Crypto lending has boomed over the last few years as interest in Decentralized Finance and cryptocurrencies hit all-time highs. Crypto loans have proven themselves to be a viable alternative to TradFi lending and in many ways offer superior opportunities for lenders and borrowers.
There are a variety of DeFi protocols that offer crypto loans with varying terms for borrowers and attractive yields for Liquidity Providers (LPs). As interest in DeFi and cryptocurrency continues to take off, prospective borrowers & lenders should be aware of all the benefits, risks, and opportunities that crypto loans can offer.
What is a Crypto Loan?
Crypto loans are a type of loan that use cryptocurrencies or NFTs as collateral for a loan. The terms of a loan can vary greatly depending on which lending platform you use. The majority of platforms or protocols that offer crypto loans typically focus on one thing: accessing liquidity without selling any crypto.
There are four notable aspects of crypto loans:
- Collateral token: which crypto can be used as collateral for a loan
- Borrowed token: what crypto can be borrowed (USDC, USDT, DAI, ETH)
- Loan-to-value ratio: the percent of crypto used as collateral versus the amount borrowed
- Loan fees: The interest paid for borrowing (APR), any applicable pool fees or transaction fees
Crypto loans are most useful for holders who believe their token will appreciate in the long term, as well as, investors who want to capitalize on time-sensitive trading or arbitrage opportunities.
The majority of crypto loans do not require a middleman. Peer-to-peer lending, through liquidity pools and order books, has made financing more accessible as lenders and borrowers find equilibrium in loan terms (interest rate, loan duration, and LTV). The immutable aspect of blockchain technology and the security that comes with smart contracts has drastically lowered processing times, lowered costs, and decreased settlement time.
If you want to learn more about decentralized, crypto loans with no early liquidation, check out this guide on Fixed Duration Loans.
Types of Crypto Loans
The most common types of crypto loans are:
Over-collateralized loans offer the most protection for lenders and are the most popular type of crypto loan. The loan-to-value ratio for the loan depends mostly on three things:
- Volatility of the underlying collateral value
- Loan duration
- Interest rate
Lenders may agree to riskier LTVs based on the above factors. The average LTV in crypto is about 50%. That means, for every $2 in collateral value an LP will lend out $1. This LTV protects the lender in the event of a black swan event, flash crash, or ongoing volatile market conditions. In this scenario, the crypto loan will stay in good health up to a 50% decrease in collateral value.
Under-collateralized loans are made possible using a combination of on-chain credit scores and borrowing history to prove creditworthiness. Though less common, under-collateralized loans are becoming more and more popular with the invention of on-chain credit scores through providers like Cred Protocol and Spectral Finance.
Centralized platforms like YouHodler, Nexo, and Binance also offer crypto loans. However, centralized companies can have more restrictions on borrower eligibility (including KYC & KYB), offer limited collateral options, and have strict standards on the use of funds.
For lenders and borrowers, over-collateralized loans from decentralized platforms are the most common choice.
How to Get a Crypto Loan?
Step 1: Choose a Lending Platform: First, do some research on which platform you’d like to use. Popular options include Aave, Compound, or Teller Protocol.
When selecting a lending platform, carefully examine and compare loan terms. While one platform might offer lower interest rates, another might offer greater flexibility in collateral options or offer other benefits such as: no early liquidation (Teller), no fixed duration (Aave), or collateral isolation (Silo).
It’s also a good idea to check loan activity and total value locked (TVL) on DeFi Llama or Dune Analytics when selecting a platform.
Step 2: Provide Collateral: After you’ve selected a lending platform, you should choose which crypto asset you’d like to use as collateral. Some platforms only allow a limited number of assets to be used as collateral, while others allow any asset.
The most common tokens used as collateral are:
Keep in mind that loan health factors and liquidation thresholds are extremely important to consider when choosing your collateral. All platforms have different liquidation procedures, but at the end of the day, you’re taking a crypto loan to access liquidity without selling your crypto asset, so the last thing you want to do is lose your collateral.
Step 3: Select Loan Terms: As mentioned above, loan terms can vary depending on the lending protocol or LP. As a borrower, you should shop around to find the best terms that fit your needs.
The most common loan terms to keep in mind are:
- Loan-to-value ratio - How much money you can borrow based on the value of your collateral
- Interest - The cost of borrowing
- Transaction Fees - Any additional pool fees, gas fees, or processing fees that will add to the overall borrowing cost
Loan terms can vary greatly. If a loan is high-risk, the terms will benefit the lender more. If a loan is “safer”, the loan terms will be decently favorable for both the borrower and the lender. Higher-risk loans unlock more opportunities for borrowers and offer a greater yield for lenders. Lower-risk loans offer safer opportunities for both borrowers and lenders.
If you want to lend stablecoins to real world businesses with cheaper fees on Polygon, check out Polytrade Finance.
