Borrowing money against your investments is a great way to access your wealth without selling your assets, as well as deferring capital gains taxes. Many wealthy investors have used portfolio loans to access cash in taxable brokerage accounts without needing to sell any of their investments.
Now, cryptocurrency exchanges are starting to offer the same service for investors. Crypto lending platforms allow users to deposit cryptocurrency and borrow against the value of those assets. Funding is typically very fast, and users can borrow fiat currency (such as U.S. dollars) or stablecoins.
Although crypto lending is becoming a popular option for long-term investors, it is important to understand how it works, what advantages it provides, and the risks involved.
What Is Crypto Lending?
Crypto lending is a type of secured loan, with crypto assets like Bitcoin or Ethereum being used as collateral to borrow crypto- or fiat currency, such as U.S. dollars. Crypto lending is provided by some crypto exchanges, as well as decentralized applications that use smart contracts to automatically lend crypto to users.
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To borrow funds, users can join a crypto lending platform or exchange, deposit whatever cryptocurrency they wish to pledge as collateral, and then choose from the loan terms that are available. Crypto loans are designed to allow investors to keep their crypto assets while borrowing a portion of their value to use for other investments or simply to access cash.
Crypto loans charge interest on borrowed funds, with interest rates generally higher as the loan-to-value (LTV) rises. For example, taking out a loan for 25% of the value of your pledged crypto may carry a much lower interest rate than taking out a loan that is 50% of your asset value.
Crypto loans come with risks, including the risk of a margin call or liquidation of your collateral. If the value of your pledged assets drop below a certain threshold, the crypto lending platform may issue a margin call, or even liquidate a portion (or all) of your collateral to satisfy the loan.
Because cryptocurrencies are highly volatile investments, borrowing a higher LTV increases your risk of margin calls.
How Crypto Lending Works
To sign up for a crypto-backed loan, you will need to sign up for a crypto lending platform or connect your digital wallet to a decentralized crypto lending application. You are required to deposit a supported cryptocurrency, such as Bitcoin, which will act as the collateral for your loan.
Once you deposit the funds, you can borrow up to a certain percentage of your digital asset value. Most lending platforms allow you to borrow up to 50% of the currency value of your pledged collateral, with some allowing you to borrow more.
The loan is typically paid out in fiat currency like U.S. dollars or in stablecoins, such as Tether (USDT). You can then choose your loan term length, with longer terms typically available for lower LTV loans.
Crypto lenders charge interest on your loan, and repayment terms typically require a monthly payment, similar to a mortgage or auto loan. If the value of your collateral drops too significantly during the repayment period, you may get a margin call to deposit more collateral, or the lender may liquidate a portion of your collateral to satisfy the loan obligation.
Overall, crypto loans offer a quick way to access cash or stable crypto assets without the need to sell your original collateral.
Pros & Cons of Cryptocurrency Lending
Although crypto loans have become a popular way to “cash out” your crypto without having to sell it, there are also some risks involved. The volatile nature of cryptocurrency may put your collateral at risk, and loans may also charge high rates depending on the loan terms. Here are a few factors to consider when looking to use a crypto lending platform:
Pros of Cryptocurrency Lending
Crypto lending can be a great way to protect your investments while saving on taxes. There are other advantages as well. Here are a few great advantages of crypto loans:
- You Don’t Have to Sell Investments. Crypto loans allow investors to deposit a valued cryptocurrency, such as Ethereum or Bitcoin, and borrow against its value. This helps long-term investors hold onto the original investment while accessing a portion of the value to use however they wish.
- No Capital Gains Taxes. Similar to investment portfolio loans, investors who use cryptocurrency loans do not have to sell their collateral, and thus can avoid paying any capital gains taxes on their digital assets.
- Fast Funding. Crypto loans are typically approved quickly, and funding can even be received the same day. When using a decentralized lending app, funding is instantaneous.
- Reasonable Interest Rates. When comparing some lending platforms to personal loan rates, crypto loans offer decent interest rates, with some platforms offering very low interest rates (under 2% APR) to borrowers.
- No Credit Check. Borrowers on crypto lending platforms do not have to pass a credit check to apply for a loan, which helps speed up approval and avoids any hit to your credit score.
Cons of of Cryptocurrency Lending
Although holding onto your crypto investment may be a good long-term investment, crypto loans come with a few risks. Here are some of the downsides of using crypto lending:
- Risk of a Margin Call and Liquidation. With the volatility of some cryptocurrency assets, the risk of your collateral losing value and receiving a margin call is high. If you borrow against a high percentage of your cryptocurrency, the risk increases, and you may be forced to deposit more funds or even sell your crypto while the price is down.
- No Insurance on Deposits. Unlike investment or bank accounts, deposited crypto funds are not insured, which means if the lending platform fails, your funds may be lost.
