Cryptocurrency trading and crypto-backed loans have been met with tremendous furor in recent years. The total market cap of cryptocurrencies soared from a million dollar industry to a billion dollar industry in merely a few years.
Crypto-traders, especially experts, prefer to follow a buy and hold strategy commonly known as ‘HODL’ in the crypto community. However, what happens when you need liquid cash to meet your requirements but want to stay invested so you don’t risk missing out on future asset appreciation?
How they work
Investors who purchase traditional financial assets and need funds, simply avail loans from banks and use their assets as collateral. Crypto-banks operate in a similar manner. Investors transfer their cryptocurrency, or a part of it, to lenders as collateral. The lenders then provide them with a loan which amounts to a percentage of the value of the cryptocurrency.
This percentage is called Loan-to-value (LTV) and protects lenders in case of a sudden downside movement in the price of the collateralized asset. The lender also charges a fixed rate of interest, as previously agreed upon and has the legal right to sell the assets if the borrower fails to make interest payments. The asset will then be returned to the borrower after the tenure of the loan is completed or once he pays off the entire loan.
The main differences between crypto-backed loans and traditional loans are that the former is carried out digitally and generally requires almost no processing time and documentation. Hence, they serve as a platform to bring together the worlds of cryptocurrency and finance.
The primary concern amongst a potential borrower is the margin call requirements. A margin call comes into play when the value of the collateral drops beyond a certain level. The borrower is then required to deposit an additional cash payment or crypto-assets to secure the loan within a period of 48 to 72 hours.
Failing to do so in a timely manner can result in the lender selling the collateral. In a volatile crypto-market, this can be a huge cause for concern for borrowers as they will be in a position where they will not just lose their assets but also have to make further payments to pay off the loan.
The Problems with Crypto-lending
In the past, crypto-banks have been met with various regulatory issues. Since this is a fairly new and unregulated space, a number of fraudulent websites have been set up primarily with the purpose of scamming investors.
These agencies lure crypto-investors by promising funds but take investors’ assets and disappear. There are no regulatory bodies that govern cryptocurrency, thereby making it hard to identify and prosecute the parties involved in these scams.
However, despite these hurdles, there is a growing demand for crypto-backed loans from all around the world. Almost 80% of crypto-investors that were surveyed provided positive feedback about this system. Furthermore, as trading volumes and the number of investors grows, so will the number of legitimate companies who wish to efficiently conduct business.
Hence, in conclusion, crypto-backed loans are a groundbreaking service in cryptocurrency and can provide investors with the potential to help solve the problem of liquidity and unlock their funds.
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Finance student who has a keen interest in securities markets and new technologies.