Nowadays, you can shop with cryptocurrencies in most online merchants. This includes even niche sites like an online casino 日本語: you can buy virtual coins used to play casino games with cryptocurrencies. However, digital currencies can do more than just be used for shopping: if you want, you can get a crypto loan too. This next-generation credit system has both positive and negative aspects, and we will cover all of them in this article.
What is a Crypto Loan?
A crypto loan is basically no different from a traditional bank loan. You borrow money to pay within a certain period of time, and a certain interest is charged on it. You have to pay the installments of your debt on time. However, a very obvious question arises here: what happens if you don’t pay? Let’s give a simple example to explain how the system works.
- User A already owns ETH but needs money for an investment and does not want to exchange his ETH.
- In this scenario, user A can borrow money from user B by showing his ETH as collateral (i.e., in a sense, pawning it).
- When User A finishes paying the installments of his debt, he gets his ETH back. If he fails to do so, ownership of the ETHs passes to user B.
The installments of a crypto loan can be weekly, bi-weekly, monthly, 3-monthly, or 6-monthly. Interest rates vary but are always determined by the loan period. There is no need for the two parties to come together for such a transaction: they can create a smart contract on a blockchain like Ethereum or use a platform set up for crypto loans. For example, Binance, in addition to being an exchange, offers loans to anyone who can show sufficient collateral.
Advantages of Crypto Loans
The most positive aspect of this system is that it does not require any credit history. Even if your credit score is not enough to get a bank loan, you can still get a crypto loan. This greatly increases the number of potential users. For example, freelancers cannot meet loan requirements because they are not recognized within the traditional banking system. Likewise, people whose credit scores drop for any reason are pushed out of the traditional financial system. But crypto loans are for everyone, and your credit history doesn’t matter. Note that your anonymity is still protected in this system: the lender and the borrower don’t even know who each other really is.
For the same reason, the whole process completes very quickly. With traditional bank loans, the background check can take days to complete. With crypto loans, as long as you have enough collateral, you can complete the entire thing in seconds. You also don’t have to pay different types of fees: a bank will continue to charge you for “processing fees” throughout the entire process. Crypto loans do not have any fees.
Finally, let’s mention that interest rates are much lower. For example, BTC loans have a daily interest rate of 0.0400%, which is lower than most banks’ personal loan rates. Moreover, if you pay before the due date, there is no penalty.
Disadvantages of Crypto Loans
All these are advantages of crypto loans, but of course, there are some disadvantages as well. First of all, this system is more like the working principle of pawnshops. In order to get a loan, you must already have as many assets as that loan. What you do is practically no different than pawning your property: if you pay off your debt on time, it’s fine, you get it back, if you don’t, you lose your assets. This means that crypto loans appeal to a very specific user base: people that already own crypto and need money but don’t want to exchange their crypto for some reason – there aren’t many people who fit that description.
Another problem is the risk of liquidation. For example, let’s say you have 1 BTC and you have received a loan of 10 ETH to be paid 6 months later by showing your BTC as collateral. (The numbers are given as an example; they do not represent the actual values.) There is a possibility that the value of 10 ETH will exceed 1 BTC after three months. So suddenly your collateral may not be enough for the loan. In this case, you must either show additional collateral or repay your debt immediately. Otherwise, your initial collateral may be confiscated (before it loses any further value). Considering the volatile nature of cryptocurrencies, this is a very possible risk that can be quite common, and it could spoil all your plans.
Late repayments are another problem: it’s true that interest rates on crypto loans are low, but that’s changing with late repayments. For example, if you got a loan using Binance, you need to pay a fee of 2% of the total loan amount for late repayment. In short, crypto loans are currently not an alternative to traditional bank loans and only appeal to a specific user base. But they have the potential to offer more in the future.