Step 4: Receive Funds: Once you’ve decided on your loan terms, approve the collateral in your wallet of choice and sign the transaction. Make note of the repayment details in a safe place and set a reminder for any upcoming loan payments and/or set price alerts for your collateral (to make sure your loan stays in good health.)
In the majority of situations, you can use the borrowed funds for any purpose, either trading, buying an investment property, staking ETH, yield farming, investing, or covering real-life (IRL) expenses. Some platforms (like Aave), may require the borrower to take an active role throughout the loan process (ie adding more collateral if the collateral value decreases too much). While other platforms, (like Teller) offer a more passive borrowing experience due to no early liquidation.
Step 5: Repay the Loan: After you’ve utilized the loan (for either short or long-term purposes), make sure you close the loan by paying it back.
Regardless of which lending platform you used, failure to repay loans can negatively affect your on-chain credit score. Lower scores may impact your ability to take a loan in the future and can greatly increase the cost of borrowing (with higher interest rates and less favorable loan terms.)
Crypto Loan Risks
Any type of lending activity comes with inherent risks. Crypto loans, similar to TradFi loans, are not exempt.
The main risks for crypto loans are:
Liquidity: Many peer-to-peer (P2P) protocols use liquidity pools. If there is a decrease in available capital, liquidity pools can be quickly drained which leads to a “bank run” type of situation.
Volatility: Price fluctuations from market volatility can quickly shift the loan health or good standing of active loans. This can trigger liquidations and margin calls and can cause systemic risk to protocols themselves if the associated token/coin sees a dramatic change. (FTX)
Exploits: No centralized or decentralized platform is immune to hacks or contract vulnerabilities. There have been many notable incidents where hackers can steal platform or user funds. While many DeFi protocols are audited, that is not a guarantee that malicious actors can’t steal tokens or take advantage of bugs. Always do your own research (DYOR), when it comes to DeFi platforms.
Regulation: Crypto users are at the mercy of state and country restrictions. While many countries are crypto-friendly, new or updated regulations can occur rapidly, shifting the legality of both centralized and decentralized platforms and activities. Always research the current rules and restrictions within your residency before engaging in on-chain activities.
Crypto loans are a great option for holders with a long or short-term investing strategy. They offer competitive interest rates and flexible collateral options and typically don’t have restrictions on capital use. For crypto natives who have stacks of ETH, or O.G. Bitcoin Hodlers, crypto loans can be a very functional and reasonable method to unlock the value of your crypto without selling your tokens.
Borrowing crypto with a crypto loan or lending crypto as a liquidity provider (LP) can be a useful tool to unlock liquidity and opportunity.
Frequently Asked Questions
Can I get a crypto loan without collateral?
Yes, although it’s uncommon. If you have a good on-chain credit score and have a history of loan repayments across DeFi, you may be eligible for an uncollateralized loan through Masa.finance.
Can I use an NFT for a crypto loan?
Yes. There are many NFT lending protocols that accept NFTs as collateral. There can be more limitations with NFT lending ie: only certain NFTs can be used as collateral and more strict loan terms due to the volatility of NFTs. Any NFT (ERC721, ERC1155) can be used as collateral on Teller Protocol with no risk of early liquidation.
How do crypto loans work?
Most crypto loans are decentralized peer-to-peer loans through liquidity pools or order books. A borrower agrees to terms (either fixed or variable), and uses a crypto asset (ERC20, NFT) as collateral. Loan terms vary greatly depending on the DeFi protocol used.
Can anyone get a crypto loan?
Yes. Regardless of how much crypto you have, anyone can get a crypto loan. In most cases, there is no restriction on loan size or use of funds. Businesses, investors, or traders can utilize crypto loans for a variety of purposes.
Can I get a margin call in crypto?
Yes. Liquidations are possible with crypto loans and borrowers need to be aware of the margin, loan health, or repayment schedule of a loan in order to avoid loan default or liquidation.
What happens if you don’t pay back your crypto loan?
If you don’t pay back your loan, you will forfeit some or all of your collateral, and your on-chain credit score (that is attached to your crypto wallet) will be negatively affected.
How to calculate interest for a loan?
The easiest way to find out how much you’ll pay in interest for a loan by using a simple calculation.
Simple Interest = P × n × r / 100 × 1/365 P = loan amount n = number of days r = Annual interest rate (APR)
For example: Joe takes out a $100 USDC crypto loan at 10% APR, for 10 days. At the end of the 10 days, Joe needs to pay back $100.27.
What crypto can you borrow?
Typically, stablecoins (USDC, USDT, DAI) are the most common crypto to borrow. Lending protocols (like Teller) let users borrow any crypto asset. These borrowed tokens may be used for: staking, airdrops, yield farming, speculation, trading, and more.