What are Bitcoin Loans? And How Do They Work?

Bitcoin-backed loans are an extremely useful element of the financial world. They are a fantastic tool for giving people more economic mobility, by allowing them to access fiat and stablecoins without directly selling their BTC. For people who are highly-focused on holding their assets, and feel a sense of FOMO if they let go of them, Bitcoin-backed loans are the perfect tool for leveraging their holdings without the need to liquidate their assets.

Let’s take a look at how exactly Bitcoin-backed loans work, and whether they suit your needs.

What is a Bitcoin Loan?

A Bitcoin-backed loan is a loan where you receive an asset (usually fiat) in exchange for placing your BTC in collateral. A Bitcoin loan could also refer to a loan somebody takes out in order to buy more bitcoin, also using your BTC as collateral (such as Ledn’s B2X loan product). 

How Do The Different Types of Bitcoin Loans Work?

There are various types of Bitcoin-backed loans on the market, all with their own distinct quirks and differences.

Collateralized Bitcoin Loans

This is the most common form of Bitcoin-backed loan, where you place your BTC in collateral, and then receive another asset back. Typically, what you receive will be worth somewhat less than the Bitcoin you hand over, meaning it is an overcollateralized loan. Although, it is possible for the opposite to happen, and for you to receive more than your Bitcoin’s worth, meaning it is undercollateralized. However, this is extremely rare to come by.

Uncollateralized Bitcoin Loans

This is slightly different from a typical Bitcoin-backed loan. Instead of handing over your BTC as collateral to access another loaned asset (typically fiat), an uncollateralized Bitcoin loan would involve you borrowing an asset without handing anything over for the period. In this case, you would likely be borrowing Bitcoin, rather than borrowing another asset and using Bitcoin as collateral. These are hard to come by, but not impossible. Although, to receive an uncollateralized loan, the provider would likely check various factors, such as your credit score, your financial history, or other forms of data that could indicate trustworthiness. They are risky for lenders, and so they tend to take strong precautions before giving something like this.

DeFi (Decentralized Finance) Bitcoin Loans

A DeFi Bitcoin loan is where you use your BTC to borrow funds from an automated and blockchain-based network. Since Bitcoin is not currently compatible with most DeFi services, you will likely have to use a wrapped version of Bitcoin– a type of cryptoasset that is designed to match the price of BTC, but which functions on other blockchains. A common form of this is WBTC, which is a cryptocurrency that mimics Bitcoin’s price, but can be used in Ethereum-based DeFi projects.

Advantages of Bitcoin Loans

Let’s take a look at the advantages of Bitcoin loans, to help explain why some people seek them out.

No Credit Checks and Quick Disbursements 

In many circumstances, it can be easier to obtain a Bitcoin loan than a fiat loan. This is because some companies, such as Ledn, have a simple and streamlined approval process. People can apply to borrow fiat by collateralizing their BTC and be approved in the span of just 24 hours. Loan disbursements can happen as quickly as 72 hours after a loan application is submitted.

This is extremely speedy, and better yet, it is less invasive than many fiat loan services, as no credit checks are made. This is great as it allows for more social and financial mobility, especially for individuals who are underbanked, or who have been unable to develop a satisfactory credit score in their lives.

Get Fiat Liquidity Without Selling Your BTC

Many Bitcoin owners struggle with the idea of selling their assets for fear they will miss out on future potential gains. Bitcoin loans help alleviate this problem by giving people access to fiat without them actually selling their BTC for it. Instead, they simply collateralize it so they can borrow fiat. It is the perfect solution for those who need access to legal tender quickly, as a means of solving cashflow issues, but who are uncomfortable with losing their position on the markets.

As the Price of Your BTC Increases, Your LTV Decreases

One of the key features of Bitcoin is the price volatility. As the price appreciates, the loan-to-value (LTV) ratio on your loans decreases.  This means that, depending on the platform you use, you may be able to use the price appreciation to lower your outstanding loan balance.

Read more about: Ledn Loan Rebalancing

Risks of Bitcoin Loans

Like all forms of financial activity, Bitcoin loans come with some inherent risks. These are three of the biggest issues that can arise.

