Bitcoin-backed loan underline the growing synergy between the cryptocurrency market and the traditional finance sector. This type of loan allows Bitcoin holders to use their virtual assets to enjoy more liquidity without having to sell their holdings.
While offering a new way of interacting with cryptocurrency, Bitcoin-backed loan offer a new pathway to borrow and invest with virtual assets. The loan mostly operates in a system where there will be a market of lenders and borrowers.
The lenders are the liquidity providers as they deposit their Bitcoin into the platform to earn high passive returns. On the flip side, the borrowers enjoy access to the capital provided by the lenders and they won’t have to liquidate their crypto holding to apply for the loan.
Instead, the borrowers often provide collateral that can come in any other form of cryptocurrency. Most platforms allow borrowers to secure loans in stablecoins and fiat.
In the crypto market today, Bitcoin-backed loans are popular and accessible due to their easy application process. Speaking of their accessibility, Bitcoin-backed loans are riding on the support of the growing advancement of decentralized finance (DeFi) platforms.
The advancement of DeFi led to the introduction of smart contracts that help automate the loan application and approval process. With smart contracts, there is no need for third parties which helps boost the transparency and security of the lending procedure.
Benefits And Shortcomings of Bitcoin-backed Loan
One of the key strengths of Bitcoin-backed loan is how it allows traders to keep their BTC while having access to the loan. Consequently, it allows them to retain ownership of their virtual assets, aiding them to gain more profit from future price increases.
Likewise, the application and approval process for a Bitcoin-backed loan is faster than a traditional loan. Through its quick approval processes, crypto loans give investors an advantage in a situation where they need access to liquidity to take advantage of a market opportunity.
Meanwhile, for the lender, Bitcoin-backed loan is an avenue for investors to earn mouth-watering interest rates. In most cases, lending cryptocurrency on top platforms comes with higher yields and returns compared to traditional savings accounts.
Despite having their upsides, Bitcoin-backed loans also has their shortcomings too. One of the downsides of this type of loan is the volatility of the cryptocurrency market.
The prices of assets can easily fluctuate in a volatile market. By that, the borrower of a Bitcoin-backed loan faces the liquidation of their collateralized assets most especially if the value declines below a certain benchmark.
Additionally, the fluctuations in the prices of virtual assets can as well affect loan servicing as it mandates that borrowers must develop risk management plans. Meanwhile, don’t forget that the interest rates on Bitcoin-backed loans are mostly subject to market volatility.
With such a method, borrowers are exposed to high borrowing costs; in a situation where their interest rate increases during the loan period. The change in interest rates can impact the affordability of the loan and also affect the financial stability of the borrower.
How to get a Bitcoin-backed loan
First, before applying for a Bitcoin-backed loan, the borrower must understand the collateral management system, loan requirements, potential default consequences, and repayment options. After confirming the aforementioned details, the borrower will then make an official application and provide details on their collateral, and indicate the loan amount.
Moving forward, the borrower must then deposit the stipulated collateral into an address put up by the lending outlet. After depositing, the lending platform will then assess the value of the collateral and decide the LTV ratio.
Don’t forget that it is the LTV ratio that determines the amount of loan the borrower will receive. For instance, if the LTV ratio is 50% and a borrower deposited $1,000, in return, the receiver of the loan can borrow about $500.
Thereafter, the platform will initiate the disbursement process and make payment to the borrower’s desired asset. Nevertheless, the borrower will be mandated to pay interest according to the agreement with the lending platform. The receiver of the loan must do well to keep up with the repayment plan to avoid losing their collateral.
Conclusion
Bitcoin-backed loans are struggling to gain due relevance due to the regulatory uncertainty the virtual assets industry is facing. The unclear guidelines on cryptocurrency have left borrowers with the huge task of staying informed about the latest developments to mitigate any risks.
Also, since most virtual assets are uninsured unlike what’s obtainable in the traditional finance space, both borrowers and lenders face the risk of losing their funds in a situation where the platform suffers a hack or is battling insolvency. Despite the dangers, Bitcoin-backed loan still present the best opportunity for investors to enjoy swift and easy access to liquidity.