What Is Crypto Lending? A Beginner’s Guide To Crypto-Backed Loans

In recent years, the use of cryptocurrency has grown exponentially across the globe. Falling from its peak market cap of $3 trillion in 2021, the current crypto market cap sits at $1.05 trillion, according to CoinMarketCap. 

That said, crypto lending is a newer component of the digital finance industry and has piqued the interest of crypto enthusiasts enough for them to use their investments for things like refinancing a mortgage, despite the risks involved.

Let’s take a deeper look at what crypto lending is, the process for getting a crypto-backed loan and some alternative options for borrowers to consider. Please note that our friends at Rocket Mortgage® neither offer nor recommend crypto loans at this time.

What Is Cryptocurrency?

Cryptocurrency is a digital form of currency that uses electronic tokens rather than physical money to make investments. Some common cryptocurrencies include Ethereum (ETC), Bitcoin (BTC) and Tether (USDT). Most cryptocurrency networks use blockchain systems or digital ledgers to track digital transactions for services and goods.

To invest in cryptocurrency, the user has a digital wallet that stores electronic tokens. With a wallet, the user is able to trade and transfer the digital assets through the system using a provided key. The key allows the user to write their transaction in the public ledger. 

What Are Crypto Loans?

A crypto loan, or a crypto-backed loan, is a type of secured loan where your cryptocurrency investments are held as collateral by the lender. Some crypto lenders will finance your loan with Stablecoin, a cryptocurrency that’s pegged to the U.S. dollar (USD). Once you’re approved for the loan, you’ll start making payments toward the full loan amount. In the meantime, your lender will hold onto your crypto assets.

You’ll recover your crypto holdings at the end of the loan term – so long as you make all of your loan payments. If you default on the loan, your lender can keep the cryptocurrency you pledged as collateral. This way, the lender can liquidate and recoup their losses from the failed loan payments.

Types Of Crypto Lending Platforms

The two main types of crypto-backed loans are centralized finance (CeFi) and decentralized finance (DeFi). Let’s take a closer look at how they both work.

• Centralized finance (CeFi): CeFi is a network of lending platforms that allow investors to lend and borrow cryptocurrency through a centralized crypto exchange network. CeFi lending platforms are owned by companies, and these companies have more control over your crypto holdings during the loan repayment period. This does not necessarily make CeFi safer however, noting the 2022 collapse of several CeFi lending platforms.
• Decentralized finance (DeFi): DeFi loans are offered through peer-to-peer (P2P) financial applications based on blockchain technology. Compared to CeFi lending, DeFi lending platforms allow investors to maintain control over their crypto holdings and connect directly with other investors on the platform.

How Does Crypto Lending Work?

Crypto lending uses digital assets as collateral and provides borrowers a loan in exchange for liquidity. This process is similar to using physical assets, like your house, for a mortgage loan. The crypto loan amount is typically a loan-to-value (LTV) ratio of the cryptocurrencies you’re using as collateral. The specific terms of your loan, like the length of your repayment period, can vary by lender.

Like personal loans, crypto loans can be used at the borrower’s discretion. Paying your mortgage with cryptocurrency is a newer concept, and many mortgage lenders have yet to officially adopt it as an acceptable form of payment. However, some have begun to recognize cryptocurrency as a digital asset to determine how much you’re qualified to borrow when you apply for your mortgage.

This may change as mortgage lenders become more comfortable with digital currencies, but due to its extreme volatility, it will take time before it’s fully accepted in the housing market.

How To Take Out A Crypto Loan

To take out a crypto-backed loan, you first have to hold cryptocurrencies. Then, the lender you want to borrow from also has to accept your crypto holdings, so be sure to do your research before applying for the loan.

In addition to researching different lenders, there are other steps involved in getting a crypto loan.

1. Make an account with a lender and start the loan application.
2. Confirm your identity and crypto holdings. A credit check isn’t required in the crypto loan application.
3. Select your ideal loan amount. This involves deciding on the crypto collateral amount and loan repayment period.
4. Submit your crypto loan application and wait to receive your funds.

Pros Of Crypto-Backed Loans

Crypto-backed loans have distinctive features that set them apart from other traditional, secured loans.

Some advantages include:

• Low interest rates: Crypto loans typically have lower interest rates than alternative credit cards and personal loans.
• No credit check: Most crypto lending networks and exchange systems don’t require a credit check when you apply. This can be appealing to those who don’t have a healthy credit score or lack a credit history.
• Fast funding: Once your loan is approved, you may be able to receive funds in as little as a few hours.

Cons Of Crypto-Backed Loans

Although there are benefits to crypto lending, it also comes with serious risks. Here are several disadvantages to be aware of before choosing to apply for a crypto loan.

• No access to your assets: As long as you have a sitting balance in your loan, you’re unable to access your digital holding for any transactions or trading. This can be a problem if you need to pull out cash quickly or if the currency value drops significantly.
• Margin calls: A margin call happens when the value of your cryptocurrency falls below a specified threshold, at which point your lender requires you to increase your holdings to keep your loan. Cryptocurrencies are highly volatile, so there’s a high chance you may experience this with your loan.
• Repayment terms vary: Although these types of loans work similarly to installment loans, the repayment terms may vary. It’s important to understand the terms beforehand to assess whether you’ll be able to make these payments in the allotted time.

Alternatives To Crypto Loans

As crypto loans are still a new concept in the lending industry, here are some alternatives to consider if you need extra cash.

• Personal loan: You can apply for a small personal loan with our sister company, Rocket Loans^SM, or other financial institution. Lenders will likely require you to have a credit check, proof of income and your bank account information. It’s recommended to have a credit score of 620 or above.
• Home equity line of credit (HELOC): With a HELOC, you can borrow money against the equity your home has, or the difference between the market value of your home and any outstanding money you owe on it. You’re able to use this line of credit for a variety of purposes, including education and home improvements.
• Mortgage loan: If you’re looking to purchase a home and have a strong credit history, applying for a mortgage can help you get your dream home.
• Student loans: If you need help paying for higher education, applying for a student loan through a private lender or the federal government is an option. There are different loan programs available, each with different terms and repayment plans. Do your research and discuss with your advisor to evaluate all your options, including financial aid.
• Loan from a friend or family member: If you’re having trouble getting approved for a traditional loan, seeking financial help from a close friend or family member is another option. Be specific about how much money you need to borrow as well as your repayment plan so both parties are informed and understand the terms of the agreement.

The Bottom Line

A crypto loan may be an option for you if you have sufficient crypto holdings and find a lender that accepts your cryptocurrency. That said, be sure to weigh the pros and cons, as well as alternative loan options, before taking out a crypto-backed loan.

If you’re looking for a way to track your digital assets, turn to Rocket Money. The Rocket Money app helps users see all of their investments (including crypto wallets) and monitor monthly costs, so you’ll never miss a payment.  

Ready to get started? Download the Rocket Money app today.