How Do Crypto Loans Work

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 4 minute read

You can avoid paying capital gains taxes right away and gain access to your wealth by taking out a loan against your investments. Portfolio loans have been used by a number of high net-worth individuals to withdraw cash from their taxable brokerage accounts.

These services are now being provided by cryptocurrency exchanges. Users of a crypto lending platform are able to borrow funds based on the value of their deposited digital currency. Users can borrow either fiat currency (such U.S. dollars) or stablecoins, and funding is often instantaneous.

Long-term investors should familiarize themselves with the mechanics of crypto lending as well as its potential benefits and drawbacks before making any commitments.

What Exactly Is Crypto Lending?

To borrow either cryptocurrency or fiat currency (such as dollars), crypto lending is a form of secured lending in which digital currency is pledged as collateral. Some cryptocurrency exchanges offer crypto lending, while smart contracts in decentralized applications can lend cryptocurrency to customers automatically.

If you want to borrow money, you can sign up for a crypto lending platform or exchange, deposit the cryptocurrency you want to use as collateral, and then select a loan with the terms that suit you best. When taking out a crypto loan, investors are able to preserve their crypto assets while borrowing a percentage of their value.

A higher loan-to-value (LTV) typically means a higher interest rate on a crypto loan, as the cost of borrowing money increases. A loan for 25% of the value of your pledged cryptocurrency, for instance, may come with a considerably more favorable interest rate than a loan for 50% of the value of your assets.

There is always a chance that your cryptocurrency loan’s margin may be called and your collateral will be liquidated. The crypto lending platform may issue a margin call and/or sell some or all of your collateral to cover the loan if the value of your pledged assets falls below a particular threshold.

If you borrow more money than you can afford to pay back, you run the danger of being hit with margin calls due to the extreme volatility of cryptocurrency.

How Do Crypto Loans Works

To apply for a loan secured by cryptocurrencies, you must join a crypto lending platform or link your digital wallet to a decentralized crypto lending app. To secure your loan, you must first deposit a cryptocurrency that is accepted as collateral, such as Bitcoin.

After making a deposit, you may borrow money up to the value of your digital asset(s). You can usually borrow up to 50% of the currency value of your pledged collateral on most lending platforms, however some may go higher.

Typically, the loan is repaid in stablecoins like Tether or fiat currency like the U.S. dollar (USDT). After that comes picking a loan term, with lower LTV loans often having more flexible terms.

Interest is added to the principal of your loan when you take out a crypto loan, and repayment terms usually ask for a monthly payment, just like a mortgage or car loan. You may receive a margin call to deposit additional collateral throughout the repayment period, or the lender may liquidate a portion of the collateral to satisfy the loan obligation.

In general, crypto loans provide a convenient alternative to selling your original collateral in exchange for cash or stable cryptocurrencies.

How to Borrow and Lend Bitcoin

You can borrow bitcoin by creating an account on a crypto lending platform, putting up collateral, and choosing your own terms. It takes only a short time from the time of application to the time of receiving funding in either traditional currency or crypto stablecoins.

Loans are typically repaid monthly, and their terms can be anywhere from a few weeks to five years or more. Some online lending platforms only accept repayment in the currency originally borrowed, while others will accept payment in another currency or cryptocurrency.

Money placed into a crypto lending platform but not used as collateral for a loan would often accrue interest. Users can make deposits in one of several supported cryptocurrencies and immediately start earning income. The annual percentage yield (APY) is a measure of the rate of return offered on a deposit of cryptocurrency and can be over 10% for certain stablecoins.

The cryptocurrency you deposit on a crypto lending platform is loaned out to borrowers in exchange for interest, much like a bank would with traditional cash deposits. You can still get your money, and you can get your crypto out of most exchanges whenever you choose.

What Are the Crypto Loan Interest Rates?

Loan terms, collateral, and the lending platform all affect how much interest is charged on a cryptocurrency loan. Borrowing up to 25% of collateral from some companies at 1% APR is much cheaper than the average personal loan. However, the annual percentage rate (APR) for borrowers who borrow 50% or more of the value of their crypto assets is 8.95 percent.

Bottom Line

Some cryptocurrency lending platforms have reported over a billion dollars in pledged assets and hundreds of millions in interest rewards paid out on cryptocurrency deposits, demonstrating the industry’s continued growth and popularity.

These loans provide a risk-free method for users to access a portion of the value of their cryptocurrency holdings while still retaining the ability to hold onto their investments for the long term.

However, users should exercise caution while taking out crypto loans and avoid overextending themselves to the point where they face a margin call or have to sell up their collateral. Crypto loans are risky because of the high volatility of cryptocurrencies and the fact that their prices are more likely to fluctuate widely than those of conventional assets.

In general, crypto lending platforms cater to customers who wish to “hold” their cryptocurrency holdings while still realizing some of the value of their holdings in the interim.

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