Harness the True Potential of Digital Assets
- Differences between crypto loans and traditional bank loans
- Understanding the risks involved with crypto loans
- FREE DOWNLOAD: Rich Dad’s Currency eBook
Did you know you can get loans using cryptocurrency? These loans work differently from the traditional ones you’re used to. There’s no need for a perfect credit score, your annual or monthly income isn’t considered, and there’s no lengthy approval process. Basically, no third parties stand between you and your crypto loan—but there’s a catch.
In this guide, we’ll cover everything you need to know about crypto loans, including where to get them, how to use them, and the risks involved.
What are Crypto Loans?
Crypto loans are a type of secured loan typically available on DeFi chains such as Ethereum, Avalanche, Base, and many more. This means that you use digital assets such as Bitcoin, Ethereum, or other cryptocurrencies and put them up as collateral. These platforms allow you to borrow other cryptocurrencies for between 50%-70% of the dollar value of the crypto you put up as collateral.
Unlike traditional loans, which rely on your credit score and financial history, crypto loans are based purely on the current dollar value of your crypto assets.
If your Ethereum goes up in value, you can borrow more from it.
Here’s an example, imagine Jill wants to buy a special gift for her father but doesn’t want to sell her Ethereum holdings. She has $1,000 worth of ETH at the current market price. Instead of cashing out her ETH, Jill decides to use it as collateral to get a crypto loan.
Here’s how she does it in three simple steps:
- Jill puts up her $1,000 worth of ETH as collateral on a crypto lending platform.
- In return, she borrows $500 USDC (a stablecoin pegged to the US dollar) from the platform.
- Jill then converts the $500 USDC into cash to buy her father’s gift.
This way, Jill doesn’t have to sell her Ethereum and can still benefit if the price of ETH goes up in the future. Over time, she repays her $500 loan with a low interest rate, which is typically lower than traditional bank loans. Once the loan is fully repaid, Jill gets her $1,000 worth of ETH back.
How Are They Different From Bank Loans?
Traditional bank loans and crypto loans have some major differences:
- Approval Process: Bank loans require credit checks, income verification, and other documentation. Crypto loans bypass this with an automated process, if you have any amount of the crypto the platform supports you can use it for borrowing/lending.
- Collateral: Traditional loans might use property or other assets as collateral. Crypto loans will only accept the digital currencies its platform supports.
- Flexibility: Crypto loans are more flexible about their interest rates and when you have to pay them back, you can even formulate your own payment schedule for them in some cases.
Unlike a bank loan, if you default/get liquidated on a crypto loan, the lender automatically claims your collateral(crypto). This is one of the biggest risks of using crypto-based loans.
The Risks Involved With Crypto Loans
While everything you read might sound wonderful, everything comes with its risks, and crypto-loans have some big ones. Keep in mind, that all crypto involves risk and do proper risk management before getting involved with crypto.
Volatility & Liquidation
Since it’s based on the dollar value of the crypto you put up as collateral, when the dollar price of your crypto falls, it can cause your assets to get instantly liquidated to cover the loan.
For example, let’s go back to Jill and imagine this:
- Jill uses $1,000 worth of ETH as collateral to borrow $500 USDC.
- When she takes the loan, ETH is valued at $2,000 per ETH, so she has 0.5 ETH as collateral.
- Suppose the price of ETH drops to $1,000 per ETH. Now, her 0.5 ETH is only worth $500.
- Many lending platforms have a liquidation threshold, often around 80% of the loan value. In this case, 80% of her $500 loan is $400.
- Since her collateral is now worth $500, and it’s dangerously close to the liquidation threshold of $400, the platform might liquidate her collateral to cover the loan which would result in Jill losing her 0.5 ETH.
Regulatory Uncertainty
Another big concern for borrowing/lending in crypto is the regulatory environment for cryptocurrencies. These days it feels like they’re specifically hunting down DeFi and looking for ways to stop individuals from profiting within it. This means these options at any time could either become unavailable, or regionally locked.
Take the time to educate yourself and really understand all of the ins and outs related to crypto to safeguard your tokens. By understanding how crypto loans work you can make better financial decisions going forward as you venture further into the world of DeFi.
If crypto loans seem too risky, consider exploring lower-risk options in the crypto space. Check out Rich Dad’s complimentary e-book on cryptocurrency for insights into safer investing strategies.
(Disclaimer: This article is not financial advice and is intended for educational purposes only. Our articles are not sponsored or affiliated with any of the businesses, tokens, teams, or protocols mentioned. It is important to conduct thorough research and only invest an amount that you are comfortable potentially losing. For personalized financial advice, consult a professional.)
Regards,
Robert Kiyosaki
Contributor, Freedom Financial News
