Like investments such as a house or a car, cryptocurrency can be used as security for crypto loans. The major advantages that crypto loans have over traditional loans are the low-interest rates and the fact that the money is available instantly without the need for a credit check.
The downside for the borrower is that when the value of the cryptocurrency falls, you may need to gauge more crypto. The risk involved is likely to be one of the very few disadvantages to crypto loans.
Let's evaluate crypto loans in more depth to determine whether it is right for you.
A cryptocurrency is essentially a digital form of money that differs from traditional fiat money in that it exists as a decentralized entity, not controllable by any one organization. Cryptocurrency remains, for the time being, disembodied.
Cryptocurrencies can be transacted across various decentralized systems because of complex cryptography.
We have all heard of Bitcoin. Bitcoin is the most widely known cryptocurrency. It is an alternative form of money in the shape of digital tokens. These tokens can be exchanged for goods and services on a blockchain platform. A blockchain, in short, is a digital ledger that tracks and manages all transactions that take place on it.
The consensus on which a specific blockchain is based will determine many of the incorporated "rules" of transactions.
A crypto loan is similar to an auto loan, where borrowers pledge a particular asset to secure their financing. Cryptocurrency serves as the asset that is pledged. Currency is offered to an interested lender, and an agreement is made that the borrower will pay off their debt in weekly or monthly installments.
Crypto lending is a form of decentralized finance. Simply put, investors lend money to borrowers and receive payments that include interest. These payments are referred to as crypto dividends.
Examples of crypto lenders include BlockFi, Unchained Capital, and Celsius. These lenders have meager annual interest rates and typically offer 1 to 3-year loan terms. Their minimum loan amount is relatively high, making this agreement almost irresistible.
Crypto loans are great investments for those who have gathered a large amount of cryptocurrency and would like it to grow without selling and possibly paying tax on it. Hereby, investors generate a steady passive income with their growing cryptocurrency.
Let's refer to an example to clarify what crypto lending entails.
You have 20 bitcoins and would like for them to grow in value. You decide to deposit these 20 bitcoins into a crypto lending platform. The platform ensures that you will receive interest in weekly or monthly installments. Interest rates will differ depending on the lending platform you decide to use.
Security of your loan is ensured as it is based on crypto-backed lending. Borrowers stake the cryptocurrency they own as a guarantee of repayment. If the borrower fails to pay their installment, the lender can simply sell this stake and cover their losses.
Most platforms require a 25 to 50% stake for the loan to be possible. This amount is generally more than enough to ensure that investors don't lose money.
The lender and the borrower must be connected through a third party for crypto lending to occur successfully. These third parties are the online crypto lending platforms that act as intermediaries, ensuring your crypto assets are protected, the loan repayment amount and interest rate are respected, and loan terms are adhered to.
This could be anyone holding cryptocurrency that wants to grow their crypto assets without withdrawing them. If someone wants to wait for the currency's value to increase, loaning is a great way to maintain crypto until that happens.
These platforms ensure successful borrowing and lending agreements and control all transactions that take place. These lending platforms are completely decentralised and autonomous.
There are two types of crypto lending platforms to make use of:
These platforms generate dividends automatically as soon as your assets are deposited into their crypto wallet.
These platforms require manual staking of a predetermined amount of your assets to generate dividends.
These are people who are looking to obtain funds. Borrowers can include businesses or individuals who need funding or who want to use crypto or fiat money as collateral to obtain financing.
Investing on a platform like Celsuis.Network would mean that the entire lending process will occur automatically.
All you need to do is deposit coins into your online wallet, and the platform will automatically generate dividends of a given amount that depends on the deposited amount. The dividend amount will differ between cryptocurrencies. Stablecoins generally have the greatest yield, increasing between approximately 10 and 18% per year. The yield of crypto coins averages around an 8% annual increase.
An example of a platform that lets you lend your crypto assets manually is CoinLoan. With CoinLoan, borrowers determine their own loan requirements regarding the amount, repayment duration, interest rate, and collateral coin amount.
The borrower then posts these requirements on the marketplace of the platform, and an interested investor can accept their terms and set the loan in motion.
On a manual platform, investors can basically "shop" for loan requirements that best suit their needs. You can instantly back the loan request if the terms seem agreeable.
This is comparable to peer-to-peer lending. The investor will then receive repayments based on whether they chose an Interest-only or a Principal plus Interest contract.
A borrower goes onto a crypto lending platform to request a loan and backs it up with their existing crypto assets.
The borrower can stake his crypto collateral as soon as the lending platform accepts his request. Once the correct amount is staked, the borrower no longer has access to those funds until he has paid off the total loan amount.
Lenders/investors can fund the loan on the platform through an automatic process. If the value of their crypto balance remains unchanged, the investors won't even notice the loan taking place, only the increased payout as interest was included.
Interest payments are made in weekly or monthly repayments.
If the borrower has successfully repaid his loan, he has access to the collateral funds that were initially inaccessible to him.
This general concept is the same for all crypto lending platforms, even though they might vary regarding other aspects.
The whole process of a crypto loan can be secured efficiently with the use of smart contracts.
A smart contract is a program stored on a blockchain that commences when specific conditions are met. Their most common use is to automate the implementation of an agreement to ensure that all participating parties are clear on the outcome of the agreement. Smart contracts eliminate the need for an intermediary and save a lot of time. They operate based on an automated workflow where the action is put into motion pending the approval of the previous action.
Firstly, investors need to decide whether they will be using an automated or a manual platform. Automated platforms are advantageous because funds will never be left forgotten without generating a profit.
Before choosing a suitable platform, consider the following:
It is essential to stay updated on the cryptocurrency collateral as it is very volatile and can change at any moment.
Aave has a large variety of crypto loan options and additionally offers flash loans that are not collateralized. They offer fixed interest rates short-term loans and encourage low borrowing rates.
Abracadabra.money is growing fast in the Defi world. They accept collateral crypto in the form of tokens that generate interest. Borrowers can receive asset-backed stablecoins, generating an income from the crypto they stake to initiate a loan.
Alchemix provides loans that can pay themselves off over time. Users deposit a stablecoin into a smart contract in exchange for a token that represents the future yield of the deposit.
Gemini does not offer crypto loans, but it does offer attractive interest-earning opportunities. They offer daily compound interests and allow a lot more freedom in moving your funds.
Mango functions on the Solana chain and offers borrowing, swapping, trading, and low-latency lending. They allow leveraged trading as well as cross-trading.
Nexo is currently a very popular lending platform for more conservative investors. This is due to their very large insurance on custodial assets.
Unchained Capital offers security and transparency to borrowers with its multi-sig collaborative custody model. However, they only allow for loans in bitcoin and are still limited in that transactions can occur exclusively in the United States.
If the lending platform manages loans efficiently and both the lender and borrower uphold all the agreement terms, taxes should never be encountered.
Cryptocurrency is considered to be property, according to the IRS. Using your crypto assets as collateral is equivalent to using property as collateral, which is not considered a taxable event.
There are, however, certain loan scenarios that can affect your taxes.
The interest that providers charge borrowers on loans can possibly be written off when you use your loan as an investment or for business purposes.
Lenders can liquidate much of a borrower's assets if they fail to make their repayment amounts. Naturally, this results in losses on the part of the borrower.
Your collateral will be liquidised if you do not meet the margin call. The borrower will be held accountable for capital gains tax on the increase of the value of the collateral from the time of the purchase until the lender sells the assets.
Self-paying loans are subject to taxes because the applied structure leads to debt cancellation income.