What Is Crypto Lending and How Does It Work?

What Is Crypto Lending and How Does It Work? article image.

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The increased popularity cryptocurrency now enjoys among mainstream investors and consumers means it's becoming easier to buy, use and invest in. With some crypto exchanges and other platforms, it's also possible to use your digital asset holdings to secure a loan.

The benefits of doing so can be appealing, but it's important to understand the risks associated with crypto lending before you apply.

What Is Crypto Lending?

Cryptocurrencies like Bitcoin and Ether are digital assets that have a lot of uses, including securing a loan.

With a crypto loan, you pledge a portion of your crypto holdings as collateral for the money you borrow. As with a secured loan like a car loan or mortgage, you retain ownership of your cryptocurrencies while you pay down the loan. If you fail to repay the loan as agreed, however, you risk losing a big chunk of your collateral.

In most cases, you can borrow up to 50% of your digital asset balance, though some platforms allow you to borrow up to 90% of your portfolio's value. But there are some restrictions on what you can do with the assets, and if you default on your debt or the price of your crypto drops significantly, you could default on the loan and lose the assets.

Depending on the platform you use, you may be able to get your loan funds in U.S. dollars or in select cryptocurrencies. However, the types of cryptocurrencies you can use to secure a loan can be limited and will vary by platform. If you don't have the right currency, you'll have to exchange it for another one to qualify.

Also, some lenders allow you to secure a loan with non-custodial crypto, which are assets you have in a digital wallet that's not connected to an exchange, but many require you to hold your digital assets with the platform to be eligible. While crypto exchanges are generally secure, you may not want to keep your assets with a platform you think might fail.

Benefits of Crypto-Backed Loans

There are many reasons to consider using your crypto holdings to secure a loan. Here are some of the top benefits:

  • Low interest rates: Because they're secured by an asset, crypto loans tend to charge lower interest rates than many unsecured personal loans and credit cards. As a result, they can be appealing for someone who has digital assets they don't plan to use or trade and want to save money.
  • Ownership: If you need cash, a crypto loan allows you to get the money you need without forcing you to sell your holdings.
  • Quick funding: Once you're approved, you may be able to get your loan funds within hours.
  • No credit check: In many cases, the crypto lending platform won't run a credit check when you apply. If your credit history is less than stellar, this could be an incredibly attractive alternative to bad credit loans.

The Drawbacks of a Crypto Loan

While there are some key benefits that could appeal to certain consumers, there are a lot of downsides to consider as well:

  • Minimum borrowing requirements can be high. While platforms can vary, you may simply not have enough holdings to secure the minimum loan amount the lender offers. With BlockFi, for instance, the minimum loan amount is $10,000, and with a 50% maximum loan-to-value ratio, that means you need $20,000 or more in holdings to get approved.
  • Repayment terms are short. Crypto loans typically have terms of 12 month or less, which means you don't have a lot of time to repay them, especially compared with personal loans, which can offer longer terms. If you default on the debt, the platform may liquidate your holdings, which could result in a tax bill if your portfolio has gained in value since you first bought the digital assets.
  • Margin calls are a threat. A margin call occurs when the value of your collateral assets drops below a threshold set by the lender. If the price of your crypto assets drops significantly—which is more likely with crypto versus traditional assets due to the volatility of the crypto market—you may need to deposit more into your account to keep your assets. If you don't, the platform may choose to sell your holdings, which could affect your tax liability.
  • Assets are inaccessible. As long as your loan is outstanding, you can't use or trade your crypto assets. In other words, if the price of your assets tanks, you're stuck, and there's no insurance against the loss.

Alternatives to Crypto Loans

As with any financial decision, it's a good idea to research and compare several options before you settle on one. That's especially the case with relatively risky decisions like using digital assets to secure a loan.

Here are some potential alternatives to consider:

  • Sell your crypto. If you don't have enough crypto holdings to meet minimum loan requirements or you need more than you're allowed to borrow, it may make sense to simply sell the digital assets you have to get the funds you want. Just keep in mind that there can be tax implications when you sell crypto.
  • Take out a personal loan. Personal loans can be more expensive than crypto loans, but the upside is that many are unsecured, and you'll typically get a longer repayment period.
  • Apply for a 0% intro APR credit card. If you have good or excellent credit, you may be able to get approved for a credit card with an introductory 0% APR promotion. These deals allow you to make purchases and pay them off over 12, 15, 18 or even 20 months without interest. Just keep in mind that the card's potentially high ongoing interest rate will apply to any balance left over after the introductory period ends.
  • Ask family or friends for help. Depending on your situation, you may be able to ask a family member or friend to help you with your financial issues. Be clear about the repayment agreement and make sure you stick to it to avoid damaging the relationship.

Whatever you do, take your time to shop around and carefully mull over your options. Consider using Experian CreditMatch™ to compare personalized credit card and personal loan offers.

Also, make sure to avoid high-cost forms of financing like payday loans and auto title loans. While these can provide you with fast cash, they have incredibly short repayment terms and exorbitant interest rates.

Build Your Credit to Increase Your Options

One of the reasons crypto loans can be appealing is that there's generally no credit check involved, and the alternatives can be high-cost loans. Regardless of how you choose to handle your current financial situation, take time to improve your credit so you'll have more options in the future when you need financing.Start by checking your credit to review areas that you can address. You can get a free copy of your credit report from all three bureaus through AnnualCreditReport.com. Your FICO® Score based on Experian data and your Experian credit report are also available for free. Once you've reviewed your credit, take action to make improvements. This process can take time and effort, but it can pay off big time in the long run.