How to Borrow Against Crypto– Decoding Crypto Loans

Intro

Learning how to borrow against crypto can take some time. If you have never used crypto to take out a loan before, or to perform any action other than buying and holding, then there are a few concepts you need to learn before you can make an informed decision. 

In truth, the act of borrowing against crypto is relatively simple, depending on the lending provider you choose, but it can no doubt seem daunting to a complete beginner. The aim of this guide is to unpack some of this process, and shed light on how to borrow against crypto, and how crypto loans can work for you. 

What is a Crypto Loan?

A crypto loan is any type of loan that is related to cryptocurrency. This could mean that cryptocurrency is being used as collateral for a loan, often referred to more directly as a crypto-backed loan, or it could mean a loan that is taken out in fiat (legal tender) so that somebody can use the money to buy a cryptocurrency. 

Related Content: The Ultimate Guide to Crypto Lending 

What is a Crypto-Backed Loan?

A crypto-backed loan is a specific loan where somebody lends you money or stablecoins with your cryptocurrency used as collateral. In other words, your loan is backed by your own crypto assets. This can be Bitcoin, Ethereum, or any number of other coins and tokens on the market. Some places even let you take out loans that are backed by NFTs, which are another type of crypto asset. Although, this is relatively rare in this current era of the industry.

When you get a crypto-backed loan, the funds you are lent can be in the form of cryptocurrency, or in the form of fiat. This all depends on what options the platform you choose has, and what suits your needs best. For example, Ledn allows people to receive USDC in return for their Bitcoin collateral, as well as offers a range of local fiat currencies.

Generally speaking, when people talk about “crypto loans”, they are referring specifically to “crypto-backed loans”. And so, this discussion will follow suit with that terminology.

How do Crypto Loans Work?

Generally, crypto loans work by having you hand over your cryptocurrency as collateral, with you then being lent some funds USin return. The funds you receive could be fiat or crypto (e.g. stablecoins). You will further be given instructions on when you need to pay it back, and what will happen if you miss your payment deadlines. 

In broad strokes, this will be the case whenever you borrow against crypto, although some services will have slightly different rules and protocols. For instance, the time you have to repay, and the interest rates are two big variables to keep in mind when picking a loan.

Centralized and decentralized lending providers will also have big differences in how their loans function. For instance, with a decentralized service, everything will be crypto-based, and there will be no human representatives to either approve your loan or offer much in the form of customer support. The upshot of this is that there are usually zero wait times for your loan to get issued. Centralized services, on the other hand, can work with fiat, and often have more customer support, although their approval times may be slightly longer. The most efficient services can offer a loan in an hour or less, although some providers take days or even weeks.

How Do You Borrow Crypto?

Most crypto loan providers will let you borrow crypto in exchange for your collateral. This is the case even if you are also using crypto as collateral. The vast majority of lending providers will allow this.

How to Borrow Crypto in 5 Steps?

Let’s break this down into five steps, to show you how exactly you can borrow against crypto!

Select a Borrowing Platform

This is both the easiest and hardest step. Choosing the right borrowing platform for your needs can be time-consuming, as it can take a lot of research, however, if you find the right place then the rest of the process will be much simpler. Although, we have explored some of the top providers and summarized them ourselves, to help you on your journey!

Choose your Collateral

Pick which currency you want to provide as collateral. Practically every provider will allow you to borrow against crypto. Your provider will also list which currencies they support. Common cryptocurrencies you’ll see accepted are Bitcoin, Ethereum, USDC, and USDT. That being said, do not take this for granted, as not every service offers them all. Some places might even let you use two different currencies combined as your collateral.

Related content: Crypto Loans without Collateral; How to get a Loan on Ethereum 

Pick How Much You Want to Borrow

The next step when borrowing against crypto is to decide the amount you actually want to borrow. The amount you put up in collateral for your crypto loan will determine how much you are allowed to borrow. This is calculated via LTV, or loan-to-value ratio. Essentially, this is where a lending provider decides what percentage of the amount you have collateralized can be lent to you.

Typically, crypto loans are over-collateralized, which means that the LTV ratio will be lower than the amount you hand over to the lending provider. Let’s illustrate this. Imagine you want to borrow against 1 BTC, meaning you are willing to hand over 1 Bitcoin to the lender. The likelihood is that the lender will agree to lend you less than this amount, such as perhaps 0.5 BTC worth in fiat or stablecoins. This would give you an LTV ratio of 0.5. Some providers show it as a percentage, rather than a ratio. In that case, it would be 50%. Our crypto loan calculator can help you to grasp this in a more practical way.

