What Is a Crypto Loan?

While considered a relatively uncharted asset class, cryptocurrencies have a lot of potential. For most crypto newbies, cryptocurrency is synonymous with volatility, and they believe that HODLing is the only way to make a profit on the chain, but this isn’t true.

The world of DeFi and cryptocurrency exchanges provide crypto users with several opportunities to earn income on their funds. Inversely, crypto users also have the option of gaining access to liquidity when needed. The different ways of lending on the blockchain have varying levels of risk. This article will explore the different types of crypto loans, how they work, and their benefits. Finally, the risks of crypto lending and where to obtain a crypto loan will be explored.

What Is a Crypto Loan?

A crypto loan is the transfer of cryptocurrency in exchange for collateral, a fee, or interest on the received loan. The collateral rate or interest rate often varies on different platforms. Lending cryptocurrency is mostly the same as lending money from a bank because it involves borrowing money for some time to pay it back later.

However, crypto loans require less verification and rarely consider a crypto user’s credit score. With the world of DeFi, crypto users from around the globe have access to cryptocurrency loans.

Crypto loans can come from a centralized or decentralized exchange but the principle of borrowing and paying back after stays the same. On some platforms, users can stake their crypto to earn passive income. That staked crypto goes to a liquidity pool that finances the loans requested on that platform.

How Do Crypto Loans Work?

The mechanism behind a crypto loan differs depending on the platform on which the loan is requested. On a centralized exchange, the parties to a loan agreement are the centralized exchange and the borrower. On most centralized exchanges, crypto users must submit identity documents and complete a KYC verification before initiating a crypto loan.

Conversely, decentralized exchanges are open-source and permissionless; anybody with a cryptocurrency wallet can get a loan. Decentralized exchanges do not require you to submit any identity documents. Instead, to collect a crypto loan, a crypto user must submit their cryptocurrency as collateral. DEXs are managed by a decentralized community, so the three main elements of a crypto loan are the borrower, lender, and smart contract. A smart contract is an automated program that executes the terms of an agreement between the parties. As such, the process of lending and borrowing on DEXs is executed by these contracts.

Types of Crypto Loans

As mentioned earlier, the cryptocurrency industry gives users a wide range of options in terms of use cases for their cryptocurrency. Crypto loans thus come in various forms with different terms. The different types of crypto loans include:

Collateralized Loans

As the name suggests, collateralized loans require the borrower to provide collateral, often in the form of cryptocurrency, to get the loan. Most decentralized exchanges opt for the over-collateralization method, that is, depositing collateral at more than the value of the loan required. Over-collateralization is necessary to protect the users from liquidation in cases where there is a significant change in the market value of the deposited crypto.

MakerDAO is a decentralized exchange requiring users to deposit collateral in crypto like ETH to back their loans. On MakerDAO, the collateralization rate is 150%, so to obtain a loan of $50, a user must deposit $75.

Flash Loans

A flash loan is an open-source, unsecured loan often used by traders to benefit from arbitrage opportunities. There is no need to deposit collateral on a flash loan. Instead, users pay a minimal fee of about 0.09% of the loan. All flash loans are backed by smart contracts, which execute the transaction in seconds.

Uncollateralized Loans

Uncollateralized loans are very similar to traditional loans gotten from banks. They are mostly available on centralized exchanges. To obtain an uncollateralized loan, users must have an account on the exchange platform, pass a KYC verification and submit a loan application. The fees on uncollateralized loans are a little higher due to the lack of support of collateral.

What Are the Benefits of a Crypto Loan?

Over the past few years, the DeFi space has expanded, and crypto finance with it. Crypto loans have become a basic tool utilized by both traders and regular users. Some of the benefits of crypto loans include the following:

• Accessibility: In the absence of CeFi loans, DeFi platforms are set up to allow anyone across the globe with a cryptocurrency wallet to access funding. Some DeFi loaning transactions happen instantaneously, allowing the user to profit almost immediately. While other loans may take longer, the process is significantly less burdensome than traditional loans.

