Complete guide to crypto loans
Crypto enthusiasts are often encouraged to “HODL” (short for “hold on for dear life”) their assets, meaning keep them safe in a wallet until the price of their chosen currency rises again. But just as you would feel uncomfortable leaving your cash in a bank with low-interest rates, a common question is: how can you make your digital currency grow?
That’s where crypto lending comes in. Not only can you earn interest on your crypto holdings, but you can also unlock the value of your digital assets by using them as collateral for a loan. Take a look at the scale of this market — сrypto lending was DeFi’s largest single segment in 2021, accounting for about half of the total value locked in DeFi.
What is crypto lending?
Crypto-lending refers to a type of decentralized finance that allows investors to lend their cryptocurrencies to various borrowers. In return, they receive interest payments, the so-called “cryptocurrency dividends.” A cryptocurrency-backed loan uses digital currencies as collateral, similar to a securities loan. The basic principle works like a car loan or a mortgage — you pledge your crypto assets to get a loan and pay it back over time. You can get a crypto loan through a blockchain-based bank, crypto exchange, or crypto lending platform. Many platforms that specialize in cryptocurrency loans accept stablecoins as well as popular cryptocurrencies.
By retaining ownership of the cryptocurrency you used as collateral, you lose some rights, such as the ability to trade or use it for transactions. And if the value of your digital assets drops significantly, you could end up owing a lot more than you borrowed if you can not service your loan.
Let’s take an example
Imagine that you have 10 BTC. You don’t want to sell them because you are sure that the price should rise significantly. However, you may want to use cryptocurrency for arbitrage trades. In such a case, you can use crypto lending platforms to use your Bitcoins as collateral and get a loan in stablecoins or another asset. Due to the volatility of digital assets, you usually have to put up “excess collateral,” which means blocking more BTC than the total value of the funds you receive.
After the repayment of the loan and interest, your cryptocurrency will be fully returned — and you’ll make a solid profit when BTC eventually rises in value. Your cryptocurrency is only at risk if you fail to meet the loan terms or if the value of the Bitcoins used as collateral falls below the loan value you received.
Crypto loan use cases
There are various use cases for crypto lending, but we will look at the most common ones:
- Arbitrage trading — you can use crypto loans for arbitrage trading, where you use price discrepancies on different exchanges to make a quick profit.
- Margin trading — you can use crypto loans for leverage to prevent yourself from liquidation.
- Tax-free liquidity — for investors who want to keep crypto assets in their account, taking out secured crypto loans to receive fiat currency can be the best way to avoid income taxes.
What are the risks and benefits of crypto loans?
Compared to traditional secured loans, crypto loans have unique features that make them attractive to cryptocurrency enthusiasts:
- The absence of credit checks: one of the main benefits that many see in a cryptocurrency loan is that, unlike traditional banks, your credit score is not evaluated. This means that lending is more affordable for people with no financial history, unbanked consumers, and the self-employed who have difficulty accessing credit because their fluctuating incomes do not meet banks’ strict criteria.
- Low-interest rates: while they are typically not as cheap as mortgages or car loans, cryptocurrency loans are a low-cost alternative to personal loans and credit cards. It is often possible to obtain a cryptocurrency loan with an interest rate of less than 10%.
- The loan amount you can receive depends on the value of your assets: usually, you can borrow up to 50% of your portfolio’s value.
- Availability of different loan currencies: depending on the platform and your needs, you can usually get a loan in the form of stablecoins or choose a cryptocurrency. Users can also switch between crypto assets to deposit ETH and borrow USDT on the same platform.
- Fast financing: while it can take several days to disburse a loan in the old-fashioned financial world, crypto loans can be received instantly. Once you are approved, you can receive your money in a matter of hours.
In addition, you can make your assets liquid without incurring taxes — and you can customize the loan to suit your needs.
However, you should also consider some disadvantages occurring due to the nature of secured loans and cryptocurrencies:
- Margin requirements: cryptocurrencies can be very volatile; therefore, crypto loans are almost always over-collateralized. In such a way, the lender can be insured from the collapse of cryptocurrency prices. However, it can have a negative impact on the borrower, especially if the platform requires maintaining a loan-to-value (LTV) ratio at all times. Margin calls occur when the value of your collateral falls below a particular limit, and you should increase your funds to support the loan. In some cases, a part of your assets can be sold to lower the loan-to-value ratio.
- No access to your funds: when you deposit your crypto as collateral, you cannot access your assets for trading or transactions. This can cause issues if the currency rate drops significantly, or you require cash urgently.
- Repayment terms vary: These loans usually work like traditional installment loans, and depending on the crypto platform, you may have less than a year to repay what you borrowed. For shorter terms, you must know in advance if you can afford these payments.
- Not all digital assets are suitable: Depending on the crypto lending platform you use, you may need to exchange your currency for an appropriate digital asset. This may not be desirable if you want to keep particular crypto, and it is not suitable as collateral on any platform.
How does PointPay lending work?
There are both centralized and decentralized lending providers operating on the market. Even though some users might seek higher anonymity, preferring DeFi lending protocols, such as Compound or Aave, centralized providers have several significant benefits. For instance, a blockchain-based crypto bank like PointPay is operating in a regulated environment, so you can be sure that you are not borrowing money that is laundered in the course of financial fraud. Furthermore, you have access to a support service that works 24/7.
The loan currency depends on the collateral you want to leave. For example, you can deposit popular cryptocurrencies such as BTC and ETH to borrow USDT. Conversely, you can leave USDT to borrow cryptocurrencies. The ratio between the loan amount and collateral ranges from 20% to 70%. It is important to note that participants require a margin call at 75% and a liquidation loan-to-value at 83%.
The margin call allows you to prevent your collateral from being fully liquidated if you add collateral. Due to price fluctuations in the crypto market, PointPay will notify you via email that you need to add assets as collateral because the LTV level for the margin call has been reached.
Liquidation loan-to-value represents the maximum LTV limit allowed. If the LTV limit reaches 83%, this can result in the complete liquidation of your collateral. To prevent this, you can add crypto collateral.
The term of the loan can range from 7 days to 3 years. You can also buy PXP tokens to lower your annual interest rate.
Let’s go through this process step by step.
1. You create a request to receive cryptocurrency backed by PointPay CryptoBank.
2. PointPay CryptoBank receives the collateral and provides you with the borrowed cryptocurrency.
3. After you get a crypto loan, you start paying interest.
4. After you pay the crypto loan and interest, PointPay CryptoBank returns your cryptocurrency collateral to you.
PointPay crypto bank allows anyone to get a cryptocurrency loan, regardless of the previous credit history or your residence. Crypto lending gives people who have long been excluded from traditional institutions the ability to transact quickly and affordably. We also offer financial stability to customers in countries with volatile local currencies. In this way, we can facilitate financial freedom by offering crypto banking services available worldwide.
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