That being said, this is merely an example; you may be able to find greater LTV rates on the market. However, it’s worth pointing out that a high rate (meaning you are allowed to borrow a lot against your crypto), can indicate risks internally with the lending provider. In an era that has seen many giants of the lending world fall, every good deal should be taken with a bit of skepticism , as some lenders may not be transparent about what they do with your collateral. A sensible ratio and transparency is what you should look for if you want to stay safe financially. 

Not only this, but a higher LTV will also typically incur a higher interest rate. This is the amount you have to pay additionally for the loan, alongside having to buy back your collateral. Usually, a greater ratio will mean more interest is added. 

Connect Your Crypto Wallet

You will need to connect your crypto wallet to the lending provider’s platform. This is because the provider needs access to your funds, so that they can kick off the process of finalizing the loan. For a decentralized project, this takes on a very literal definition, where borrowers will have to use their crypto wallet as a tool for signing into the lender’s network, giving them the ability to use the service.

When it comes to centralized services, this process can be slightly different. Connecting your wallet could mean simply giving the lender your public key, allowing them to see how much you have within your wallet, but not allowing them to do anything else with that funds.

Give the Loan Provider Access to your Collateral

When you are confident that you would like a loan, and you’re happy with the LTV and interest rates, you then hand over your collateral. Once this is approved, the provider will issue your crypto loan. In a decentralized service, this happens all through smart contracts, where you sign over your funds and have the application send it to a special wallet which is used as a place to hold it.

For centralized services like Ledn, you would be provided with a crypto wallet address and a specific amount to send from your own wallet. After you do this, the provider will send you the agreed-upon amount to a wallet of your own or bank account.

Related Content: CeFi vs DeFi - Key Differences Explained

Different Types of Crypto Loans

Let’s take a look at a range of different crypto loans on the market.

Centralized Crypto Loans

These are offered by centralized services, such as Ledn. They are loans that are provided by companies. Some of them, like Ledn, can disperse in crypto and/or fiat. Plus, they can often work with a wider range of cryptocurrencies, as they are not bound to any specific decentralized ecosystem or structure.

Decentralized Crypto Loans

Decentralized loans are those issued by decentralized applications and networks. These are not necessarily companies (although they can be), but rather a system of built of codes and smart contracts that provides a more automated service. They work exclusively with crypto, and often cannot handle Bitcoin, but rather are limited to the coins and tokens that are compatible with their chosen network. For example, AAVE, is a decentralized network that functions on the Ethereum blockchain, meaning that it can only work with Ethereum-based cryptocurrencies.

Margin Lending

Margin lending is where somebody borrows against crypto so that they can use the loaned funds in an upcoming investment. This makes it a specialized trading instrument. Technically, any loan can be used for margin lending, in the sense that they can be used to make an investment, however, usually when somebody refers to this, they are discussing a protocol that has been advertised as such. Oftentimes, margin lending is offered as an integrated feature of an exchange.

Stablecoin Lending

This can refer to either the act of using stablecoins as collateral (meaning you are borrowing against them), or it could refer to the currency you are lent in return for other collateral. Many people enjoy using stablecoins when they work with crypto loans because they are less volatile, and can be pegged to fiat currencies. 

Peer-to-Peer Crypto Loans

This is where two individuals enter into a lending situation, with one being the lender and the other being the borrower. The decentralized nature of cryptocurrency allows for this to occur between two people who have never met before, and never even need to. Smart contracts can be used to lock away funds and ensure that they are sent to the right place. So long as the infrastructure you are using is reliable, this can be a valid way of getting a loan. 

Related content: How Crypto P2P Lending Works 

Crypto-Backed Fiat Loans

This is where you borrow against your crypto in return for fiat. This can only be done via a centralized service, as decentralized projects cannot work with fiat. They are great for people who have cryptocurrency, but do not want to sell it for fear that it will rise in value after doing so, but who also need to pay bills or other essentials.

Pros and Cons of Crypto Loans

Let’s look at the pros and cons of using crypto loans. This will also help us to understand why people borrow crypto.

