How to use crypto as collateral for your business loan
- Cryptocurrency (or cryptocurrency) is increasingly popular with investors and even as an accepted form of payment in businesses around the world.
- As it grows in popularity, crypto lenders are becoming more common as an alternative source of loans for small businesses and individuals.
- Learn about crypto lending and the rise of digital currencies from Nav’s small business experts.
What is Cryptoloan?
Crypto lending (or crypto lending) is the process of using crypto currency, such as Bitcoin (BTC), as collateral, just like you would with a secured loan. It is a decentralized finance (or DeFi) service that uses blockchain to lend crypto assets to borrowers and then earn crypto interest. For a crypto lender, this can be compared to opening a high-yield savings bank account, where you earn interest on the money in the account, but instead use cryptocurrency.
It sounds simple and like many, but since digital currencies are still new and the crypto market is not necessarily always stable, it is not yet common for traditional lenders to participate in crypto lending. However, crypto lending is quickly becoming one of the most popular DeFi services on cryptocurrency platforms and exchanges.
How does the crypto loan work?
With crypto lending, both lenders and borrowers use a crypto platform or exchange as their lending marketplace. Both will sign up for the platform using their digital wallets. To engage in crypto lending, a crypto lender will move their cryptocurrency from their digital wallet, or crypto wallet, to a high-interest loan account on the platform. Borrowers can then apply for crypto loans through the platform, which will approve the borrower and set interest rates and fees. The loan will be paid using funds from the accounts of the cryptolenders. As the borrower repays the loan in monthly installments, the crypto lender and the platform will collect the interest.
Each platform will have its own interest rates and fees. Lenders can earn a higher annual percentage yield (APY) if they are willing to keep their cryptocurrency locked in the account for a period of time without making withdrawals, giving the platform better access to funds at loan purposes.
There are also automated crypto-lending methods. In this scenario, borrowers and lenders simply connect their digital wallets to a centralized lending protocol that handles approvals and transfers based on certain conditions met. These terms are called smart contracts, and they consist of code running on blockchain networks that automatically determine when a loan can be approved.
Advantages and Disadvantages of Using Crypto as Collateral
As with any financing, there are risks associated with crypto lending. There are also pros and cons:
- No credit check for borrowers
- Can be used by borrowers who may not qualify for other loans
- Often offer lower interest rates than traditional loans
- Lenders Earn Passive Income on Crypto Holdings
- Lenders can get higher interest rates than other savings accounts
- Crypto lenders are not insured by the Federal Deposit Insurance Corporation (FDIC), so lenders are at a higher risk of losing their money
- Borrowers can be required to have a loan-to-value (LTV) ratio of up to 50%
- Liquidity issues can make it difficult to sell the borrower’s collateral quickly enough to cover the principal, meaning both the lender and the borrower lose money
- If you are using a stablecoin, the value of your collateral depends on the US dollar (USD) value of the cryptocurrency you are using
Is crypto collateral good for bad credit?
One of the reasons crypto lending is popular is that it doesn’t require a credit check like more traditional forms of financing like a personal loan or business loan. This means that borrowers who have a less than stellar credit score can borrow through crypto lending. This can be especially tempting for entrepreneurs looking for start-up loans for small businesses because they don’t yet have a business history or credit rating.
But even in the realm of crypto lending, poor credit can make borrowers more likely to fall prey to high interest rates and short-term repayment agreements. It’s a good idea to learn how to build business credit and improve it over time, especially if you’re interested in small business loans. You can also consider business credit cards to help pay for business expenses and build credit over time.
The risks of crypto lending
Crypto lending carries a range of risks.
- Volatility – Cryptocurrencies are known to have huge price increases and decreases depending on the whims of the market. Due to this volatility, they are considered less stable than other currencies, which can complicate your loan.
- Counterparty credit risk for lenders – There is a chance in any loan scenario that the borrower will default on the loan and not be able to make their final payments, but it is particularly high with crypto-loan.
- Platform Insolvency – Due to the volatility we mentioned above, cryptocurrency platforms can fail at higher rates than FDIC-insured banks and traditional lenders. It is unlikely that the lender or borrower will be able to recover their money if a platform goes bankrupt either.
- Security Issues and Cyberattacks — Because cryptocurrency is run entirely through digital means, it is a prime target for hackers. The most popular currencies, such as Bitcoin and Ethereum (ETH), are often exposed to the risk of cybersecurity attacks from the outside. Additionally, newer cryptocurrencies may not have such strong security features for your digital assets, putting you at risk.
- Technology Failures with Smart Contracts — New technologies often have many problems to solve, and smart contracts are susceptible to coding errors if implemented in a rush or unregulated. This can lead to errors similar to bank errors, such as too much money being placed in or withdrawn from your account.
- Unclear regulations – Laws and regulations regarding crypto lending and cryptocurrency in general are still being written. It’s a bit like the Wild West, and because the legal issues aren’t clear, it can mean you won’t have much recourse if things go wrong.
Best Crypto Lending Platforms
Because crypto credit is new and still in development, it’s hard to say which platforms are proven. However, there are some standards you can use when looking for a good crypto lender, including:
- Good security (like encryption)
- Reduced interest rates and fees for borrowers
- Flexible term rates for loans
- Support for multiple currencies (e.g. for BTC and ETH)
- Low (lower) risk of platform insolvency
- Deposit limits (for lenders)
Here are some cryptolenders that meet these criteria:
As always, check with each lender for lending terms and, in the case of cryptocurrency and crypto lending, read up on the platform to make sure they’re not in hot water.
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