Risk of Platform Insolvency

There have been several casualties in the crypto lending sector, with some prominent companies facing insolvency or even bankruptcy. In particular, the collapse of the BlockFi and Celsius Network led to a level of cynicism and worry in the industry. The best way to avoid this is to research your potential lending provider, and ensure they employ strong risk management protocols, act with transparency, and have a good track record for legitimacy and trustworthiness. This is why many people choose to work with Ledn, as they have proven their competency over an extended period of time, and are known to be extremely careful and attentive in all their activities.

Inability to Pay Your Loan

While Bitcoin loans are great for accessing fiat without selling your assets, you need to be mindful about paying your loan back. If you want your collateral returned to you, then you must be prepared to pay back the principal with interest when the loan expires (usually 12 months after loan approval). It is a good idea to plan for this, and assess your current financial position before trying to obtain a loan.

Market Crashes

The Bitcoin market is highly temperamental, and extremely prone to sharp rises and falls. This means your BTC could drop significantly in value during the loan period and your loan could be liquidated if the LTV rises above 80-90%. Of course, this risk also exists even if you do not obtain a loan, as it is an unavoidable element of being involved in the crypto market. Nonetheless, you should keep this in mind. 

Eligibility Requirements for Bitcoin Loans

Different lending providers will have different rules for eligibility. Some may perform credit checks, require a certain amount of collateral, ask personal information, or seek knowledge about your history of financial activity.

When it comes to Ledn, you can access a Bitcoin-backed loan by collateralizing a minimum of $1000 worth of BTC. You will need to provide information about yourself, for KYC (know-your-customer) purposes, so that they know you are a real person. You will also need to be located within a country that Ledn operates within. Their loans are accessible throughout the world, although there are some countries which are restricted. Afterwards, you will find out whether you have been approved within 24 hours. 

As you can see, this is a relatively low barrier for entry, which is why Ledn is a top choice for many people. Their loans are highly accessible, and with no credit checks being made, they are especially appealing to people who may not have any credit history, or who have struggled to maintain a good score (which, in many cases is no fault of the individual, but rather a reflection on the restrictive and complex nature of credit scores in general).

Bitcoin Loans vs Traditional Loans 

The primary difference between Bitcoin loans and traditional loans is that they are typically easier to obtain. The process is usually more streamlined, especially in the case of Ledn, and approval times can be faster in some circumstances.

Another major difference is that Bitcoin is much more volatile than any fiat you would use for a traditional loan. The value of your collateral for a BTC loan is likely to rise or fall in a much sharper way than with assets like USD, EUR, GBP, etc. This could affect your loan terms, although it depends on the provider you choose.

Why Should You Use Ledn For a Bitcoin-backed Loan?

Ledn is favored by BTC fans for a myriad of reasons. Ledn’s loans are typically approved in 24 hours, with a loan-to-value ratio of 50% (meaning you can borrow half the worth of your collateral), and the company itself is highly transparent, posting its proof-of-reserve data and open-book reports.

Another huge benefit of Ledn’s loans is that, if your BTC rises in value whilst it is collateralized, then this will have no effect on what you repay– whatever your agreement is with Ledn for repayment stays, meaning any gain in collateral is yours to keep. This is a huge relief to those who choose to access a loan because they are worried about losing their position in the market.

Conclusion

Bitcoin-backed loans are an important part of the crypto ecosystem– they allow people to access fiat and/or stablecoins in a smooth and efficient way, overall giving people more financial freedom and flexibility. They are also a fantastic instrument for giving people more autonomy over their money, by providing an efficient method of solving cashflow issues. For those who are typically unable to obtain traditional loans, due to their banking history, credit score, or financial complications related to their country, Bitcoin-backed loans are also great at empowering individuals and communities by offering a bridge to financial inclusion where traditional providers may be unavailable.

Disclaimer: This article is sponsored by 21 Technologies Inc. and/or its subsidiaries (“Ledn”) and is for general information, discussion, or educational purposes only and is not to be construed or relied upon as constituting legal, financial, investment, accounting, tax, estate-planning, or other professional advice or recommendation. Please read Ledn’s full Risk Disclosure Statement and Disclaimers.