Ever since it launched in 2009, Bitcoin has challenged many of our assumptions about finance. Learning how to invest in Bitcoin, for example, can feel very different from other types of investments. But in plenty of ways, Bitcoin and other cryptocurrencies still work like many other financial assets, and that means that you can borrow against your Bitcoin holdings.
What Is a Bitcoin Loan?
With a Bitcoin loan, a borrower typically offers up their bitcoins as collateral, and the lender holds the collateral, gives them cash, and charges interest.
There are many online platforms that allow a borrower to take out loans against the bitcoins they own. CoinLoan and Cred are two of these platforms, and new competitors continue to sprout up regularly. Some of these loan platforms work by connecting Bitcoin-investing borrowers with cash lenders—known as decentralized financing, or DeFi—while others offer the loans directly to Bitcoin investors.
That means an individual can either be a cryptocurrency borrower or lender. It’s possible for investors to use lending platforms to lend money to Bitcoin investors, hold their bitcoin as collateral, and create an income stream from the interest payments of the borrowers.
Reasons to Take Out a Bitcoin Loan
Bitcoin loans offer both speed and flexibility, in addition to cash liquidity—all of which may be attractive to some Bitcoin investors.
In recent years, Bitcoin and many other cryptocurrencies have delivered profound returns for individuals investing in cryptocurrency. Long-term investors may be reluctant to liquidate their cryptocurrency digital assets while at the same time needing money for short-term needs, like a business or medical emergency, or an investment opportunity. That’s where a Bitcoin loan can make sense for some people.
For borrowers, Bitcoin loans have a few major advantages over traditional loans:
1. Quick turnaround time. An investor can get the money very quickly, once you’re verified on a platform.
2. The loan comes with no strings. As opposed to the home-, auto- or business-loan process, a Bitcoin lender has no interest in what you use the money for.
3. Credit scores don’t matter. But a “trust score” does. Borrowers are asked to present documentation that will increase that score, including but not limited to: government-issued ID; address verification, such as a gas or electric bill; email verification; verification of online financial accounts, such as PayPal; credit card verification. Some borrowers can also improve their trust score with their social media presence. The more of a social media profile an individual has, the more it proves they are a real person.
Reasons Not to Take Out a Bitcoin Loan
The volatility of Bitcoin and other cryptocurrencies means that the amount of the digital currency that you have to put up as collateral may be many times the amount of actual cash you receive in the loan. That, in effect, multiplies the amount you stand to lose if you should default on the loan.
As a borrower, the risks also include the wild fluctuations in the value of Bitcoin or other cryptocurrency used as collateral. If the value of the collateral goes down, some lenders can make a “margin call” in which they ask for more collateral, to return it to the original ratio of the loan. While a borrower will get that bitcoin back upon repaying the loan, that situation can come with financial penalties if they don’t have the bitcoin to meet it.
Additionally, there’s some evidence that Bitcoin loans tend to default frequently, which makes them both more expensive for borrowers, and riskier for lenders. (Since Bitcoin lending isn’t regulated in the same way as ordinary loans, there is little recourse if an overseas borrower defaults.) The interest rates that crypto lending platforms charge to borrow against bitcoin can be much higher than the average mortgage, and in some cases quite close to double-digit interest rates charged by credit cards.
Typically, borrowers also have to pay the lending platform a commission, along with other fees. It can be helpful to look closely at the interest rates and the fees, and think carefully about one’s own expectations for Bitcoin over the term of the loan, before proceeding.
How to Get a Bitcoin Loan
While a borrower’s first impulse may be to borrow against their bitcoins at the lowest available rate, there are other factors to keep in mind. For example, it is important to check if a given platform is reliable. Nexo , for example, boasts military-grade security, which has earned them a reputation for safety and professionalism.
Steps to Getting a Bitcoin Loan
1. Select a platform.
2. Create an account. Borrowers will need to verify both the cryptocurrency collateral they’re offering, as well as their identity (“trust score”).
3. Select a loan type. Platforms may have options: Sometimes, if a borrower agrees to a higher interest rate, they won’t have to put up as much bitcoin as collateral. In some situations, a lender can choose how much they want to lend, and set the interest rate themselves.
4. Receive and accept loan offers. This can take just a few hours after submitting an application. Once a borrower accepts the terms of the loan, they’ll receive the money.
As new as Bitcoin and other cryptocurrencies are, Bitcoin lending is even newer. And while it creates a new set of possibilities for quick liquidity, it also comes with its own set of possible pitfalls for Bitcoin investors.
These loans come with costs and risks—and only an individual borrower can determine if it’s worth it to take a loan against their Bitcoin holdings. A lot can go into that decision, including carefully researching possible lending platforms, and reading the fine print of a loan offer before accepting one.
For investors wondering about how bitcoin works, it can be helpful not only to do research, but to consult an expert. After all, there are many things to know before investing in any cryptocurrency. It’s a new and complex area of the capital markets.
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