What Is a Crypto Loan and How Does It Work?
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Over the past several years, cryptocurrency has grown from a fringe financial interest to an asset traded on mainstream investment platforms. As crypto becomes more mainstream, lenders have begun to offer crypto loans, which let you use your cryptocurrency as collateral — similar to how a house or car could be used to secure a mortgage or auto loan, respectively.
While crypto loans provide several benefits (such as low interest rates, fast funding, and no credit check), they also come with downsides to keep in mind. For example, if the value of your cryptocurrency falls, you’ll either have to pay back the loan or pledge more crypto — which could be a major issue considering the high volatility of cryptocurrency.
If you’re wondering what a crypto loan is and how it works, here’s what you should know:
What is cryptocurrency?
Although the idea for an entirely digital currency has been around since the 1980s, cryptocurrency as we now know it started in 2008 with an anonymous computer programmer’s white paper describing the concept of bitcoin.
By 2009, the anonymous programmer had created and launched Bitcoin, the first cryptocurrency.
As of 2022, more than 12,000 cryptocurrencies are available, with more being created every month.
Cryptocurrencies are stored and recorded on the blockchain, which works like a digital, public ledger and offers additional security to transactions.
Additionally, cryptocurrencies are decentralized, meaning there isn’t a central authority regulating or distributing them.
Learn More: How Long It Takes to Get Approved and Get a Personal Loan
What is a crypto loan and how does it work?
A crypto loan is a type of secured loan, which means it requires collateral. With many kinds of secured loans, your lender could take your collateral if you don’t make payments — for example, you risk foreclosure if you fail to make your mortgage payments.
However, with a crypto loan, you’ll offer your cryptocurrency as the collateral asset in exchange for a lump-sum payment, which you’ll repay in installments. If you default on a crypto loan, the lender could either liquidate or cash out your cryptocurrency.
However, the minimum loan amount tends to be quite high compared to other options, so you’ll likely need a large amount of cryptocurrency to use as collateral.
Lenders that offer crypto loans
Several lenders provide crypto loans, including:
- BlockFi offers crypto-backed loans starting at a minimum of $10,000. These loans can be used for a variety of expenses, such as consolidating debt or purchasing real estate.
- Celsius crypto loans start at a minimum of $1,000 with repayment terms from one to three years. Additionally, borrowers can use over 40 different cryptocurrencies as collateral with Celsius.
- SALT Lending provides crypto-backed loans starting at a minimum of $5,000 up to $1 million or more. Repayment terms range from three to 12 months.
- Unchained Capital offers loans that can be backed only by Bitcoin. You can borrow $10,000 up to $1 million with terms from three months to three years.
When does it make sense to borrow against your crypto?
Taking out a crypto loan could be a good option in some cases, but it isn’t the right choice for all crypto users. Here are a few scenarios where it could make sense to borrow against your crypto:
- You want a low interest rate but don’t have good credit. With most loans, you’ll need good to excellent credit to qualify for the lowest interest rates. Crypto loans, on the other hand, often provide low interest rates without requiring a credit check — you’ll simply need to have sufficient collateral to back the loan.
- You want to avoid taxes. Cryptocurrency is taxed just like any other capital asset — meaning that if you have a capital gain (such as if you sell your crypto for more than you paid for it), you’ll owe capital gains taxes on the sale. If you sell crypto that you’ve held for less than 365 days, you’ll be subject to short-term capital gains tax, which is the same as your ordinary income tax bracket. But if you take out a crypto loan, you could access some of the value of your cryptocurrency without having to pay taxes on the amount as long as you pay the loan back.
- You want to make a large purchase. You can use a crypto-backed loan for a wide variety of purposes, including major purchases.
However, keep in mind that unlike with crypto loans, you’ll typically need good to excellent credit to qualify for a personal loan — a good credit score is usually considered to be 700 or higher. Some lenders also provide personal loans for bad credit, but these loans tend to come with higher interest rates compared to good credit loans.
If you decide to get a personal loan instead, be sure to shop around and consider as many lenders as possible to find the right loan for your needs. Credible makes this easy — you can compare your prequalified rates from multiple lenders in two minutes.
