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Crypto loans: How it works, risks and rewards

Unlock your crypto investment by using it as collateral.

If you’re a crypto investor or merely crypto curious, new products to the market allow you to borrow against your crypto investments to buy property, renovate your home — or, yes, invest in more crypto.

A crypto loan means you won’t have to sell your Bitcoin or Ethereum to take advantage of its value — and because you aren’t buying or selling it, you can avoid capital gains. But crypto’s market volatility could leave you on the hook for pledging more than you own or even defaulting on your loan.

What are crypto loans?

Crypto loans are a form of alternative lending that uses your crypto assets as collateral at typically lower rates and with faster turnarounds than traditional financing. You can find crypto loans starting at 0% APR with Nexo, 1% APR with Celsius and 4.5% APR with BlockFi compared with an average 9% APR for traditional bank loans.

These loans are similar to mortgages and auto loans that require you to pledge your home or car as security against default, except you pledge your cryptocurrency instead. If you aren’t able to repay what you borrow, you’re at risk of losing your pledged crypto investment.

But the value of cryptocurrency is more sensitive to supply and demand than homes or cars. Prices can fluctuate wildly over the course of a day or week, resulting in the value of your pledge dropping lower than what you borrowed against.

That’s where the loan-to-value ratio — or LTV — is important.

How crypto loans work

An LTV expresses the value of the amount you’re borrowing against the value of the collateral you’re using to secure the loan.

Unlike traditional lenders, which determine how much they’re willing to allow you to borrow based on your credit scores or income profile, crypto lending platforms want to see that you own far more crypto assets than you’re looking to borrow.

Many of these alternative lenders offer loans at a maximum 50% LTV for 12-month terms, though outliers like YouHodler advertise up to 90% LTV for popular coins like Bitcoin and Ethereum. A 50% LTV means that for you to borrow $5,000, you’re required to prove that your crypto assets are worth at least $10,000 to secure it against default.

The lower your LTV ratio, the lower your interest rate. And so a loan of $10,000 with cryptocurrency valued at $50,000 — an LTV of 20% — could see a more competitive APR.

Many crypto lending platforms allow loan payouts in either US dollars or a coin it supports — up to 10 or more cryptocurrencies with platforms like Binance, Nexo and Celsius.

How to calculate a loan-to-value ratio

To find the LTV ratio, divide the amount of the loan by the accepted value of the asset.

Graphic explaining LTV.

What happens if the value of my crypto drops?

If the value of your crypto collateral falls significantly below your loan’s LTV, it could trigger what’s called a margin call. A margin call is when the borrower is required to put up additional crypto assets or pay down the loan to maintain the loan’s original LTV.

You receive a notification by email or text that provides a deadline of hours or days to pledge more crypto as collateral. If you fail to add more assets to the platform or your wallet and your LTV continues to increase, the lender will liquidate your collateral.

Each lender has its own guidelines, but most trigger margin calls when the LTV increases to around 65% and liquidation when the LTV reaches around 85%. Carefully read the terms of a loan’s LTV and understand the margin call trigger before agreeing to any contract.

Some providers offer reverse margin calls if your crypto increases in value, returning a part of the locked collateral back to you. For instance, Celsius releases a portion of your crypto collateral if your LTV drops at least 50% of the LTV noted in your contract.

Volatile collateral makes crypto loans risky

Crypto loans are risky compared to other types of secured loans because the value of your collateral can change so quickly. In some cases, you might only have hours to pledge more crypto before your lender sells some or all of your collateral.

Thie most dramatic example of this is the 2018 crypto crash, where Bitcoin dropped 80% in value in a matter of months. This table shows how Bitcoin’s value has fluctuated more recently. Other types of cryptocurrency may be even more volatile.

Staying up to date on the value of your crypto at all times is key to staying on top of margin calls — and keeping your crypto while you’re paying back the loan.

Steps to borrowing against crypto

Many crypto loans function like peer-to-peer loans, relying on an intermediary — in this case, a crypto lending platform:

  1. You sign up with a crypto lending platform, apply for a loan and wait for approval.
  2. You lock in the crypto collateral required to borrow the amount you’re seeking.
  3. The crypto lending platform funds the approved loan amount.
  4. You pay off the loan, and your crypto assets are returned to you.

Unlike traditional loans, you won’t likely repay your crypto loan through monthly payments. Instead, the full balance is due at a specified maturity date.

How to lend out your cryptocurrency

Many lending platforms allow you to stake your cryptocurrency for others to borrow, providing you with interest in return. Depending on how much crypto you own, you can earn a healthy income on your investment without needing to sell it.

As with any loan, you can lose money if a borrower isn’t able to repay it or the value of your crypto drops. And any interest that you earn may be subject to capital gains taxes. Talk with a tax professional before signing any contract to learn more about how crypto lending can affect your tax responsibilities.

