The emergence of cryptocurrency has not just occurred to address the issue of centralized finance. Instead, the technology continues to evolve, and its use is rapidly increasing because it offers significant opportunities to earn without needing to trade.
Because trading puts you quickly in a position to profit, you pay greater attention to the buzz surrounding crypto's massive price pumps and the sudden 10x, 100x gains of crypto assets. Even though these price surges do not happen very often, you may not always be able to catch them and profit from the significant price increase.
Surprisingly, simply keeping your crypto assets in your possession and watching them build your portfolio can enhance the value of your crypto assets without trading. Similarly, using your smartphone, you can request a loan from someone you don't know —what they look like, where they reside.
Traditionally, when banks issue loans, they collect your information, do credit checks, demand proof of income, and do a lot of other paperwork to protect themselves from losing money if a borrower defaults on the loan. However, you can get a cryptocurrency loan without paperwork with revolutionary blockchain technology.
What is a Crypto Loan?
Crypto loans are loans obtained by a borrower by collateralizing their crypto holdings. This means a borrower can utilize their existing cryptocurrency portfolio holdings as collateral for a crypto loan. Once the collateral is received, the lending platform makes the loan, which is often in the form of a stablecoin, and the crypto used as collateral is held until the loan is fully repaid.
However, you don't have to be the borrower only. For example, you can earn interest while sleeping by depositing your cryptocurrency in a pool that manages your assets. This means that in exchange for the loans they lend, crypto loans pay interest payments known as 'crypto dividends' to the crypto lenders. As a result, the risk of losing funds is usually low, depending on the trustworthiness of the smart contract you're utilizing.
How Does Crypto Loan Work?
The fundamental premise is similar to a traditional loan: you pledge your crypto assets in exchange for a loan, which you then repay over time. This loan can be obtained through a crypto exchange or a crypto lending platform.
Three parties are involved in a crypto loan; the lender, the borrower, and the lending platform. In a crypto loan transaction, the borrower (first party) and the lender (second party) are two separate parties. A crypto lending platform that works as a third party connects lenders and borrowers. Hence, to secure a loan from a lender, borrowers put up their cryptocurrency as collateral.
To begin, the borrower goes to a lending platform and requests a crypto loan. When the lending platform accepts the borrower's loan request, the borrower will stake some cryptocurrency as collateral. However, they will not have access to or be able to retrieve the staked cryptocurrency until they have repaid the total loan to the platform.
Lenders often fund the loan but are unaware of the loan process. Lenders receive their interest at the stated period agreed with the lending platform. The borrower will receive the collateral crypto at stake after repaying the total loan and the interest incurred.
Every loan platform has restrictions and interest rates, but the method is the same. Usually, a DeFi lending dApp or a cryptocurrency exchange might be used to do this. Also, if the value of your collateral falls below a specific threshold, you must top it up to avoid liquidation.
Smart contracts entirely automate the borrowing and lending procedure using cryptocurrency loans. It's a simple way for many people to earn APY on their crypto assets.
Crypto loans enable you to make income from your digital assets by lending out a portion or all of your holdings.
Types of Crypto Loans
DeFi loans and CeFi loans are the two types of crypto loans. The primary distinction between these two sorts is that a smart contract handles one while a central authority manages the other.
Custodial Loan (CeFi Loans)
In CeFi loans, the user information and the collateral are controlled by a centralized authority. The authority implements KYC before any trade can occur and trades cryptocurrencies and fiat currency with the custodian to secure the assets during this onboarding. The centralized loan is quite flexible when forming partnerships with different enterprises and drafting custom loan terms. Because CeFi loans are custodial loans, traders do not have access to the collateralized assets because the lender has access to the private keys.
Non-custodial Loan (DeFi Loans)
There is no centralized authority to oversee the terms of non-custodial DeFi loans. As a result, DeFi loans function as peer-to-peer loans, with borrowers connecting with lenders through a Defi crypto lending platform controlled by smart contracts based on blockchain. Also, if a trader takes out a DeFi crypto loan, they will have access to the private key to their assets unless they default on their crypto loan.
Benefits of Crypto Loan
No Credit History Review
A crypto loan does not require a credit check, making it an appealing choice for borrowers with poor credit records. The absence of a credit check is a significant advantage of crypto loans. You don't need a good credit score to get a crypto loan, and you don't have to be concerned about not getting one because you didn't pay your credit card debt once.
Fast Funding
Once approved, you can get your loan funds in as little as a few hours. In addition, unlike traditional lenders, who may take several days to deliver your money, crypto loans may immediately disburse payments.
Trustless
Because the process is managed using blockchain, lenders no longer have to trust the creditworthiness of borrowers because smart contracts are adequately structured to enforce liquidation in cases where borrowers default.
Passive Income
Many cryptocurrency exchanges offer interest accounts, which allow you to lend your digital assets for a high APY. Users can earn APY by storing their cryptocurrency in a vault on an exchange and earn passively, rather than managing the loan themselves.
Risk Involved with Crypto Loan
Volatility Risk
The prices of cryptocurrencies are volatile. As a borrower, you face volatility risk because the platform may liquidate some of your collateral due to market value declines. For example, if the value of your digital currency falls, your lender may require you to increase your collateral to keep the loan, a situation known as a margin call. Sometimes, your lender may sell some of your assets to reduce your loan-to-value (LTV) ratio.
Technological Risk
In the decentralized space, smart contracts pose a technological risk. To manage cryptocurrency loan transactions, computer code in smart contracts monitors cash flow within lending platforms. Smart contracts and their control functions are susceptible to hacking and security flaws.
Final Takeaway
Crypto loans have the potential to completely transform the financial sector because of their decentralized nature. As a result, crypto loans appear to be a realistic option due to many benefits, including cheap interest rates, the opportunity to choose your loan currency, the lack of a credit check, quick funding, and the chance to generate passive income on your crypto that would otherwise remain idle.
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