- Limited Crypto Eligible for Loans. Although popular cryptocurrencies like Bitcoin and Etheruem are typically available to be pledged on crypto lending platforms, not all crypto can be used. Some platforms only support a handful of select crypto, which means you may be required to exchange your crypto for an eligible asset to participate, which is not ideal.
- High Interest Rates on Some Platforms. Some crypto lending platforms charge very high interest rates, occasionally charging 10% APR or more. These rates are much higher than most lending products and may be cost prohibitive to borrowers.
How to Borrow & Lend Cryptocurrency
To borrow cryptocurrency, you can sign up for a crypto lending platform, deposit your collateral, and select your loan terms. Once you apply, approval happens fairly quickly, and funding is paid out in fiat currency or crypto stablecoins.
Loan repayment is typically on a monthly schedule, and repayment term lengths can range from a few weeks to five years or more. Payments can be made in the same currency that was borrowed, but some lending platforms allow you to pay back the loan with other currencies or cryptocurrency.
Crypto lending platforms typically allow you to earn interest on deposited funds that are not pledged for collateral on a loan. Users can deposit from a selection of eligible crypto and begin earning interest right away. The interest rate depends on the crypto deposited, with stablecoins typically paying the highest rates, sometimes over 10% APY.
When you deposit funds onto a crypto lending platform to earn interest, the platform lends out your cryptocurrency to borrowers, much like a bank handles cash deposits. You still have access to your funds, and most platforms allow you to withdraw your crypto at any time.
Crypto Lending FAQs
Crypto lending platforms offer a great way for crypto investors to borrow against their holdings, saving on taxes and paying a reasonable interest rate on the loan. But is crypto lending right for you? Here are a few of the most common questions about crypto lending:
What Are the Best Crypto Lending Platforms?
The top crypto lending platforms available today offer a relatively wide selection of crypto, low interest rates on loan, and longer loan term lengths. Companies like Celsius allow users to easily deposit funds, post collateral, and apply for a crypto loan. Decentralized apps like Aave and Compound allow users to borrow funds immediately, using smart contracts to quickly set loan terms and repayment options.
Crypto lending also allows users to deposit cryptocurrency to earn interest on those funds. Because the platform can loan out user deposits (similar to a bank), it can pay fairly high interest rates, and users can use crypto lending as a source of passive income.
What Are the Interest Rates on Crypto Loans?
The interest rates on crypto loans vary by the type of collateral pledged, loan terms, and platform being used. Celsius, for example, allows users to borrow up to 25% of their collateral for a 1% APR, which is far lower than most personal loans. But users who want to borrow 50% of their crypto asset value will pay a much higher 8.95% APR.
Is Crypto Lending Safe?
While crypto lending is typically a safe financial instrument, there is no FDIC or SIPC insurance on cryptocurrencies. If the lending platform fails, you may lose access to all your deposited funds. That being said, most crypto lending platforms employ bank-grade security and data encryption, as well as crypto storage and encryption on all funds. Loans are over-collateralized, meaning users cannot typically borrow the total value of their deposited assets, ensuring you should never lose more than what is deposited for the loan.
What Happens if You Default on a Crypto Loan?
If you default on your crypto loan, most lenders will charge additional fees until you repay the loan. If you do not repay the loan, the crypto lender has access to your pledged collateral and will liquidate your position to satisfy the loan, refund any collateral that is left after paying off the balance of your loan.
What Are Some Alternatives to Crypto Loans?
Although crypto loans are an attractive solution to long-term investors who want to hold onto their crypto assets, they do carry their fair share of risks.
As an alternative to crypto loans, investors may want to explore traditional portfolio loans or lines of credit. Companies like Wealthfront allow users to borrow against their taxable investment accounts; the invested funds are SIPC insured and borrowed funds are in cash, not crypto.
Another alternative to crypto loans is a home equity line of credit (HELOC). These loans allow you to borrow against the value of your home and typically offer low interest rates and long repayment periods.
Borrowing against your assets is a great way to access cash and save on taxes, but always weigh the risks with the rewards of collateralized loans.
Final Word
Crypto lending continues to rise in popularity, with platforms such as Celsius boasting over $19 billion in pledged assets, and over $800 million in interest rewards paid out on crypto deposits. These loans help users hang on to their long-term crypto investments while offering a safe way to access a portion of their crypto portfolio’s value.
Crypto loans carry some risks, though, and users need to be careful of borrowing too much, potentially putting themselves at risk of a margin call or liquidation of their collateral. With the volatility of the crypto market, cryptocurrency is more likely to suffer large swings in price than most other assets, making crypto loans a risky bet.
Overall, crypto lending companies serve users who want to “hodl” their crypto assets while enjoying some of the value of their assets in the meantime.