Crypto loans unlock cash, but they come with risks
L.z. For example, a house, car, or other investment, your cryptocurrency can serve as collateral for crypto loans, which are low-interest loans, same-day financing and no credit checks.
The disadvantage? If the value of your crypto goes down, you may need to mortgage more crypto.
“That will be the main disadvantage of crypto,” says Travis Gatzemeier, certified financial planner and founder of Kinetix Financial Planning near Dallas. “It’s not a normal, stable asset that you use to borrow.”
Despite the risks, cryptocurrencies – and loans on the other hand – have become popular topics on public forums like Reddit and YouTube. But is a crypto loan right for you?
What is cryptocurrency?
Cryptocurrency entered the financial dialogue in 2008 with a whitepaper by an anonymous programmer on the concept of Bitcoin.
Bitcoin is a Cryptocurrency, or a digital form of money. It may seem complex – and depending on how you use it, it can be – but they are essentially digital tokens as opposed to physical money. It can be exchanged for goods and services on the blockchain, a digital ledger that tracks every bitcoin transaction.
“The idea is supposed to be pretty simple,” says Ariel Zetlin-Jones, associate professor of economics at Carnegie Mellon University in Pittsburgh.
Throughout history, we have accepted physical tokens in exchange for goods and services, believing that in the future we will be able to exchange these tokens as money for other goods and services. Blockchain and Bitcoin allow the same type of transactions, but without physical tokens, says Zetlin-Jones.
What is a crypto loan?
A crypto loan is a type of secured loan, similar to one Car loanwhere you pledge an asset to secure funding.
In this case, cryptocurrency is the asset that is offered to a lender in exchange for cash that you repay in installments. If you fail to repay the loan, the lender will liquidate or withdraw the cryptocurrency.
Crypto lenders like BlockFi, Celsius, and Unchained Capital have relatively low annual interest rates and one to three year loan terms, but high minimum loan amounts.
For example, BlockFi’s crypto loans start at 4.5% APR on one-year loans, but the minimum loan amount is $ 10,000.
Why borrow for crypto?
A crypto loan can be useful if someone owns a significant amount of crypto and wants to liquidate it without having to sell it and potentially pay tax, says Gatzemeier.
These funds could then be used to purchase or invest in a business, much like borrowing from one private loan.
Additionally, borrowers could get lower interest rates with a crypto-backed loan. And unlike personal loans, there is no credit check.
The problem of crypto loans
From April 2021 to October 2021, the price of Bitcoin fluctuated between around $ 30,000 and $ 64,000.
The fluctuating value of crypto can result in a margin call that requires the borrower to raise more crypto to get the value of the original pledge.
If the value of your pledged crypto drops below a threshold set by the lender, you have a limited amount of time to pledge additional crypto.
In crypto parlance, the ratio of the loan amount to the value of your collateral is known as loan-to-value, or LTV. For example, the maximum LTV for crypto lender BlockFi is 70%. At this point, borrowers have 72 hours to increase the crypto.
In addition to the unstable pricing, crypto loans are also not insured nationwide, says Gatzemeier. For example, if you lose your money in a security breach, compensation is not guaranteed.
Alternatives to borrowing against your crypto
If you have equity in your home: With a Home Equity Line of Credit, you can potentially borrow up to 85% of the value of your home. Be careful though, as you can lose your home if you don’t repay it.
If you are looking for a lower interest rate: A credit card with 0% interest offers free financing for 14 to 18 months. Note, however, that after the introductory phase, you may end up paying a high interest rate on unpaid balances.
If you have bad credit: Credit unions usually have flexible rates and terms. They also take into account your history as a member, which means they may have softer requirements.
If you need a small loan: A small personal loan – under $ 2,000 – is also a viable option. However, prices can be high depending on your credit profile and income.
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Chanell Alexander writes for NerdWallet. Email: [email protected]
The article Crypto Loans Unlock Cash, but They Carry Risks originally appeared on NerdWallet.
The views and opinions expressed are those of the author and do not necessarily reflect those of Nasdaq, Inc.