What are Crypto Loans?
Cryptocurrencies are digital currencies that have a variety of uses. Bitcoin is one of the most common cryptocurrencies, but there are thousands of other options, including Ethereum, Binance Coin (BNB), Tether and more.
A crypto loan is a loan issued by a crypto lending platform. When you take out a crypto loan, your cryptocurrency is used as collateral — just as your house or car would be used as collateral for a mortgage loan or auto loan. And like a traditional loan, crypto loans are paid off with interest over a set time.
Crypto loans are like personal loans in that they can typically be used for anything without many restrictions. For instance, you might use a crypto loan for a home renovation, to start a business or to consolidate high-interest debt.
How do Crypto Loans Work?
Crypto loans are typically offered as collateralized loans — or secured loans — meaning the loan is secured by your crypto holdings. However, uncollateralized crypto loans may also be available from certain crypto lending platforms.
Collateralized Loans
Collateralized crypto loans require you to pledge your cryptocurrency as collateral. Like a mortgage or car loan, your collateral can be seized as payment if you do not pay back your loan.
Some crypto lending platforms require overcollateralization, which means you can only borrow up to a certain percentage of the deposited collateral. If your crypto loan is overcollateralized, then the value of the collateral is greater than your loan’s value. Overcollateralization can help you get better terms for your crypto loan because it reduces the risk for the lender.
Uncollateralized Loans
Uncollateralized loans, in comparison, do not require collateral. Instead, approval depends upon other factors that ensure you can repay your loan, like a history of responsible credit use and paying on time. Uncollateralized loans are more commonly known as unsecured loans.
Collateralized vs. Uncollateralized Crypto Loans
| Loan Type | Collateral Required? | Interest Rates | Loan Amount | Risk Level for Lender |
|---|---|---|---|---|
| Collateralized | Yes | Lower | Up to 50% of collateral value | Lower |
| Uncollateralized | No | Higher | Smaller loan amounts | Higher |
If you choose to use your cryptocurrency as collateral, you have two options for crypto loans:
- Centralized finance (CeFi): With this type of loan, you borrow money from a crypto or blockchain company that operates like a traditional finance system. It’s controlled by a private central authority, which can provide more stability and security to users. CeFi loans are more common and less expensive than decentralized loans.
- Decentralized finance (DeFi):Here, borrowers can access a loan through a decentralized blockchain. DeFi products and services are managed by an open-source computer network rather than a single entity like a bank or government. Users can manage their digital assets directly, but a lender can take action if necessary.
How to Get a Crypto Loan
To apply for a CeFi loan, you’ll need to sign up for a centralized lending platform. Common CeFi platforms include Nexo, CoinLoan, Binance and YouHodler. If you decide on a DeFi loan, you’ll need to connect a digital wallet to a decentralized lending platform. Popular options include Aave, Defi Swap and Crypto.com. Make sure the lender you choose accepts the cryptocurrency you own and plan to use for collateral.
Just as you would when applying for a traditional loan, research and evaluate each lender and what they offer. Interest rates, repayment terms and funding times can vary. Qualification requirements and application processes may differ as well.
Once you’ve picked a lender, you’ll need to create an account and then verify your identity and crypto holdings. You’ll then choose the type of loan you want and the amount you’d like to borrow. The amount you’re able to borrow will vary based on how much you deposit and how much collateral you have.
After you submit your loan request, it must be approved. Many crypto lenders can approve and fund loans quickly, sometimes within 24 hours. If approved, your loan terms are locked in by a smart contract, which is a self-executing contract with the terms of your agreement written directly into lines of code. Smart contracts allow transactions to be trackable, transparent and irreversible.
Finally, you’ll deposit the collateral into the platform’s digital wallet. Your borrowed funds will then be transferred to your account or digital wallet for your use.
>> Related: Learn about where to get a loan
Benefits of Crypto Loans
- Fast approval: Applying, qualifying for and getting approved for a crypto loan can be a much faster process than getting a traditional loan.
- Potentially no credit check: Crypto lenders typically do not check your credit score or credit history for collateralized loans, so many borrowers who are ineligible for a traditional bank loan may be able to get a crypto loan instead.
- Sometimes low interest rates: Because crypto loans typically use crypto as collateral, interest rates are often lower than rates on unsecured personal loans or credit cards.
- Retain ownership of holdings: Getting a crypto loan means you can access cash without having to sell your crypto holdings.
- Tax benefits: Loans are considered non-taxable by the IRS — and that includes crypto loans.
Risks of Crypto Loans
- Volatility: Crypto lending can be risky for both borrowers and lenders because cryptocurrencies are digital assets and values change constantly.
- Uninsured: Cryptocurrencies are not insured by the FDIC, so if your crypto account gets hacked or your crypto lender goes out of business, you may lose your collateral even if you’ve been making payments on your loan.
- Margin calls: If the value of your crypto falls below a specific threshold, your lender may require you to increase your holdings or sell some of your assets to maintain your loan-to-value (LTV) ratio in order to keep your crypto loan. Because cryptocurrency is so volatile, the likelihood of a margin call is relatively high.