Pros of Crypto Loans

• More freedom and flexibility, as you can keep your crypto whilst using it as backing for fiat, meaning you do not need to sell it and fear missing out on future gains.  Also, depending on your jurisdiction, there may be tax savings to be had by holding on to your crypto vs. selling it.
• Typically it is easier to receive a crypto loan than a traditional fiat loan, as this industry is more open to those who are unbanked and underbanked.
• Crypto loans typically do not affect your credit score or rating. This is because most services do not perform credit checks, or use credit rating systems as a metric for determining LTV, interest rates, or approvals.

Cons of Crypto Loans

• There have been several big names in the crypto lending space who have collapsed or become insolvent. If you pick the wrong service, you could lose your collateral if the project falls apart. This can be prevented by picking a top company with a proven track record and a transparent and honest ethos.
• Your collateral may rise in value while it is being held by a lender. Some lenders might use this as a reason to make you pay more to get your crypto back, although reputable companies such as Ledn will never do this.

Alternatives to Borrowing Against Your Crypto

Crypto lending is not for everybody, and so it is a good idea to entertain other options. Some people might prefer to simply liquidate their assets and convert them to fiat (if this is a possibility depending on their access to traditional financial instruments). This is a fair and reasonable action, especially if you are not susceptible to FOMO (fear of missing out), and you do not care if your assets rise after you sell them. This can also be less stressful than lending, as there is no worry about having to pay back. Plus, when you sell, you may get 100% of that crypto in the form of fiat, with the exception of transaction fees.

Staking 

Staking is an option for some crypto users, depending on the coins and tokens they hold. This is the act of locking away a portion of your cryptocurrency to the blockchain, and then using that as a means of earning more money over a period of time. You earn money because your staked coins are used to perform various functions, such as validating transactions and securing the network. In return for staking your coins and contributing to the network's operations, you are rewarded with additional assets. However, you cannot do this with every cryptocurrency. For instance, Bitcoin does not support staking, but Ethereum does. It is worth keeping in mind that staking can be a long process, and it does not provide any sort of instantaneous return. It can take months, or even years, before you earn a decent amount. But if you are not in need of money immediately, then it is certainly worth considering.

Related content: The Differences Between Staking & Crypto Lending

Traditional Loans 

Of course, securing a traditional loan is also an option for some. This is where you can use fiat as collateral for fiat, or even use other assets or valuable items as collateral. For instance, it is common to receive a loan and use artwork, antiques, collectibles, and other valuable things as collateral. It can be hard to get a decent appraisal on some items, so if you do this, you should ensure you get somebody who understands how truly value your possessions so that you can get the best deal possible.

Credit Cards

Another traditional option is to simply use credit cards. Although they are not often discussed like this, credit cards are essentially loans in their own right, with their own interest rates and rules applying to them. The one difference is that they are not often collateralized in any conventional way, as you do not give a bank money before they give you money. They get around this by essentially holding your credit score hostage, with the ability to tarnish or decimate it should you fail to pay your money off in a timely manner.

How to Use Ledn for Crypto Loans?

Ledn is one of the leading crypto loan providers on the market. This is a centralized company that works with both crypto and fiat, giving greater flexibility and utility than many of its decentralized counterparts. As a way of proving its worth, and ensuring reasonable communication between itself and its user base, Ledn is committed to being highly transparent when it comes to its finances and its inner-workings. This is something that is typically missing from centralized lenders, which is why their users are often blindsided if they fall into legal trouble or become insolvent.

Related Content: Proof of Reserves in Crypto, Explained

Not only this, but Ledn is the only service that offers B2x loans. This is a specialized service that allows users to seamlessly acquire a Bitcoin-backed loan along with an equally-sized amount of BTC. After the loan is repaid, both the user’s collateral and the freshly bought Bitcoin are handed over to them. This makes it not only a lending tool, but a type of investing instrument; perfect for those who would like to further expand their position in the market.

Conclusion 

Borrowing against crypto is simple to do, although as you can see, there is a lot to consider and contemplate beforehand. While some services have a tendency to overcomplicate the process, Ledn is a streamlined project that works hard to provide a user-friendly and welcoming environment. This helps give users peace of mind, and allows them to get started with a crypto loan in just a few steps. Check out Ledn today and see if it suits your needs as a potential borrower.

Sponsored by 21 Technologies Inc. and its affiliates (“Ledn”). All reviews and opinions expressed are based on my personal views.