Crypto investors are pledging their digital assets to buy homes, cars and more in crypto by guaranteeing loans through crypto exchanges or crypto lending platforms which are fast becoming the new craze in cryptoverse.
Cryptocurrencies such as Bitcoin and Ether are used as loan collateral by investors who pledge part of their crypto assets as collateral for the money they borrow.
Lenders accept deposits in the form of cryptocurrencies, which earn higher than average interest rates. Crypto deposits are used to fund loans to borrowers who repay them over time.
Cryptocurrency lenders are taking an approach similar to traditional banks, but unlike banks, which are regulated by the government and are required to have deposit reserves to protect them from bad debt, crypto lenders are not regulated to the same standards.
Cryptocurrency-backed borrowers retain ownership of the assets they promise to the lender while repaying the loan. However, they risk losing a significant amount of their collateral if they fail to repay, as one would with a secured loan like a car loan or mortgage.
These new loans come in many forms. Borrowers can get dollars or other traditional currencies, or stablecoins – any cryptocurrency designed to have a relatively stable price – depending on the lender.
Some people go for crypto loans because they don’t want to use their crypto assets soon, aka hodl.
“The idea is to turn some of your digital assets into real profits so you can’t lose them” says Antoni Trentchev, co-founder and managing partner of crypto lender Nexo Capital Inc.
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Other people consider taking crypto loans because of the benefits they offer, such as low interest rates, quick funding, choice of loan currency, and no credit check. Crypto lending platforms rarely check the credit history of borrowers when they apply for a loan, which makes it attractive to people with a bad credit history.
Some lenders will ask their borrowers to get a loan with non-custodial crypto. These are assets held in a digital wallet that is not linked to an exchange. However, most lenders require borrowers to maintain their digital assets with the platform to be eligible.
Crypto loans are largely affected by margin calls, which occur when the value of the collateral falls below a certain threshold. When this happens, the lender requires the lender to increase their crypto holdings to maintain the loan.
Sometimes the lender may sell some of the crypto assets to reduce the borrower’s fees. loan to value ratio – the ratio between the amount of the loan and the value of the guarantee assessed by the lender. The likelihood of this happening is high due to the short-term volatility of cryptocurrencies.