• Smart contracts: Smart contracts are no longer an upcoming technological feature in the blockchain space. These programs help to execute transactions seamlessly and quickly. Because the lending process is automated, users seldom worry about paying back the loan manually.

• Lower interest rate: In comparison to traditional financial services like credit cards, car loans, and mortgages, the interest rate on both DeFi and CeFi loans are significantly lesser. In contrast, the average credit holder pays over 14% interest, and lending rates on the blockchain fall between 3 and 8 percent.

• Permissionless: The world of DeFi allows anyone with a cryptocurrency wallet to access liquidity pools in almost any cryptocurrency. Tiring verification processes are eliminated and people can access crypto loans anytime and from anywhere in the world. Further, across both CeFi and DeFi platforms, most users remain faceless; as such, there is no such thing as discrimination based on gender, religion, or race.

• Transparency: All transactions on the blockchain are added to a distributed ledger that anyone can access. This reduces the burden of regulation because all transactions can be looked up and tracked.

• Quick access to funds: Unlike traditional loans, most crypto loans arrive in minutes. In the case of decentralized finance, users receive their funds in seconds.

What Are the Risks Involved in Crypto Loans?

Because deposits and loans rely on the constantly fluctuating cryptocurrency market, lending in the cryptocurrency space is risky for lenders and borrowers.

• Crypto Volatility and Liquidation: The crypto market is infamous for its volatility. When it comes to crypto loans, this shortcoming of the crypto market is much more apparent. Even though DeFi loans are collateralized, the occurrence of a bear market can cause sudden drops in crypto prices and trigger liquidation.

• Smart Contract Risk: Smart contracts are a technology essential to the workings of most DeFi platforms. Given that it is a feature of decentralized finance, which is community-owned, there may be occurrences of badly written smart contracts. Badly written code on smart contracts can cause loss of your collateral or loan or even put the loan transaction in danger.

Where Can I Get a Crypto Loan?

As mentioned earlier, there are two forms of crypto loans. Choosing between a CeFi and DeFi loan depends entirely on how much liquidity a user possesses and their reason for collecting the loan.

AAVE

A DeFi protocol on the Ethereum network, Aave is a mainstream protocol where users can both lend and borrow crypto. The liquidity protocol works on a collateral basis; to collect a loan, users need to deposit cryptocurrency through an Ethereum-backed wallet like MetaMask. AAVE also offers stable and variable interest rates and allows users to choose when lending money from the protocol.

Gate.io

Gate.io is a centralized cryptocurrency exchange platform that offers a crypto loan feature. The gate loan feature allows users to borrow cryptocurrency by depositing their crypto as collateral. On Gate, the interest rate is calculated hourly, and the feature supports up to 200 tokens. The deposited collateral can be in BTC, ETH, EOS, or GT, the platform’s native token. The default repayment period stands at 10 days, with a choice of renewal and daily interest rates as low as 0.01%.

Funds loaned can be stored in the user’s Spot Margin and Futures accounts and withdrawn at the user’s liberty.

How to Get a Crypto Loan on Gate.io

Step 1: Log in to your account on the Gate.io website, go to “Earn” and click on “Crypto Loan.”

Step 2: In the search bar on the right, search for the currency you want to borrow and select it. Choose an item from the list of available rates and click on “Borrow.”

Step 3: In the section “Borrow Amount”, input the volume you would like to borrow. Below it, select the currency you would like to use to deposit collateral and enter the collateral amount. Then click on “Confirm Loan.”

Step 4: To view your loan details and make repayments, scroll down to the bottom of the Crypto Loan page to find “Borrowing History.”

Conclusion

When used correctly, crypto loans have the potential to maximize profit for lenders. Investors can now harness the potential of their money by using it as collateral, giving HODLers another way to make passive income. Understanding the terms and using a reliable platform should be your top priority when managing your loans, whether you go for a DeFi or CeFi project. Crypto loans are an effective tool for those who are interested because blockchain technology has made it simpler than ever to access and provide credit.