the lender demands you to raise your holding to maintain the loan. Sometimes, the lender may sell a portion of the borrower’s assets to decrease your loan-to-value ratio. Since cryptocurrencies are very volatile, the likelihood of this occurring can be high.
No access to assets
Provided you have an outstanding loan balance; you will not have access to the collateral. It can be a significant issue when the crypto price drops considerably or in case of an emergency that requires cash.
No insurance and technical risk
Unlike conventional finance, no federal body covers cryptocurrencies. Hence, no federal insurance for possible losses. Money in the bank has insurance. This lets you get compensation after fulfilling certain conditions. However, crypto loans lack this protection. So, when the exchange fails, you may lose all your assets. Besides, there are technical risks that include protocol failure, hacking, or breakdown.
High minimum requirements
Although platforms vary, you may not have enough assets to get the minimum amount from the lender. For instance, some platforms require at least $20,000 to get the minimum loan amount of $10,000.
How crypto lending works
Although a crypto-backed loan relies on digital currency as collateral, it works as a securities-based loan. The same principle applies. In this case, you pledge your cryptocurrency assets to get a loan that you repay over time.
As indicated, the only way you can get such a loan is through crypto lending platforms or crypto exchanges. Even though you still own the crypto, you pledge as collateral, and you will cede some rights. For instance, you will not be able to trade your collateral or use it for transactions.
As well, in casen ca the e of the crypto assets falls drastically, you may end up paying back more than you borrowed.