Crypto-backed loans are those that are collateralized by crypto assets which means that fiat money (usually US Dollars) are lent in exchange for Bitcoin, Litecoin or Ether as security for payment. The procedure is very simple and the currency is transferred directly into borrowers’ bank accounts or wallets.
These loans are very cost-effective and efficient ways for managing the cryptocurrencies while requiring access to the US Dollar. Some of the uses can be:
- Making investments in real estate (buying a home), though traditional lenders generally discourage this practice.
- Paying off the travel expenses such as going on a vacation, using crypto
- Funding a business activity
- Diversification of investments which can be useful in portfolio diversification
- Paying off a huge debt – Refinancing debt
- Borrowing against crypto assets is not a sale thereby eliminating any tax on the transaction. Investors can borrow USD against cryptocurrency and pay less interest in comparison to the taxes on capital gains.
Though explicit guidance is not available, crypto loans would be comparable to traditional lending in terms of taxation:
- Virtual currencies should be treated as property for the purposes of taxation. However, traditional lending states that property should be treated as a collateral and not be considered saleable. In this regard, borrowing against cryptocurrency would not trigger capital gains taxes.
- Interest payments can be tax deductible depending on the purpose of the loan. If the loan is taken for commercial purposes or purchasing real estate, the interest may be deductible. Loans taken for personal reasons are not considered tax deductible.
Process and Benefits
The two parties (borrowers and lenders) with their respective requirements come together in a transaction where the buyer deposits cryptocurrencies and the lender deposits fiat money. The borrower generally gets a loan up to 70% of the market value at a rate of interest agreed upon by both parties. Upon completion of the duration, the borrower pays the money, inclusive of interest, to the lender and gets back his crypto-collateral in full.
Benefits to the Lender
- The risks are minimized as the complete repayment of funds is ensured for the loans including interest without any delays. The system is largely automated and the exchange happens directly in the bank account making it easier to monitor the use of funds.
- The coverage is extended to an international audience of borrowers thereby making decentralized p2p crypto lending border agnostic.
- Loans can be extended in any available currency.
- The minimum loan amount is around $100 with a cap on the maximum amount being as per the budget of the borrower and the collateral that they can offer.
- Full legal status is granted and the robust infrastructure ensures fund security.
- There are no obstacles in terms of minimum requirements for a party. Any individual or legal entity can become a lender without any licenses.
Benefits to the Borrower
- There are no mandatory requirements to check for the credit history and proof of payment capacity. It can be viewed at as a major credit risk possibility.
- Loans can be easily transferred or withdrawn through a bank transfer or any bank card.
- Flexible lending terms and conditions can be implemented which can be optimized for both the parties.
- The loan collaterals can be in various forms such as Bitcoin, Ethereum, Litecoin etc.
- Crypto assets can be preserved as they are no requirements to sell them upon the requirement of fiat money.
The team responsible for the transaction will review the application and revert back to the customer within one business day with the loan offer, upon being accepted. The offer will consist of the terms and conditions set by the individual or institution, and also on necessary calculations. Some components of the offer are:
- The rate of interest which generally begins with 8%
- An origination fee around 1-2%.
- The APR (Annual Percentage Rate) which is a simple way to show the total price over the course of a year.
- The details of crypto collateral essential for staking a claim on the loan.
Crypto-backed loans are an increasingly sought after service in the cryptocurrency and blockchain domain, as they are issued only to hodlers or people who hold cryptocurrencies. Furthermore, the presence of a centralized authority in the form of a bank of financial fiduciary is negated – this means that elements such as creditworthiness and loan history of the borrower are not taken into consideration as a borrower can only seek a crypto-backed loan if they have cryptocurrencies that can be provided as collateral against the loan. Crypto-backed loans can be looked at as the future of lending if a scenario arises where cryptocurrency and blockchain technology become the norm.
To understand more about Crypto-backed lending, read our Ultimate Guide to Crypto-Backed Loans.
What are your thoughts on seeking out a Crypto-backed Loan? Let us know in the comments below.
Financial Analyst for JP Morgan Chase | Content Writer for eduCBA | Mentor