Cryptocurrencies are establishing themselves as an asset class of their own. As with any other asset class, several organizations are beginning to develop a variety of financial products for cryptocurrencies, including so-called cryptocurrency loans.
What are cryptocurrency loans?
Crypto loans are secured loans that require a specific amount of an asset (cryptocurrency), often held in cold storage, to be placed as collateral to receive a loan. This process typically requires the applicant to complete the Know Your Customer (KYC) process; and if accepted, the trader can deposit the cryptocurrencies and receive a loan. If the person taking out a cryptocurrency loan is unable to pay the specified amount on the required dates, the lender will likely liquidate the cryptocurrencies the person used as collateral.
From a business point of view, loans backed by cryptocurrencies have two aspects: the first is the granting of a loan to a client with agreed loan conditions and the second is the financing of this operation. For the latter, platforms
that offer crypto lending services finance the liquidity of their loans by offering profitable products such as rental, staking or savings accounts; wherein customers usually deposit money for a certain time to earn interest and passive income for it.
What are the advantages of crypto loans?
Receiving a crypto loan allows you to continue holding, ensuring you have new funds available. This is a move that should be considered if you have a high conviction that the currency will continue to maintain its value, but need a certain amount of liquid and available funds for reasons such as financing living expenses, monthly rent, paying bills and a lot more. other reasons.
Cryptocurrency-backed loans are blockchain-based, which means they are immutable as transactions cannot be modified; this makes them more reliable. Furthermore, the deadline to receive a loan is usually one day or instantly, depending on the platform, as identity verification is usually minimal; the only requirement is usually some form of government verification (since there's no need to check credit scores).
What are the risks of cryptocurrency loans?
The first and most important risk is the fact that companies granting these types of loans may become insolvent, for example in the case of the Celsius cryptocurrency platform, which recently filed for bankruptcy.
Another risk related to the security of the platform from which you may receive a crypto loan or to which you lend is the way they store your cryptocurrencies or their collateral. There are two types of cryptocurrency exchanges. There are centralized exchanges like Coinbase or Nebeus, where most of the control is in the hands of third parties. There are also decentralized exchanges where your private keys (or access to your digital assets) are only stored by the account owner and not by any third party. Both types of exchange have advantages and risks.
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Another risk to watch out for is the volatility of cryptocurrencies. If a user were to borrow a full Ethereum (ETH) when it was trading at US$ 4,000 and it dropped significantly, the value of the collateral would be lower and there would be a risk of a margin call. This is a risk that comes with the volatility of cryptocurrencies in general, not necessarily lending, and is something to consider.
Additionally, there are tax and regulatory risks associated with decentralized platforms as many of these companies do not adhere to KYC (know your customer), AML (anti-money laundering) and other regulatory protocols. As a result, an element of uncertainty comes with emerging decentralized lending practices. That said, centralized platforms adhere to requirements that eliminate the aforementioned risk and are therefore more secure.
