Crypto loan is a type of loan in digital currency without collateral or with collateral. It is issued using centralized exchanges or special loan services. Below we will consider what are the features of crypto lending, how and where to arrange a service, what are the advantages and disadvantages.
Crypto loan is a service of obtaining digital assets by a borrower from a company for a certain fee in the form of collateral or without it. Depending on the platform, the transaction processing mechanism differs, but the principle is identical. Users can borrow money and give cryptocurrencies themselves with interest from passive income. The risk of financial losses in this case is minimal, because the transaction is carried out under the control of CeFi or DeFi platforms.
The history of crypto loans began in 2020 against the backdrop of an economic downturn and the development of a pandemic. As a result, interest rates have fallen and loan disbursements have been shortened. People began to look for alternative ways to receive funds, and one of them was crypto loans. They allowed you to quickly receive money and store it in a crypto wallet.
Most loans in cryptocurrency are issued with a collateral that exceeds the amount received. This is due to the risk of a fall in the price of the cryptocurrency and the financial loss of the lender. The borrower is also at risk, which is especially important when the platform uses the LTV coefficient.
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Why is a crypto loan needed?
Making a loan in cryptocurrency without providing collateral or with collateral is useful in the following cases:
- Increasing the amount on the account for trading digital assets without using margin and selling existing assets. Opens additional opportunities for earning.
- An urgent need for money in a situation where the bearish trend prevails in the market.
- Favorable rates on a loan in cryptocurrency, allowing you to get the right amount.
- These are just some of the situations when applying for a crypto loan is a relevant and reasonable decision. But it is important to take into account the conditions for obtaining a loan, the terms of issuance, the presence of collateral / security and other points.
How does a crypto loan work?
There are three participants in a cryptocurrency loan:
- Issues the requested amount.
- Receives a loan in cryptocurrency.
- This function can be performed by a centralized or decentralized platform.
As a rule, the borrower transfers the collateral, after which he receives the declared amount. There are also options for crypto loans without collateral. In this case, the role of a creditor is taken by a smart contract that issues stablecoins, or a service for issuing money to a client. The site places digital assets in a pool, which then takes over the process management functions.
Making a loan in the form of cryptocurrencies has the following form:
- Determination of the initial terms of the agreement, indicating the amount of loan and the timing of payments.
- The choice by the platform of a lender who is ready to transfer the cryptocurrency on the stated terms.
- Transfer of one of the digital assets that the platform works with to the address of the smart contract as collateral (if it is taken).
- Receiving an equivalent – a part of the amount of collateral in the form of some kind of tokenized BTC.
- Exchange received Bitcoins on the Ethereum blockchain for plain Bitcoins.
- Repayment of debt and return of security.
The scheme is simple and allows you to get money in cryptocurrency faster than it happens in banks. The advantage is that the loan application process is automatic and there are no delays due to the human factor.
Crypto loans without collateral
This group includes crypto loans without collateral. Money is transferred and redeemed within one transaction. If the entire loan amount cannot be repaid with interest, the operation is canceled until confirmation in the block. It turns out that there was no loan, the transaction was not confirmed and did not get into the chain.
The transaction control function falls on the smart contract, and the person does not participate in the process. At the same time, a flash loan should be executed as quickly as possible due to the participation of a smart contract. Any failure to meet the conditions will invalidate the top-level operation.
How it works
Let’s say one of the cryptocurrencies is worth $1 in the 1st liquidity pool and $1.1 in the 2nd one. In the absence of funds for the purchase, it is possible to implement arbitrage using a loan without collateral and buy / sell a token in one block. Let’s give an example when an operation is performed to receive 1000 BUSD on a DeFi platform with instant redemption.
Then there is a division according to the following principle:
- Transfer of credit funds to the wallet.
- Purchase of digital assets for $1,000 from the 1st pool of 1,000 coins.
- Selling coins and getting $1,100.
- Loan repayment with a fee in a flash loan smart contract.
- If any of the conditions is not met, the lender cancels the transaction before confirmation. Such a loan does not carry risks for the borrower, because it does not require collateral. In addition, price arbitrage and swaps are available for such services. But such transactions are carried out only in the blockchain and require fast execution.
Pros and cons of a crypto loan
Getting a crypto loan has a number of advantages:
- No link to credit score.
- Accessibility for people with bad credit history.
- Flexibility of conditions.
- Possibility of registration with or without collateral.
- Management of smart contracts that ensure the security of the transaction.
- The possibility of obtaining passive income (for lenders).
On the background of the advantages, there are a number of disadvantages:
- The risk of falling for scammers (especially relevant in the absence of collateral).
- High interest rate.
- There is a high risk of liquidation when the cryptocurrency exchange rate decreases.
- Vulnerability of smart contracts for hackers.
- Increasing the overall risk of the investment portfolio when applying for a crypto loan.