What Is a Crypto Loan and How to Borrow Against Crypto?

What Is a Crypto Loan and How to Borrow Against Crypto?

UTC by Marco T. Lanz · 7 min read
What Is a Crypto Loan and How to Borrow Against Crypto?
Photo: Depositphotos

In this guide, we will delve into the details of how crypto loans work, the different existing models (CeFi and DeFi), the requirements for applying, ways to use the obtained capital, and the advantages and disadvantages to consider before taking on debt.

Loans using cryptocurrencies as collateral have experienced a surge in popularity within the crypto ecosystem in recent years. This financial instrument allows cryptocurrency holders to access liquidity without the need to sell their digital assets.

In this guide, we will delve into the details of how crypto loans work, the different existing models (CeFi and DeFi), the requirements for applying, ways to use the obtained capital, and the advantages and disadvantages to consider before taking on debt. Furthermore, we will explore practical examples of their application, including debt consolidation, vehicle purchases, holiday expenses, or their use for investment and trading purposes.

Crypto Loan Defined

A crypto loan, as the name suggests, is a personal loan secured by cryptocurrencies. In other words, the borrower provides a specific amount of cryptocurrencies like Bitcoin (BTC), Ethereum (ETH), and Tether (USDT), among others, as collateral. In exchange for this collateral, the borrower receives a sum of cash, usually in the local currency, to be repaid in periodic installments over a predetermined period, ranging from 12 to 60 months depending on the lender.

The operation is similar to any other secured loan, such as a mortgage for a home or a loan for a car. The key difference here is that the collateral is not a physical asset but a cryptocurrency.

By securing the loan with cryptocurrencies, the lender can seize the collateral if the borrower fails to make the agreed-upon payments. Conversely, if the borrower fulfills all payments on time, they regain complete control and ownership of the initially pledged cryptocurrencies.

Therefore, these loans function similarly to traditional market loans but with a significantly lower interest rate.

How Does a Crypto Loan Work?

To request a crypto-backed loan, you need to have a cryptocurrency to use as collateral. Once you possess the cryptocurrencies, the next step is to find an entity or online platform that provides these types of loans. Each financial institution or platform has its conditions, so it’s crucial to thoroughly research various options before making a decision.

When choosing a lender, create an account on their platform and link your crypto wallet to it. This allows the lender to verify your cryptocurrency balance available to secure the loan. It’s worth noting that on most centralized platforms, you’ll need to complete the identity verification (Know-Your-Customer) process, which usually requires personal and address documentation.

After completing these steps, you can request a specific loan amount, taking into account the value of the cryptocurrencies offered as collateral. Each entity sets its own criteria but typically lends between 20% and 70% of the presented crypto collateral’s value.

Finally, sign the loan agreement, and upon approval, receive the requested funds. This usually happens immediately or within a couple of hours. From the moment the money is received, you start making the agreed-upon periodic payments.

Imagine you are considering borrowing 100 USDT through the Binance cryptocurrency exchange. To do this, you would need to provide 142 USDC as collateral. This means the interest associated with the loan would be 70%. It’s akin to putting down 142 dollars as a deposit to borrow 100 dollars. This is a basic example using USDT, but you can do it with almost any cryptocurrency on the platform.

Types of Crypto Loans

There are primarily two types of loans that can be obtained using cryptocurrencies as collateral:

  1. Centralized finance (CeFi) loans. This is the most common type of loan in the crypto ecosystem. The entity providing the loan is a centralized company or institution, such as an exchange or a regulated fintech platform like Binance, Coinbase, Huobi, Kraken, Crypto.com, among others. Under the CeFi scheme, the borrower transfers their cryptocurrencies to a wallet designated by the lending platform. In this way, the platform safeguards and manages the cryptocurrencies during the loan term. Once the loan, along with all interest, is fully paid, the cryptocurrencies are returned in full to the original owner. Advantages of these loans include quick approval, low interest rates, and high liquidity.
  2. Decentralized finance (DeFi) loans. In this case, the loan is not granted by a centralized company but by a smart contract on the blockchain. These are automated peer-to-peer loans executed through code. Unlike the CeFi model, here the borrower retains custody of their cryptocurrencies throughout the process, using their own non-custodial wallet. This means there’s no need to transfer them to a third party. The smart contract manages loan release, interest, and collateral. However, similar to the previous model, if payments are not met, the smart contract automatically executes the liquidation of the crypto assets provided as collateral. This decentralized loan type avoids intermediaries but comes with higher interest rates and requires a deeper understanding of Decentralized Finance (DeFi).

