Cryptocurrency as Collateral (2021 Guide)

Do you have a wallet full of crypto you’re not using? Then no matter how much you believe in cryptocurrency’s potential, you still might be missing out.

When you put fiat money in a bank, you’ll earn interest. That’s because the bank lends your money out to other people and shares the interest payments.

A cryptocurrency investment that sits in a wallet, however, rarely does anything for its owners. You might earn more over the short run just cashing it out and putting fiat in the bank.

Cryptocurrency as collateral, however, is changing all that.

Do you want to try new kinds of cryptocurrency trading without losing your existing tokens? Do you need to finance an upcoming crypto purchase? Collateralizing your crypto for a loan might be a good option to explore.

Read on to learn more about how cryptocurrency loans and using crypto assets as collateral.

Collatoralizing Your Crypto: The Broad Strokes

Collateral is something of value that a borrower promises to a lender if they default on their loan. This setup benefits everyone.

Lenders get security from the collateral and revenue from interest payments. Borrowers gain access to more capital without losing their existing assets. Keeping assets is especially important in the world of crypto, where “HODLers” don’t cash out their tokens until their value has skyrocketed.

Most crypto collateralization has happened in the world of decentralized finance (DeFi), not in traditional banking. Because DeFi relies on peer-to-peer transactions, it doesn’t need a banking intermediary. Cutting out the middleman lowers costs for both lenders and borrowers.

Furthermore, many traditional banks won’t work with cryptocurrency at all.

Using Your Cryptocurrency as Collateral: The Important Details

Do you want to use your cryptocurrency as collateral? Don’t just go with the first crypto-friendly lending platform you can find. Though all the loans you’ll find will likely be labeled “DeFi,” there are still significant differences between lending platforms.

Understanding those differences is crucial to finding a lending platform that works for you. When you’re looking to collateralize your crypto, ask these questions.

How Does the Platform Handle Custody?

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Your collateral needs to be available to your lender in case you default on your loan. That means they’ll want it kept someplace where you won’t be able to snatch it up and runoff. At the same time, you want to be certain your lender will return your collateral if you fulfill the loan’s terms.

This is traditionally where banks and other intermediaries have intervened. A bank can keep the collateral safe while enforcing all terms of the loan. But because you’re probably not using a bank for your crypto loan, you’ll have to take a close look at your platform’s custody setup instead.

Some platforms pool their users’ funds in an online “hot” wallet for quick access. Unfortunately, those hot wallets are very tempting targets for hackers.

That’s why many platforms store large amounts of their crypto in “cold” wallets disconnected from the internet. While cold wallets are safer from hackers, their funds can be destroyed if the wallet is lost or physically damaged.

Insurance and robust security may help alleviate some of these concerns. But if you’re handing your collateral over to a platform’s wallet rather than your lender, however, are you really cutting out the middleman?

If that question bothers you, consider a platform like smartcredit.io.

Collateral goes straight from borrowers to lenders on the smartcredit.io platform, along with a “credit coin” written on the smartcredit.io blockchain. The transferable credit coin uses smart contracts to enforce the loan terms, ensuring that rule-abiding borrowers get their collateral back.

Are Loan Terms and Interest Rates Fixed or Not?

How much interest will you pay for the length of your loan’s life?

If you have a fixed-rate loan, it will be the same amount every month (or whatever other period your lender agrees to). If you have a variable rate, your loan could fluctuate from month to month.

Variable interest rates generally fluctuate in response to market-wide indicators of lending demand. Depending on market conditions and how long you pay the rate, you could wind up paying more or less interest than you expected.

What about your loan’s life itself? How long will it be? Loan lengths can also be either fixed or variable. A fixed-length loan totally resolves after a set period of time. A variable loan can be extended, sometimes indefinitely, if the borrower agrees to ongoing payment conditions.

While the longer length of a variable loan may sound appealing, keep in mind that these loans require a bigger commitment from the lender. They’ll often want to hold more collateral in return.

What Kind of Loan-To-Value (LTV) Ratio Is Available?

What if your collateral’s value shrinks over the lifetime of the loan? You may reach a point where losing the collateral is nowhere near as big a threat as it used to be. And in a nightmare scenario for lenders, you may default—leaving them holding the useless collateral instead of the valuable capital they lent to you.

To avoid this scenario, most lenders will only lend you a percentage of your collateral’s value. Your Loan-To-Value (LTV) Ratio is this percentage.

Collateral requirements can prove a serious obstacle towards getting a loan at all. If only a low LTV ratio is available, you’ll have to lock up many assets to borrow a small amount of capital.

Lenders are more likely to offer less stringent collateral requirements for fixed loans, which protect them from long-term fluctuations in the collateral’s value. Smartcredit.io focuses on fixed-term loans for this exact reason: Borrowers get far more out of their collateral.

Cryptocurrency Trading: Work With a Lender, Not a Middleman

One of the most powerful aspects of DeFi is how many choices it can offer both the lender and the borrower. Freed from a banking middleman’s need for profit, custody, and control, lenders and borrowers can work with each other directly on terms that work best for them.

While not every DeFi platform follows through on this democratic potential, smartcredit.io does. Using your cryptocurrency as collateral on this platform lets you work directly with lenders. Smart contracts, not inefficient banks, enforce loan terms, creating better borrowing and lending options for everyone.

Interested in learning more? Open an account at smartcredit.io today to start learning how to use your cryptocurrency as collateral and put your crypto assets to work.