Authored by Katie Pierce
Everything You Need to Know About Crypto-Backed Lending
Many people in the cryptocurrency community are familiar with lending terms, such as interest and principal. They know that the person who receives the loan would make a payment to the lender of the principal over time. As many people want to make those payments, they don’t usually have enough in their account at one time for it. These people didn’t consider that a new type of lending was offered: crypto-backed lending.
What is Crypto-Backed Lending?
Crypto-backed lending is using cryptocurrencies as collateral to borrow money, most likely fiat. Though this process is still in its infancy, it has the potential to grow into a significant asset class.
A person wishing to borrow money would deposit their Bitcoin, Ethereum, or other cryptocurrencies into a wallet with one of several crypto-backed lending platforms and request a loan of an equivalent value in fiat currency. The platform will then calculate the amount available for borrowing (based on the current exchange rate) and offer that amount as a loan.
How Does Crypto-Backed Lending work?
Depositing an asset with the Crypto-backed lending platform authorizes the platform to use those assets as collateral for a loan. The user can revoke this authorization at any time; additionally, a user may choose to re-purchase the asset at any time.
The Crypto-backed lending platform then sells the loaned amount of fiat currency and buys back the same amount of Bitcoin or other coins, returning them to their owner.
The borrower agrees to pay an agreed interest rate over a predetermined period. The Crypto-backed lending platform collects the proceeds of the sale and, depending on their business model, either pays the interest, then sells the coins and re-purchases them after spending the principal amount, or holds onto the coins until they are sold at market value.
Bitcoin-backed loans can also be sold simultaneously as they are issued, which means the borrower could buy up all of their loans in one transaction. Users can do so at market prices if they choose to resell their loan.
How to Borrow Cryptocurrencies?
Crypto-backed lending platforms typically have a simple procedure for borrowing Bitcoin and altcoins from users. In addition, the process is often automated, requiring little effort on the user’s part.
This can be especially advantageous to those who cannot get a loan on personal terms from traditional banks. Without a guarantee from more conventional lending institutions, it is difficult for individuals with less skill in finance to access loans that they might be unable to repay without defaulting on their payments.
Crypto-backed lending platforms differ from those offering peer-to-peer loans because they are centralized entities that manage portfolios of loanable assets. This means they will be among the few platforms to offer cryptocurrency derivatives, which has boosted investor confidence and interest.
Things to Consider Before Participating in Crypto-Backed Lending
Crypto-backed lending is still a relatively new concept, meaning that there are not many platforms available, and they vary in structure.
Investors must be highly cautious when choosing one to use. Because of this, it is necessary to do your own investigation before accepting a transfer of funds as collateral. Before making an investment in a crypto-backed lending platform, consider the following:
A Margin cell is a subsidiary company of the Crypto-backed lending platform. It functions as an individual bank and manages the collateral deposited by users.
In addition to users having complete control over when and how they use their currencies, the Margin cell will re-purchase the assets if they are no longer needed as collateral by the Crypto-backed lending platform.
Typically, the Margin cell is the division that handles all aspects of collateral management.
Some platforms operate in the dark and do not publish information about their financial conditions or operations. This means that users do not know the state of their investments and cannot verify their assets’ availability with them.
An audited and openly disclosed financial condition will help you avoid falling victim to these types of frauds.
It is also essential to consider the collateral risk involved in Crypto-backed lending. The funds that users deposit could be lost, even though they are used as security for loans from other platforms. Furthermore, since the loans are paid back with interest, users will likely not be able to recover the total amount of the collateral if something goes wrong.
This means users should be aware of the risks of using such a platform and consider if they wish to take on that risk.
Only Invest What you Can Lose
Crypto-backed lending is new and still has a long way to go. This means that, unlike traditional investment markets, it can be risky and lucrative.
The chances of making money on this kind of investment are meager, so only invest what you can afford to lose. This means clouding the waters with a large amount of collateral that you could lose if things go wrong would be an extremely foolish move on your part.
Crypto-backed lending is a form of collateralized financial service. It allows holders of cryptocurrencies to use them as collateral for a fiat currency loan.
This means that, instead of selling and losing the coins, there is an option to borrow fiat money while keeping the cryptocurrency assets in their possession. Crypto-backed lending can benefit those who want to obtain money with no guarantee in place or who want a better deal than they can get with banks or other traditional lenders.
A bear market in currencies can make this kind of loan even more appealing. To find out more about crypto-backed lending, check out our blog now.