Using a Crypto Loan

Cryptocurrency-backed loans have become highly versatile, allowing financing for a wide variety of personal or business needs. Here are some specific examples:

  • Debt consolidation. Use the obtained capital to pay off or refinance previous debts, such as credit card balances, bank loans, or personal loans. This helps improve cash flow by consolidating different payments into one at a much lower rate than traditional banks.
  • Investments and trading. Crypto investors often reinvest borrowed money into various cryptocurrencies or DeFi projects that promise higher growth potential than the cryptocurrency they currently own. For example, an investor might borrow USDT to buy ADA in anticipation of new products launching on the Cardano blockchain and repay the loan at year-end with the generated profits if ADA’s price increases.
  • Vehicle purchases. Whether it’s a car, a truck, a motorcycle, or even a boat, crypto loans are ideal for covering expenses that typically require significant cash outlays.
  • Vacations and travel. Many people use this type of financing to fund their leisure trips, whether it’s the dream Caribbean cruise or a luxury vacation in Dubai.

Pros & Cons of Crypto Loans

Obtaining money through a cryptocurrency-backed loan has several advantages compared to other types of financing. However, it also carries certain risks worth considering.

Among the key advantages of crypto loans are the following:

  • Low-interest rates. These loans usually have significantly lower interest rates than credit cards or unsecured personal loans. Rates can start from 0.95% annually in some cases.
  • Quick approval. No need to verify credit history or provide financial documentation. The application is 100% online and is typically approved the same day, making it ideal for addressing emergencies.
  • Flexible use of funds. The funds can be allocated for any legal purpose, from paying debts to investing in new assets. There are no restrictions.
  • Tax management. Access liquidity without selling crypto assets and potentially incurring capital gains taxes.

The drawbacks of crypto loans to consider include the following:

  • Partial loss risk. If the value of the provided crypto collateral drops significantly, the borrower may face partial liquidation to cover losses.
  • Possible margin calls. Additional injections of cryptocurrencies may be required to replenish the guaranteed value.
  • Limited access to cryptocurrencies. While the loan is active, access or trading with the collateral assets may be restricted.

Bottom Line

In summary, seeking a loan using cryptocurrencies as collateral is an attractive option for those looking for liquidity but unwilling or unable to sell their current holdings.

However, it’s essential to fully understand the potential risks of taking out a crypto loan before proceeding. While the interest rates are low and the process is expedited, there is a real possibility of losing all pledged holdings through margin calls or even partial liquidations of assets.

Therefore, before applying for a crypto loan, thoroughly research the terms and conditions of each platform. Compare them to find the lowest interest rate, and always have a backup plan in case the value of your collateral cryptocurrencies suddenly drops. Remember that the crypto market is known for its extreme volatility.

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FAQ

What is a crypto loan?

A crypto loan is a type of personal loan secured by cryptocurrencies like Bitcoin, Ethereum, Tether, etc. The borrower puts up the crypto as collateral in order to receive a loan in cash which is repaid in installments over a set period of time.

How does a crypto loans work?

To get a crypto loan you need to have cryptocurrency, find a lending platform, link your crypto wallet, get approved based on your collateral, sign an agreement, and receive the funds. Once you finish repaying the entire loan, you will receive your cryptocurrencies back.

How to get a crypto loan?

The steps are the following: have eligible crypto, find a lending platform, create an account and link wallet, request a loan amount based on collateral value, sign an agreement or contract, and receive loan disbursement.  

What types of crypto loans exist?

The two main types are centralized crypto loans (CeFi) offered by centralized companies and decentralized loans (DeFi) governed by smart contracts on the blockchain.

What are the uses of crypto loans?

Crypto loans allow you to access liquidity for needs like consolidating debt, vehicle purchases, vacations, or investing without selling your crypto holdings.

What are the key advantages of crypto loans?

Key advantages of crypto loans include low interest rates, fast approval times, flexible use of money obtained, and avoiding capital gains taxes.

Is crypto lending legal?

Yes, cryptocurrency lending is generally legal, though regulations vary across different countries and jurisdictions.

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