How Do Crypto Loans Work?
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Cryptocurrencies can be looked at as a unique asset class. And similar to other assets, like a stock, house or car, your cryptocurrency can serve as collateral for loans. Several new lenders provide crypto loans, which are secured by your current crypto holdings. You are required to hold crypto before considering getting a loan as an option.
The benefits to these loans are access to cash, low interest rates, same-day funding and no credit checks. The downside? You may need to pledge more crypto if the coin’s cash value falls, and a lender can trigger automatic payments or liquidate your crypto account if you miss a payment.
Despite the risks, a crypto loan can be a lifeline if you need money for purchases but don’t want to sell out of your crypto.
What is a crypto loan?
A crypto loan is a type of secured loan in which your crypto holdings are used as collateral in exchange for liquidity from a lender that you’ll pay back in installments. As long as you make your payments and pay the loan amount in full, you get your crypto back at the end of the loan term.
Typically, the crypto loan amount is a loan-to-value, or LTV, percentage of the cryptocurrency you are pledging as collateral. You can borrow up to 50% of your crypto’s value with a lender like Binance, or up to 90% with a lender like Youholder.com. Some lenders accept as many as 40 different cryptocurrencies as collateral, with Bitcoin and Ethereum being the most popular.
Loan terms can be anywhere from seven days to a year or more. Interest rates are low compared to personal loans and credit cards, with rates starting at a range of 0%-13.9% with a lender like Nexo.
Crypto loans are attractive for holders who believe their crypto assets' long-term value will increase, but need cash for purchases in the present. But crypto loans come with inherent risks, like requiring additional collateral if the value of your crypto goes down and high penalties for missed payments.
Types of crypto loans
There are 2 types of crypto loans: CeFi and DeFi.
Centralized Finance, or CeFi, loans are custodial crypto loans where a lender has control over your crypto during the repayment term. Most crypto loans fall under the CeFi umbrella.
Decentralized Finance, or DeFi, loans rely on smart contracts to ensure you adhere to the loan requirements. You retain control of your crypto assets, but a lender can take automatic actions against your account if you default or miss a payment. DeFi crypto loans can have higher interest rates than CeFi.
What can a crypto loan be used for?
A crypto loan can be used at your discretion, often without any restrictions from the lender, similar to a personal loan. The cash from the loan can be used for large payments like a down payment for a house, buying a car, tuition, refinancing debt or starting your own business.
A crypto loan may make sense if someone holds a substantial amount of crypto and wants liquidity without having to sell, says Travis Gatzemeier, a certified financial planner and founder of Kinetix Financial Planning near Dallas.
Some crypto lenders won’t be able to give you U.S. dollars directly but will provide a loan in a stablecoin, which is pegged to the U.S. dollar, or gold, which can be exchanged for cash into an account.
Certain websites offer crypto loans to exchange into other cryptocurrencies. It's a good idea to look closely at lenders to ensure they are providing the solution you need.
» MORE: Best online personal loans
How do you get a crypto loan?
To get a crypto loan, you must own any of the cryptocurrencies that are accepted for loans. Check with your lender on which coins are accepted.
Next, research reputable lenders and find the one that works best for you. Each lender has its own application process, so read the eligibility requirements and terms and conditions carefully.
Create an account with your chosen lender to begin the application process.
Complete the account opening process, including verifying your crypto holdings and identity. A lender like YouHolder may ask you to open a wallet with your collateral on their site to start the loan process. Crypto lenders don’t require a credit check as part of the loan process.
Next, you can select the type of loan you want by the LTV you are comfortable with, your loan amount and repayment term. Most lenders have calculators to see how much you can borrow and the amount of collateral required for your loan amount.
To complete your loan application, submit your request with the necessary information. Crypto lenders have been known to provide fast turnaround times. A lender like Nexo can approve within seconds and fund your account within 24 hours.
» MORE: Best Crypto Exchanges and Apps
What are the risks of crypto loans?
Crypto lenders tend not to have as much oversight as traditional banks do. And cybercrime, hacking or lender bankruptcy are risks in the market. If you lose your funds in a security breach, compensation is not guaranteed.
Crypto loans are also subject to the price volatility of the underlying coin, and additional collateral will be required if the LTV increases.
“That is going to be the main disadvantage of crypto,” Gatzemeier says. “It’s not a normal, stable asset that you’re using to borrow.”
Additionally, lenders may be able to liquidate your assets if you miss payments or your LTV has increased without additional collateral. For example, a lender like Nexo says it will initiate partial automatic repayments to pull additional collateral from your crypto account.
Identifying a trusted and secure lender is important, especially when providing access to your crypto account. Check out reviews on websites like Trustpilot, read through security protocols and research crypto platforms that accept your type of coins for a loan. And then ensure loan payments and swings in the market are worked into your current budget so there are no penalties for market volatility.
Pros and cons of crypto loans
Pros
No credit checks.
Fast approval and funding.
Doesn’t require selling out of crypto holdings.
Loan terms can be from seven days to up to 12 months.
Low interest rates.
A crypto loan can be used for almost any purpose.
Cons
May require additional crypto if the value drops.
Increases in LTV, nonpayment or multiple missed payments can lead to the liquidation of assets.
Lenders tend to have less oversight than traditional banks.
Existing crypto portfolio required.
You do not have access to your crypto when it is held with a CeFi lender.
Alternatives to borrowing against your crypto
If you have equity in your home: With a home equity line of credit, you can potentially borrow up to 85% of your home’s value. Be careful, though, as you can lose your home if you don’t repay.
If you’re looking for a lower interest rate: A 0%-interest credit card can offer free financing for 14 to 18 months. However, note that after the introductory period, you could pay a high interest rate on unpaid balances.
If you have bad credit: Credit unions consider your history as a member, which can typically mean more flexible rates and terms for credit union loans.
If you need a small loan: A small personal loan — below $2,000 — is also a viable option. However, rates may be high depending on your credit profile and income.
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