Benefits of cryptocurrency loans

Cryptocurrency loans look and act like traditional securities-backed and peer-to-peer loans, but with the benefit of lower APRs, no credit checks and no need to sell your crypto. And you don’t need a traditional savings or checking account to borrow against your assets, which might benefit those who are unbanked or marginally banked.

Low interest rates

You can expect lower interest rates than you’d find with traditional lenders. We’ve seen borrowing rates as low as 1% with platforms like Celsius. The key is keeping your LTV low.

Minimal personal requirements

You aren’t subject to a credit check or even income or employment requirements to borrow against your investment. With most crypto lending platforms, you need only to sign up and prove you have the crypto assets needed to back the loan.

Same-day funding

Most crypto platforms that allow you to buy and sell coins also allow you to borrow against it. Keeping it all to one site makes for nearly instantaneous funding — though it could take up to three business days for funds to make their way to a traditional bank account.

No tax responsibilities

Crypto loans allow you to unlock a portion of the value of your cryptocurrency assets without triggering a taxable event. That’s because you’re using the assets you’ve stored on a crypto lending platform as collateral for the loan, not selling them outright. It’s similar to how a HELOC works: You aren’t buying or selling the home, rather borrowing against the appreciated value of your property.

Because a loan isn’t technically selling or trading, the amount you borrow or pay back is not subject to capital gains. But if you fail to pay it back, your lender may sell off your collateral, which will trigger a taxable event.

What to watch out for

Crypto loans come with risks you won’t find in traditional finance, including a higher risk of default without the protections of the FDIC.

Volatility and margin calls

Unlike other secured loans, the value of your collateral — in this case, your cryptocurrency — is at risk of market fluctuations that can result in steep price drops. If they cause your LTV to rise above your platform’s set threshold, you may be required to put up more crypto until it stabilizes to the original LTV. If you can’t, you risk defaulting on your loan and your lender selling off your crypto.

No FDIC insurance

Unlike a savings account from your local bank, money in your platform or loan account is not insured against exchange failure. If you lose money to a security breach — or if the platform you’re using collapses — there’s no way to recoup your losses.

No access to your assets

Once you tie up your crypto as collateral, you no longer have the ability to trade or earn interest on it. You won’t be able to cash out if the value of your crypto raises or drops significantly. But check with your lender — you may be able to pay off your loan early if you need to quickly cash out.

Loan terms vary greatly

Crypto loans come with short repayment terms, similar to payday and installment loans. The most common term is 12 months, although Celcius offers terms of up to three years. And because the minimum loan amount typically starts at $10,000, you’ll have a small window to make monthly payments — or one lump sum payment due at the end of your loan term.

Not all crypto qualifies

Although larger platforms like Binance accept a wide range of crypto assets, not all cryptocurrency can be used for a loan. BlockFi, a big name in the industry, accepts only three types of cryptocurrency: Bitcoin, Ether and Litecoin.

Not available in all states

New York and a handful of other states have enacted regulations that restrict who can trade and lend cryptocurrency. Cryptocurrency legislation is pending in thirty-three states and Puerto Rico as of 2021. Make sure the platform you choose is legal in your state before signing up.

Loans may not be in USD

Not all crypto lending platforms pay out what you borrow in fiat currency. If not, it could require you to convert your crypto from one coin to another multiple times and possibly across crypto platforms before you can get US dollars.

Once your crypto has been converted to USD, it could take a few days for your bank to process and deposit your loan.

Alternatives to crypto loans

Crypto loans are technically the alternative to traditional lending. So if you don’t have enough invested in crypto to make up for the LTV ratios set by lenders, you can turn to other options instead:

  • Personal loans are a safe way to borrow for an expense or to consolidate debt, with amounts of $1,000 to $50,000 — and up to $100,000 with digital lenders like SoFi or Lightstream. You can’t take out a personal loan to buy crypto, however. This is because cryptocurrency is considered a speculative investment, like stocks, mutual funds and bonds.
  • Credit cards can be a good choice for small expenses or more regular spending. A card with a 0% APR introductory period can help you save on interest for up to a year.
  • HELOCs and home equity loans can help you borrow against the equity you’ve built in your home. Interest rates are often lower than those of personal loans and credit cards, and you can use them to pay off big expenses, like college costs and home renovations.

The APR and terms you qualify for depend on your income and credit score.

Bottom line

If you already own cryptocurrency, a crypto loan could be a way for you to unlock its value without having to sell it, helping you to avoid capital gains. But a volatile market and high risk mean you should carefully consider other options if you don’t have the money to lose.

Learn more about loans, credit cards, trading accounts and other products designed to help you to tap into your crypto assets in our guide to crypto banking.

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