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Why crypto loans could be problematic
While crypto loans could be a good option for crypto investors to access the value of their coins, they also pose some serious risks that are important to consider, including:
- Major volatility: Cryptocurrency is entirely unregulated. This is a large part of what draws investors to crypto — because it’s decentralized and not backed by any government, it’s essentially an entirely unfettered marketplace. However, the flip side to this lack of regulation is the incredible volatility of the crypto market. The value of various cryptocurrencies has had major fluctuations, with a coin’s value soaring one month and dropping sharply the next.
- Potential margin calls: If you’re using your crypto as collateral for a loan, the volatility of the crypto could lead to a margin call — this is when the value amount of the collateral dips below the lender’s threshold. If this happens, the lender could require you to pledge more crypto in order to maintain the original value of the loan.
Your lender allowed you to borrow up to 50% of your crypto’s value ($58,500) — this ratio of the loan amount to the value of the collateral is called loan-to-value (LTV). In this case, your LTV would be 50%.
However, then say that Bitcoin’s value suddenly dropped to $25,000 per coin — meaning your collateral is now only worth $75,000, but you have accessed a loan worth $58,500. This would put your LTV at 78%.
If this is higher than your lender’s maximum LTV allowance, you’d likely have a matter of days (usually 48 to 72 hours, depending on the lender) to increase your crypto pledge or pay down the loan to remain in good standing. If you aren’t able to increase the pledge or pay down the loan, the lender would liquidate your cryptocurrency.
Check Out: Where to Get a Personal Loan
Alternatives to crypto loans
If a crypto loan doesn’t seem like the right choice for you, here are some alternatives to consider:
Personal loan
Several types of lenders offer personal loans — including online lenders as well as traditional banks and credit unions. You can use personal loans to cover almost any personal expense.
Additionally, most personal loans are unsecured, which means you don’t have to worry about collateral. However, because this is riskier for the lender, rates tend to be higher compared to secured options.
If you’re struggling to get approved, consider applying with a creditworthy cosigner. Not all personal loan lenders allow cosigners, but some do. Even if you don’t need a cosigner to qualify, having one could get you a lower interest rate than you’d get on your own.
Before taking out a personal loan, also be sure to consider how much that loan will actually cost you. This way, you can be prepared for any added expenses.
You can estimate how much you’ll pay for a loan using our personal loan calculator below.
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Home equity loan
If you’re a homeowner, you might be able to tap into your home’s equity with a home equity loan. With this type of loan, you’ll receive a lump sum that you can use how you wish — similar to a personal loan.
Like a crypto loan, a home equity loan is a secured loan — in this case, your home is the collateral. This means you risk losing your home if you fail to make payments on the loan.
Home equity line of credit
Another option to access your home’s equity is with a home equity line of credit (HELOC). Unlike a home equity loan, a HELOC is a type of revolving credit — which means you can repeatedly draw on and pay off your credit line, similar to a credit card.
Just keep in mind that because your home acts as collateral for the loan, the lender could seize it if you fail to make your payments.
Credit card
Credit cards are another kind of revolving credit — but unlike a HELOC, they generally don’t require collateral. Keep in mind that credit cards typically have higher interest rates than secured loans as well as unsecured personal loans.
However, if you can’t pay off your card in time, you could get stuck with some hefty interest charges.
Is a crypto loan right for me?
Cryptocurrency is having a major moment, which could make it tempting to jump in with both feet and explore the different options that this new currency offers — including crypto loans.
But ultimately, while crypto loans provide several perks, it’s important to take the time to fully understand the potential risks involved.
If you need access to cash but don’t like the pitfalls associated with crypto loans, a personal loan might be a better choice. Before taking out a personal loan, remember to shop around and compare your options from as many lenders as possible to find the right loan for you.
Credible makes this easy — you can see your prequalified rates from multiple vetted lenders in two minutes.
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Published at Wed, 30 Mar 2022 16:16:35 -0500
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By Assessoria de Comunicação – MPPE on 2022-03-31 12:08:28