How do crypto loans work?
Crypto loans allow you to unlock the value held in your crypto, without the need to sell.
Crypto loans are not readily available yet in the UK – but they are elsewhere and may take off here in the future. For the crypto curious, they present an interesting opportunity to borrow against your crypto investments to free up capital for whatever purpose you have in mind.
They allow you to take advantage of the value of your crypto assets without having to sell them. And because you aren’t buying or selling crypto coins, you can theoretically avoid capital gains tax. However, regulatory uncertainty in the UK has meant that crypto loans aren’t available here yet. Plus they carry a high level of risk due to the volatility of the crypto market – meaning you could end up pledging more than you own or even defaulting on your loan.
What are crypto loans and how do they work?
Crypto loans are a form of alternative lending that uses your crypto assets, like Bitcoin or Ethereum, as collateral. Theoretically, they can offer lower rates than you might be offered without collateral plus a fast turnaround.
They work by using your crypto assets as security, similar to mortgages or logbook loans. Instead of pledging your home or car as security against a default, you pledge your cryptocurrency. If you fail to repay what you borrow, you’re at risk of losing your pledged crypto investment.
Much like mortgages, crypto loans work on a loan-to-value – or “LTV” – basis. This is the value of the amount you’re borrowing against the value of the collateral you’re using to secure the loan. The lower your LTV ratio, the lower your interest rate.
The important thing to note is that if the value of your crypto falls significantly below your loan’s LTV, it could trigger what’s called a margin call. This is when you are required to put up additional crypto assets or pay down the loan in order to maintain its original LTV.
If you are unable to do either of these things, then the lender will sell your crypto assets in order to protect itself.
How much can I borrow?
Most crypto lenders offer loans at a maximum of 50% LTV – or up to 50% of the current value of your crypto. However, there are some outlier platforms that advertise up to 90% for popular coins like Bitcoin and Ethereum.
For example, if you took out a 50% LTV crypto loan, you could then potentially borrow £5,000 if you were able to prove that your crypto assets were worth at least £10,000 to secure it against default. Just remember, crypto loans are not currently in the UK just yet.
Do I need good credit?
In more traditional forms of lending, your credit score can have a significant impact on how much you can borrow and the rate you’re offered. But this is not the case when it comes to crypto loans.
Here, your collateral is your credit score. So there is no requirement to prove that you are a responsible borrower as long as you have the required amount of crypto assets.
This is because the platforms can sell your crypto assets if their value drops between the required threshold or you fail to repay what you borrow. This means they won’t be out of pocket if you default, so they do not need to know if you have good credit or not.
What does a crypto loan cost?
The cost of a crypto loan comes in the form of interest. So just like a personal loan, you will pay an interest rate on the amount you borrow.
When you take out a crypto loan, you will be set an APR based on the duration of the loan and what level of collateral you are pledging. Across the pond, interest rates range from as little as 1% all the way up to nearly 15%. Typically, the lower your LTV ratio, the lower your interest rate.
Crypto loan alternatives
Crypto loans are risky compared to other types of financial products 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.
So it is worth keeping in mind other forms of borrowing that don’t rely on the value of your crypto. For example, you could look into the following loan options:
- Unsecured personal loans. You could look to get yourself a personal loan. There is no collateral required, but interest rates will depend on your credit score and income.
- Secured personal loans. With a secured loan, you would need to secure the amount you borrow against something. This is typically your home or another asset like your car.
- 0% purchase credit cards. If you are looking to make a large purchase and want several months to repay the balance, you could look to get a 0% purchases credit card. This would give you a set interest-free period in which to pay down your balance.
Pros and cons of crypto loans
- Lower interest rates than traditional lenders
- No credit check or proof of income requirements
- Same-day funding
- Reduced tax implications as you are not selling your crypto
- The crypto market is extremely volatile
- You stand to lose your crypto collateral if the value drops below your LTV threshold
- No access to your assets while your crypto is tied up as collateral
- Loan terms can vary greatly
- Not all crypto qualifies – Bitcoin, Ethereum and Litecoin are the most common
- Not currently readily available in the UK
Crypto loan scenarios
Let’s take a look at how crypto loans work in reality. As you are putting your crypto assets up as collateral, fluctuations in coins value can trigger different scenarios with your crypto loan.
What happens if the value of my crypto drops?
If the value of your collateral drops, then this can trigger a margin call. When this happens, you will need to put up additional crypto assets or pay down the loan to maintain your LTV.
Here’s how the process works:
You will receive a notification by email or text that will give you a deadline of hours or days to pledge more crypto as collateral.
At this point, you can deposit more into your account to keep your assets.
If for some reason you are unable to add more assets to your account – and your LTV continues to increase – the lender can liquidate your crypto assets.
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%. You may also be charged a liquidation fee by the lender.
It is important to research the terms of a loan’s LTV and understand the margin call trigger before agreeing to any contract.
What happens if the value of my crypto rises?
If the value of your collateral rises while you hold a loan, then you can remove some of your collateral ahead of time. So if your LTV is lower than the initial LTV, you can choose to remove a certain amount at this point.
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 it is important to understand the risks attached to this sort of borrowing.
A volatile market means there is a high risk that you could lose your crypto collateral. If the value of your crypto assets drops, then your lender could liquidise your collateral and you could be left with nothing. And as the cryptocurrency market is unregulated and has no protection schemes in place, there would be no way to recover your crypto assets.
Frequently asked questions
Cryptocurrencies are speculative and investing in them involves significant risks - they're highly volatile, vulnerable to hacking and sensitive to secondary activity. The value of investments can fall as well as rise and you may get back less than you invested. Past performance is no guarantee of future results. This content shouldn't be interpreted as a recommendation to invest. Before you invest, you should get advice and decide whether the potential return outweighs the risks. Finder, or the author, may have holdings in the cryptocurrencies discussed.
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