Why do we need cryptocurrency loans and how do they work?

1. What is a loan secured by cryptocurrency?

A loan secured by cryptocurrency works like a regular loan: the borrower borrows money for a set period of time and pledges value, in our case, cryptocurrency. When the term expires, the borrower must repay the loan amount and interest in the same currency in which he borrowed. The loan can be received in national currency (RUB, USD, EUR) or in digital assets (BTC, ETH, DOGE).

2. How does a secured cryptocurrency loan work?

Due to the volatility of cryptocurrency prices, the value of collateral can rise or fall, but the loan itself is always fixed in fiat money. If the price of bitcoin has risen over the life of the loan, the borrower can repay the loan at a profit. Here’s how it works:

Initial bitcoin price: $3800.
Loan rate: 8% per annum.
Loan amount: $15,000.
Loan term: 180 days.
Discount: 30%.
Amount of deposit: 5.86157174 BTC
Initial collateral value: $22,273
Final bitcoin price: $10,000.
Accrued interest: $590.
Amount to be returned: $15,590.
Amount of the returned deposit: 5.86157174 BTC
Final value of the pledge: $58 615
Borrower’s income from the transaction: $35,752.

On the loan platform, the currency of the loan is U.S. dollars, hence all amounts are fixed in USD. Credit can be received in fiat money or cryptocurrency. Transactions are settled based on the current exchange rate of the issuing currency to USD.

3. Why do I need cryptocurrency loans?

Cryptocurrency collateral loans are an alternative to exchanges and exchanges. Such loans are needed in order not to sell cryptocurrency at an unfavorable rate and thus preserve the digital asset, which can grow in value.

The main difference between loans with cryptocurrency collateral and their traditional counterparts is the high volatility of digital assets that act as collateral. This is also the main value of such service: if the collateral grows in value, the transaction will be profitable for the borrower. For the creditor, the profit is always fixed in USD.

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4. Where is the collateral stored?

There are two options for storing collateral:

  • The collateral is held by a third party. This option is offered by platforms that lend with their own funds. In fact, they get users’ cryptocurrency into temporary possession. This option is also offered by some p2p services that provide a platform for interaction between lenders and borrowers. The borrower transfers the collateral to the address specified by the service, and the lender releases the money. When the loan is repaid, everything happens in reverse order.
  • The p2p platform stores the collateral at the multisig address. In this case, the platform acts as a guarantor of the transaction. For each transaction, a new multisig address is created from the public keys of the borrower, the lender and the platform, to which the collateral is transferred. One private key remains with the borrower, one with the lender, and one with the platform. Funds are released when 2 of the 3 keys are entered.

5. Under what conditions can I get a loan with cryptocurrency collateral?

Platforms that lend from their own funds and hold users’ assets set terms for loans. They set minimum and maximum loan amounts, interest rates, discount, loan-to-value ratio (LTV) and terms. In p2p lending, borrowers and lenders negotiate among themselves and choose their own terms.

6. How is the collateral amount determined?

The value of collateral in any type of loan must be higher than the loan amount. The amount of collateral depends on the loan amount, the annual interest rate, the term of the loan, and the discount – the “safety margin” of the collateral.

The discount indicates how much the exchange rate of the collateral currency may fall before the value of the collateral equals the loan amount and the transaction closes (this situation is called the emergence of a margin call). The higher the discount the borrower sets, the higher the value of the collateral will be.

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7. What documents do I need to get a loan secured by cryptocurrency?

Platforms that hold users’ money and collateral impose strict conditions for obtaining loans. This is due to money laundering and terrorist financing laws. Such platforms are required to conduct a KYC procedure in which the user must provide their passport information and other personal information.

On p2p platforms, the registration procedure usually dispenses with passport data and is limited to entering an email address, username and password, but requirements may vary depending on the jurisdiction.

8. In what currency are cryptocurrency loans issued?

Most platforms lend in USD, but you can choose other fiat money or cryptocurrencies.

9. How do I get a secured cryptocurrency loan?

A platform that makes loans on its own, transfers them through bank transfers or credits the borrower’s account with staplecoins like Tether (USDT). P2p services use bank transfers and payment processors.

10. Why get a cryptocurrency loan secured against cryptocurrency?

When you get a cryptocurrency loan, its price is still calculated in USD at the time of the transaction. Cryptocurrency here acts as a method of transferring funds. When repaying the loan, the borrower returns the same amount in USD that he took, along with interest. If the price of the cryptocurrency has risen in the meantime, the borrower will repay less than he borrowed. Long-term investors can profit from the growth of the value not only of the collateral, but also of the loan body.

For example: a borrower borrows $1,000 in bitcoins at $3,800 per BTC and receives $0.2632 BTC. When the bitcoin price goes up to $10,000, he will get back the $1,000, but now it will be 0.1 BTC.

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Another advantage of a cryptocurrency loan is faster transactions compared to bank transfers. At the same time, the borrower does not provide personal data to a third party and can not fear the freezing of assets.

11. What happens if the rate of a pledged cryptocurrency changes?

If the rate of the cryptocurrency collateral goes up, the value of the entire collateral goes up as well. When the rate goes down, the total value of the collateral goes down as well.

If the value of the collateral falls to the amount that the borrower owes back, a margin call occurs. This means that the deal closes and the collateral goes to the lender to repay the debt. This way the lender gets his investment and the borrower keeps the loan amount but loses the collateral. For the borrower, the situation is equivalent to selling the cryptocurrency at the market rate.

The risk of a margin call depends on the discount percentage that the borrower specifies. The higher the discount, the lower the risk of closing the transaction because of the margin call.

12. What happens if you don’t repay the loan?

On p2p cryptocurrency lending platforms, disputes are resolved through the use of multisig wallets. If the borrower fails to pay on time, the platform transfers his private key to the lender, who unlocks the multisig address and reimburses the loan amount against the collateral.

13. Memo

  • Choose a platform that does not store your money and private keys. Pay attention to the volatility of the collateral currency and the term of the loan.
  • The higher the discount, the further the margin requirement. Biterest recommends a discount of at least 30%.
  • Not ready to disclose passport information – use a platform without KYC.

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