- Illiquidity: You cannot trade or transact your crypto assets while you have an outstanding loan balance, which may be a problem if the price of your crypto drops significantly.
>> Related: Learn more about the pros and cons of personal loans
Crypto Loan Interest Rates and Fees
One of the most attractive benefits of securing a crypto-backed loan may be the low interest rates. Crypto loan interest rates tend to be lower than the rates for credit cards and unsecured personal loans because crypto loans are secured by an asset — your cryptocurrency — while unsecured personal loans are based on factors like your credit score and history of repaying debts.
Interest rates vary by crypto loan lender, and they can fluctuate frequently because of the nature of cryptocurrency. When applying for a crypto loan, be sure to find the most recent interest rate for your chosen crypto lending platform.
However, be mindful of origination fees charged by different lenders. Origination fees, or closing fees, are upfront fees charged by lenders to process a loan application. Crypto loans usually include origination fees in their annual percentage rate (APR), which is the annual cost of borrowing money from a crypto lending platform and includes both the interest rate and fees.
>> Related: Learn more about interest rates
Alternatives to Crypto Loans
If you need a loan but are hesitant to apply for a crypto loan or don’t own the required cryptocurrency for a crypto lender, you have options.
Personal Loans
A personal loan offered by financial institutions and online lenders can be used to repay debt, pay for medical expenses and many other purposes at your discretion. Approval is based on factors like your income and credit score.
If you have excellent credit, you may be a good candidate for a personal loan. These factors can also affect your interest rates. Just as you would when choosing a crypto lender, be sure to evaluate different lenders when getting a personal loan.
Home Equity Lines of Credit
HELOCs, or home equity lines of credit, are based on your home’s equity, which equals the home’s market value minus what you owe. When you take out a HELOC, you can borrow what you need from your line of credit and pay it back in monthly installments. The interest you pay is based only on the amount you draw.
Because you’re not taking your loan as a lump sum upfront, a HELOC offers more flexibility than other types of loans. HELOCs typically have lower interest rates than personal loans or credit cards since your home is used as collateral. However, you could lose your house if you default or struggle to make payments.
>> Related: Learn more about the best HELOC rates
Credit cards
A credit card may be another option to access the funding or flexibility you need. Credit cards allow you to make purchases up to your credit limit, but typically come with higher interest rates than other types of loans or lines of credit. Like crypto loans, you may be able to choose from a secured credit card or an unsecured credit card. If you are in credit card debt, review our picks for the best credit card consolidation loans.
Impact on Taxes
If you’re a crypto lender, taxes on crypto earnings can get complicated. The IRS states that cryptocurrency may be subject to either income taxes or capital gains taxes, depending on how it’s used and received.
For example, if you earn cryptocurrency from mining or receive it as payment in your business, it’s considered regular taxable income. If you gain or lose money on cryptocurrency, however, you will likely have to claim it as a capital gain or a capital loss.
The Bottom Line
Cryptocurrency loans are attractive options for borrowers who may not qualify for traditional loans. If you already use cryptocurrency, you can borrow money using your crypto assets as collateral. Because the application and approval process for crypto lending is fast — and doesn’t usually involve a credit check — you may be able to access funds more quickly. Interest rates are comparatively low, too.
However, crypto lending has its own set of unique risks. Cryptocurrency lacks the insurance and protection that traditionally regulated bank loans do. If your crypto lender folds, your account is hacked or you run into problems with a purchase, you could lose your crypto assets. And while you still own your cryptocurrency in a crypto loan, you can’t access your holdings to trade or transact.
Crypto lending is highly volatile because the crypto market itself is inherently volatile. If you’re unsure of the risks associated with a crypto loan, evaluate other options for funding like personal loans, HELOCs and credit cards.
Frequently Asked Questions About Crypto Loans
Crypto loans offer unique benefits, such as relatively low interest rates and quick funding. They can be a cheaper alternative to personal loans or credit cards since they’re secured by collateral. The process of applying for, qualifying for and getting approved for a crypto loan can also be a much faster process than a traditional bank loan. Additionally, borrowers who are ineligible for traditional loans may be able to secure a crypto loan since credit checks are not required.
Cryptocurrencies are highly volatile and the crypto market is ever-changing. The value of your cryptocurrency depends on that market. Security breaches may also be a concern. Cryptocurrency is not insured by the FDIC, and crypto lending platforms are not regulated like banks are. Crypto-backed loans come with their own unique risks.
Generally, no. While applying for a personal loan can impact your credit score and credit history, crypto loans do not require a credit check, so taking out a crypto-backed loan should not affect your score. Crypto loans won’t impact your total credit, nor will they appear in your credit history.
If your crypto collateral drops in value, a margin call may be triggered. Your crypto lender may need you to deposit more collateral to maintain your loan-to-value ratio. They may even need to sell some of your assets or risk liquidation.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
If you have feedback or questions about this article, please email the MarketWatch Guides team ateditors@marketwatchguides.com.
