Cryptocurrencies have become increasingly popular in recent years. As a new asset class, crypto also brings new uses to financial markets and institutions. One of those is the use of crypto as collateral for loans. Some question whether it’s even possible to secure personal loans against crypto. This blog will define what crypto is, discuss crypto loans in general, and look into the question of crypto collateral loans. You should have a much better understanding of crypto and its uses as a form of collateral by the end. Read on and explore this new asset class and its uses in securing loans.
What is cryptocurrency?
Before discussing crypto loans, we want to answer the question of what is cryptocurrency. However, first, let’s define a currency. Currencies are a medium of exchange to ease trade and commerce. Currencies are fungible; they are mutually interchangeable, making them ideal as a store of value. Fiat currencies are the U.S. dollars, euros, and pounds you are likely familiar with, and global central banks in individual nations issue these. Because these governments back them, they are considered stable.
However, another feature of fiat currencies is that they are inflationary due to a continually increasing supply. This erodes their value over time. In 2009 a pseudonymous individual named Satoshi Nakamoto created an alternative that is not inflationary, would hold its value, is fungible, decentralized, and not dependent on global governments. He called this new alternative Bitcoin, and it is the first and best-known cryptocurrency.
What are crypto-backed loans?
Crypto backed loans are a type of secured loan where the crypto is used as the collateral for the loan. Before taking a loan against crypto, you should have an understanding of secured vs. unsecured loans. A secured loan is where some other asset is used as borrowing against crypto. If a loan default occurs, the lender can take the asset that secures the loan to offset the default in payment. A crypto loan simply uses crypto as the collateral to secure the loan. Loans against crypto allow crypto holders to get the money they need now without selling their cryptocurrency.
How can a cryptocurrency be used as collateral?
Just like you might use your car or home in a traditional secured loan, you can also use crypto as collateral in a secured loan. When using crypto as collateral, you retain ownership of your cryptocurrencies. However, you also lose the right to make any trades or transactions with the cryptocurrency. And if the cryptocurrency drops significantly in value, you might end up owing far more than you borrowed if you default on the loan. This means they may not be the best loans for everyone.
For whom are crypto collateral loans relevant?
The most likely candidates for crypto collateral loans are those who already own some cryptocurrencies. Investing in crypto has been increasingly popular, and as of late 2021, 16% of Americans hold some form of crypto, according to a survey by the Pew Research Center. And that number will only continue to grow. Using crypto as collateral against a loan has several benefits for these crypto investors. It can be one way to unlock the value tied with digital assets without selling them. This not only keeps the crypto in the holders’ possession it also avoids the tax event that would occur if the crypto was sold.
What is the downside to taking out a crypto loan?
Investing in crypto or taking a crypto loan isn’t without risks. As mentioned above, there’s the possibility of volatility in the price of the crypto used as collateral. That’s particularly troubling for those considering using a loan to invest in crypto. In the event of default, this could mean the borrower ends up owing far more than they borrowed. There also remains a great deal of uncertainty regarding cryptocurrency regulation. Until banks and other lenders get some clarity regarding the regulatory status of cryptocurrencies, they will continue to give pause before considering them as acceptable currencies for use as collateral.
What are alternatives to crypto loans?
Cryptocurrencies are a new asset class, and crypto lending is even more recent. This brings several uncertainties and risks for those who want to use crypto collateral loans. Potential borrowers might want to consider alternatives, such as home equity loans, credit card loans, or personal loans, to avoid this risk. At Lendstart, we work with many lenders, offering the best personal loans. These traditional personal loans avoid the risks associated with crypto lending, giving you peace of mind and the cash you need to solve your financial troubles.